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Case Study: The cost of not making contributions

Managing the process of advising younger clients of the need to apply for fixed protection and cease further pension contributions.

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The problem: In the process of advising a company on auto-enrolment, it has become clear that a client who is many years away from retirement is at risk of breaking the new, reduced lifetime allowance. How do you deal with a client who thinks he should still be paying as much into a pension as he can?

One of Andrew’s clients is causing him something of an issue. David is the chief executive of a design company for which Andrew has been given the brief to sort out both individual and workplace pensions. This meant advising the company on its auto enrolment strategy. As an employer with between 160 – 249 employees, the staging date for their auto enrolment process was set for 1 April 2014.

Andrew is keen to make it a success, but he has encountered some lethargy in getting buy-in from the management. And having looked at the details of David’s pension, another issue threatens to undo a lot of Andrew’s good work.

David has a Sipp with a commercial property in it, which is leased back to the company. The value is approximately £400,000 with rent of £42,000 p.a. (£3,500 p.m.). There is also about £100,000 in trustee investments that sweep up the excess funds when the rent was paid in.

David is 45 and wants to retire at 65, so Andrew is assuming a 20-year investment period and had a feeling that, mathematically, this could mean getting close to the lifetime allowance. He did the calculation (£400,000 + £100,000 + £3,500 p.m. over 20 years) and was surprised to see that, even if there was no investment return, the fund would exceed the proposed new LTA of £1.25m, and that just a 1 per cent p.a. return would take him very close to £1.5m.

Andrew had had these figures done as part of an exercise to consider protection issues pending the LTA reduction and the more he looked at the numbers the more concerned he became.

Some of his best pension clients had followed his advice over the years and now had a reasonable fund value with a few years to go to retirement. Suddenly, they were faced with the possibility of opting for fixed protection to protect an LTA of £1.5m but with the condition that they would have to cease making contributions.

It was this that gave Andrew a real problem – could he really advise a client with perhaps £500,000 to stop paying pension contributions? If the investment return was 1 per cent then this should be achievable over the term, but at what level would the investment problem become an issue – 4 per cent p.a.? 5 per cent p.a.? And surely the LTA would have to change again in the future, purely to counter the effect of inflation over the time period – for David we were talking at least 20 years.

Andrew also has a problem with telling clients who were at their peak ability to pay pension contributions, that they couldn’t!

Andrew has been in this industry long enough to know that the legislation could change in the future, and that his fixed protection clients could potentially end up with some form of disadvantage.

He had always worked to the rule that you can only advise based on the prevailing legislation at the date you give the advice. (Although he had been caught out before – when the annual allowance had previously reached £255,000 p.a. he had advised several clients to defer making contributions for a couple of years so they could catch up in the future. Unfortunately, the fall to an annual allowance of £50,000 had intervened and although the carry forward rules had helped to mitigate this, a couple of his clients had lost out.)

The alternative is to forget the constraints of the LTA and to carry on paying contributions and taking as much tax relief as possible, then paying the tax on the excess.

This would be a real option for those of Andrew’s clients who were in DB schemes where there was no chance of an employer redirecting pension contributions as another form of remuneration – why not take 45 per cent of something that you would have not got anyway?

Then there is the question of ongoing reviews. How could he justify charging for an annual review on pensions when the fund just had to accumulate? What value could he add?

In this case there is the issue of the commercial property. They had got a good deal on it at purchase and it had served the company well. Andrew would have the restructuring conversation and thinks that the practicalities would outweigh any tax charge.

Aside from the details of David’s individual arrangements, there is one final conceptual problem for Andrew – how was he going to get real enthusiasm and cooperation from the management for the auto-enrolment exercise when David, and possibly some of the other senior executives, are being advised that they should not make any further contributions? 2014 would hold some real fun for Andrew.

Mike Morrison is head of platform technical at AJ Bell

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