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Crystallised clear

As my fund has fallen way below the A-Day value of 1.7m and is now worth around 1.35m, admittedly through following our agreed aggressive risk strategy, should I pay more into the pension now to benefit from tax relief and build up the funds again?

This was an interesting question raised by my client Robert. Shortly after A-Day, we applied for both primary and enhanced protection.

Primary protection gave protection at 117 per cent of prevailing lifetime allowance. If more is paid into Robert’s pension the enhanced protection is lost but primary is not.

The lifetime allowance has for now been capped from 2010 at 1.8m until the 2015/16 tax year when it will be reviewed.

If I assume Robert (now 57) retires at age 60 then the rolled-forward figures at 5 per cent per annum show a pension value then of 1.56m.

Assuming 25 per cent is taken as tax-free cash, that is, around 390,000 from the pension. This leaves around 1.17m to provide income.

Assuming Government Actuary’s Department rates of 7 per cent (the new GAD rates were not known at time of writing) the maximum income rates would be 82,000 a year.

At this stage, Robert has no problems as the pension fund is below the then lifetime allowance of 1.8m.

I explain to Robert that the critical points are what are termed benefit-crystallisation events. One is when Robert draws down benefits. The next benefit-crystallisation event occurs when he is 75 and decisions have to be made as to whether to buy an annuity or go into alternatively secured income.

If we assume 82,000 continues to be taken out of the pension then this would leave a residual fund of around 574,000 at 75.

If we assume enhanced protection is broken and Robert falls back on primary protection, then the calculations are as follows:

Robert’s primary protection is 117 per cent of the lifetime allowance. This means he has a personal lifetime allowance of 2.1m (117 per cent of 1.8m). At 60, he used up 1.56m of 2.1m, that is, around 74 per cent of his lifetime allowance. This leaves 26 per cent or 546,000 that can be used at age 75, assuming the 1.8m does not rise.

With the assumptions I have made, this leaves a sum of around 574,000 in the pension at age 75. It is all uncannily close.

So the simple question has produced a long answer. We have uncertainties as the lifetime limit could increase in the future, in which case the margins would not be so close.

We need to remember that the figures I have worked out are to show if Robert lost enhanced protection how closely he could steer to the lifetime limit and these calculations have not taken into account further contributions that would clearly raise the amounts and could threaten the breaches of the lifetime limit.

We need also to bear in mind that, once in unsecured income, the levels of permitted income are assessed every five years. What this means is that Robert would not be allowed to deplete the fund too much so the fund could be greater at age 75 than I have illustrated.

The answer could be to wait until Robert is nearer retirement, given that the date of his retirement is not determined, and see how the land lies then.

Amanda Davidson is a director of Baigrie Davies

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