The more I look at fixed protection, the more I see the words “disaster waiting to happen” written all over it.
Pension reform is doing its part. The potential for employees to lose £300,000 worth of tax-advantaged pension saving through being automatically enrolled into their company scheme and then failing to opt out in time is just one factor. So draconian is the penalty for those who get it wrong that some are expecting HR directors to take the opt-out form into their chief exec’s office and refuse to leave until he or she has signed it. I have even heard one adviser recommending that HR directors break the law and not enrol their senior executives at all, on the basis the penalty for doing so is nothing when compared with the six-figure loss that could be incurred by someone losing fixed protection. When auto-enrolment comes in pension professionals will be walking on eggshells and some will crack.
For other high-earners in final-salary schemes, including senior civil servants, doctors and dentists who have historically felt they can proceed through life without the benefits of financial advice, matters are considerably more complicated.
The criteria for losing fixed protection for defined-contribution savers are clear – pay a penny in after claiming it and you lose it – the defined-benefit arena offers a more nebulous environment, which arguably makes it easier to get it wrong.
The rules provide that increases in DB plans will not breach the fixed protection if they fall within the “relevant percentage”, which is either what was in the scheme rules or CPI for the previous year to September. That means next year’s relevant percentage, the amount by which DB plans can increase, will be capped at this September’s annual CPI.
For senior employees in the happy position of needing to claim fixed protection as a matter of urgency, this offers a crumb of hope they could live to regret eating. Given the pay freeze in many organisations and presuming August’s 4.5 per cent CPI figure is replicated, an extra year’s accrual will not be enough to breach the lifetime allowance, so leaving the scheme to preserve fixed protection will not be necessary.
But how many people who follow such a strategy will get it right year after year, through pay rises and incremental promotions?
Fixed protection is also raising questions at the other end of the scale. Consider a 40-year-old with a pension of £750,000 today. In 20 years time, assuming net returns of 5 per cent a year, that fund will grow to more than £2m, breaching the lifetime allowance by £200,000 if the investor goes for fixed protection, and by £500,000 if not, with 55 per cent tax payable on the excess.
Claiming fixed protection is a no brainer, as you lose nothing by doing so. But the act of having to decide whether to or not before next April will make even investors in their 40s who have less than half the current lifetime allowance face up to the question of whether they should still be putting more money in their pension.
Given opposition to fatcat pensions, and the support of thinkers such as Michael Johnson of the Centre for Policy Studies for a redistribution of higher-rate tax relief, it is in no way certain the lifetime allowance is going to be increased any time soon.
For advisers, crystal-ball gazing is a nightmare. But for some clients, opting for fixed protection makes it a necessity.
John Greenwood is editor of Corporate Adviser