In a previous article, I raised the question of whether a section 32 contract is the ideal product to be in before A-Day (Money Marketing, July 29). The argument went that a blanket decision to move all individuals into a section 32 is not the panacea it has been made out to be. Rather than having discussions as to which section 32 has the most bells and whistles, perhaps more thought needs to be given to whether section 32s are actually appropriate vehicles in the first place, as the legislation stands at the moment.
This time, I want to look at a decision that is just as important as the right vehicle for an existing preA-Day pension fund – where future contributions will be allocated.
The area of legislation previously highlighted was the cash protection which applies if the member is entitled to more than 25 per cent of the funds on A-Day and is not seeking pension protection.
In these cases, preA-Day lump sum rights will be indexed in parallel with the increase in the standard lifetime allowance while post-A-Day pensionable service generates a tax-free lump sum of 25 per cent of post-A-Day accrual.
In a money-purchase scheme, post-A-Day accrual means growth as a result of further contributions.
Peter has an entitlement to a lump sum on A-Day of £100,000 from a pension fund worth £200,000. He makes further contributions after A-Day and when he finally vests or crystallises his benefits, his fund has grown to £400,000 and the lifetime allowance has grown to £2m.
Cash = (£100,000 x 2/1.5) + (£400,000 – (£200,000 x 2/1.5))/4 = £133,333 + (£400,000 – £266,667)/4
= £133,333 + (£133,333)/4
= £133,333 + £33,333
Because the calculation of post-A-Day accrual is a function of the funds on vesting compared with the funds on A-Day adjusted in line with the increase in the standard lifetime allowance (and is not strictly related to the proceeds of new money invested after A-Day), this means that it is possible to achieve postA-Day accrual by contributing as little as £1.
So we could have the situation where Peter makes no further contributions to his fund after A-Day and just before vesting is told his fund is now worth £399,999. If he just takes benefits, he will be entitled to £133,333 as tax-free cash. However, if he contributes just £1, he would be able to take an extra £33,333 as tax-free cash.
The plan into which future contributions will be invested is also important as, unfortunately, it is possible that the additional cash rights from post-A-Day accrual could be negative, resulting in a reduction in cash entitlement.
Ian has an entitlement to a lump sum on A-Day of £100,000 from a pension fund worth £200,000. When he finally vests or crystallises his benefits, his fund has only grown to £250,000 and the lifetime allowance has grown to £2m.
Cash = (£100,000 x 2/1.5) + (£250,000 – (£200,000 x 2/1.5))/4 = £133,333 + (£250,000 – £266,667)/4
= £133,333 + (- £16,667)/4
= £133,333 – £4,167
Although, in this example, the new investment has brought a negative result, giving a reduced cash entitlement, if the new investment had instead been placed in a different plan, there would have been no reduction to the pre-A-Day cash figure of £133,333.
The final cash entitlement would have been £133,333 plus 25 per cent of whatever is the fund value in the new plan.
It is imperative, therefore, that some thought is given as to where any further pension contributions are placed. It would seem that the best solution would be to put new contributions into a new plan but ensure that existing pre-A-Day funds are in a plan that can accept contributions after A-Day.
The vehicle for these pre-A-Day funds could not, of course, be a section 32. It is not certain that the Government intends for poor growth on future contributions to have this effect so we may see some future amendments.
Watch this space.