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Once in a lifetime

Dentons Pension Management director of technical services Martin Tilley says fixed protection may be needed after lifetime allowance changes

There is a general misconception by pension savers that there is a limit on the amount that can be saved within a pension. This is, of course, not the case and in fact there is no limit on the amount an individual can save. The misconception comes from the fact changes have been made to the lifetime allowance.

The lifetime allowance was introduced in 2006 and provided each individual with an uppermost limit of the amount that could be saved within a registered pension scheme during their lifetime without incurring tax charges.

There have been changes to the lifetime allowance since 2006 and there is a further reduction for individuals saving into a pension that comes into effect on April 6, 2012, with the maximum amount benefiting from tax relief dropping from £1.8m to £1.5m.

Individuals may be subject to a tax charge of up to 55 per cent on the excess over £1.5m.

We have seen a marked increase in the number of technical queries coming from advisers regarding this reduction.

The majority of these have been from advisers wishing to discuss the accumulation phase of their client’s pension and the issues surrounding the building up of big pension funds.

“Advisers have only until April 5 to get their fixed protection applications to HMRC so the clock is ticking”

For those advisers with clients in the accumulation stage, discussions are centred on the potential for future contributions, the reduction in the lifetime allowance, its potential impact on them and whether fixed protection should be considered.

For advisers, there are a number of occasions (benefit crystallisation events or BCEs) when the pension scheme administrator needs to check if the client has exceeded the lifetime allowance.

There are 11 BCEs and most of these occur at the point that the client takes benefits. In addition, HMRC also states that the lifetime allowance is tested when:

  • The client reaches age 75
  • There is a transfer to certain overseas schemes
  • Certain lump-sum death benefits are paid on the death of the member
  • Some lump sums when paid in error

At a BCE, the value of the individual’s pension savings crystallising at that time is measured and if the current BCE takes the individual over their available lifetime allowance or if the individual has already exceeded their lifetime allowance, a lifetime allowance charge arises on all or some of the crystallised value of the benefits caught by the event.

The amount of tax is governed by the size and method of withdrawal of the excess. In most cases, however, 55 per cent should be expected.

The lifetime allowance is very complex and it is easy for advisers to focus on those in the accumulation phase and overlook those clients that are already receiving income.

Individuals who have drawn benefits since A-Day (April 6, 2006, when sweeping changes were made to personal and workplace pensions to make saving in pension schemes more flexible) are re-tested at age 75 against the lifetime allowance.

Some who have experienced good investment performance might have a problem, particularly with the new lower level of lifetime allowance that may well be lower than the allowance that was in force when benefits first came into payment.

This is a strange situation, where good performance can be a bad thing for a client. It may also be a reason to modify the client’s investment portfolio since if positive investment performance brings the potential of a large tax charge, it might be wise to move into lowerrisk assets, with less potential for investment gains.

Others who have elected not to draw income at all may also be affected since without withdrawals, it will be all the more easy to exceed the new maximums and thus cause a charge.

I would suggest advisers would be wise to review any post-A-Day vested clients to see whether or not fixed protection should be applied for as this will give them protection up to the current lifetime allowance of £1.8m, even if this is just a precaution.

Applying for fixed protection is relatively simple and costs very little but could save clients a large amount of tax.

Time should not be wasted, though, as advisers looking to review their clients in this situation have only until April 5 to get the applications to HMRC so the clock is ticking.

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