The Changing Landscape of Pensions

The Lifetime Allowance & Excess Charges

The start of the 2016/17 tax year saw further changes brought in affecting pension legislation.  A reduction to the Lifetime Allowance (LTA) was applied meaning that it now stands at £1m.  It was not so long ago that the LTA was £1.8m, but we have now seen £800,000 wiped off this allowance in the last 5 years alone!

A million pounds still seems like a lot of money, but as individuals continue to contribute into pensions whether that be via their employer, themselves or a combination of both, and underlying fund values grow, one thing is for sure, the gap between pension values and the LTA is narrowing quicker now than it ever has before, and there are chances that more and more people will get caught out unless they take action and receive the right advice not just now, but as an ongoing financial planning subject matter.

Here at Robertson Baxter, as Paraplanners (or Technical Assistants as we are referred to here) we have been tasked with going through our client base and highlighting those individuals who may become affected by the change in the LTA, not necessarily immediately, but also looking at those who still have a few years until retirement, but contribute or have sizable fund values that via growth will edge them ever closer to that magic £1m figure.

As these clients were highlighted it soon became apparent that they all had one thing in common, and that was their main concern when this issue was brought to their attention… What happens if I breach the LTA?

The charge for breaching the LTA is known as the ”˜excess charge’, and this can be applied in two forms, but over three different trigger points.  The two key figures are the charge rates than can apply, 55% or 25%.  Both reasonable chunks, and whether it be 25% or 55%, I’m sure if asked a client would not want to lose either one of those portions of their pension savings to the tax man!  But how are they applied in practice:

Ӣ The 55% charge is only payable pre 75, and out of all the articles and press releases regarding pension change legislation, the pre 75 element of the 55% charge is never well publicised and I have only come across this mentioned a couple of times. The 55% is taken on the value of the pension in excess of the LTA if the excess is taken as a lump sum.

”¢ The 25% charge is taken where the excess pension savings over the LTA is taken as additional income. The charge is applied at the outset, so 25% would be taken off the top leaving the remaining fund to be allocated to drawdown.  It is also worth noting that the fund will then be taxed again on the way out of the pension in the hands of the policy holder in the form of income tax in line with their marginal rate.  This can be viewed as a double tax charge and depending on the marginal rate of the individual concerned, they could end up paying in excess of the higher 55% charge had they taken the excess as a lump sum.

For example, an additional rate tax payer pays income tax at 45%.  Should they have a value over the LTA of £100,000 and wish to take this as additional income, they will have to pay £25,000 up front (25% excess charge) and then a further 45% income tax on the residual fund of £75,000.  In some cases they may have been better paying the 55% charge and taking the lump sum option and drawing income off the lump sum as and when needed.

”¢ Irrespective of whether an individual has crystallised their pension pot already, most people are subject to a second LTA test at age 75 unless they are fully crystallised and only receive annuity income. The test works as normal on uncrystallised pots, and only the growth achieved on already crystallised funds is tested at this same point.  Any excess over the LTA is subject to a 25% charge, not the 55% charge which is a common misunderstanding.

At Robertson Baxter we as Technical Assistants / Paraplanners are just as responsible as the advisers for keeping abreast of such changes and the implications, if not more so, as we are the one writing the recommendation reports that contain this level of information for the clients.  We run quarterly CPD sessions on topical matters such as this, and with there only being three of us within our team, we each take it in turn in hosting these sessions for the advisers, and the feedback we get is great.

Action can be taken to help those clients who are concerned about breaching the LTA.  Applications for Fixed and Individual Protection 2016 (FP & IP16) are now open and can be applied for online via HMRC.  Briefly FP & IP16 are defined as:

”¢ Fixed Protection 2016– Individuals will retain a £1.25million LTA.  This is based on the condition that contributions to all Defined Contribution schemes need to have ceased by 5th April 2016. This also applies to benefit accrual within Defined Benefit schemes.

”¢ Individual Protection 2016 – Provides a personal LTA between £1m and £1.25m (capped at £1.25m), based on the collective value of a client’s pension holdings at 5th April 2016.

One of the main differences between FP16 and IP16 is, with IP16 pension savings can continue, with FP16 contributions must have ceased prior to the 5th April 2016.

Make sure conversations are taking place with your clients.  Be proactive, don’t leave it until it’s too late.  Applying for protection is quick, easy and free, and could save the client having a nasty and unwelcome surprise as they embark on what should be the longest and most enjoyable holiday of their lives.

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