As the end of the tax year approaches, our thoughts turn to how to ensure we don’t pay any more income tax than is necessary. Such planning will usually involve your pension however, this year there are some important changes and factors that you need to take into account.
The implication of these changes is that far from not saving enough for your pension as the recent press headlines have suggested, you could in fact be saving too much. Furthermore if you don’t
take action before 5 April 2014 then you could find yourself significantly worse off than you had expected.
With effect from the 6th April 2014 the lifetime allowance (LTA) for pension purposes will be reduced from £1.5m to £1.25m. The way that tax on pensions works is you can save as much as you want towards you pension and the LTA is a limit on the amount of your pension savings that benefit from tax relief. The LTA therefore is not a contribution limit but how much you can have in your pension when you come to retire. If you save over and above the LTA limit then you end up paying a tax charge on the difference. The upcoming reduction in the LTA means there is likely to be a substantial tax bill for those with pension funds either already in excess of, or likely to be in excess of the new lower limit by the time they retire.
The charge that applies to pension benefits in excess of the LTA is 55% on benefits taken as a lump sum (PCLS), or 25% on benefits taken as income (which are also subject to income tax in the normal way). The upcoming reduction in the LTA means more people will now be drawn into this charge regime.
For starters don’t panic, all is not lost. Those of you hoping to preserve your previous higher allowance have two protection options available to you: 'fixed protection 2014' and 'individual protection'. The best option for your individual circumstances could be to select either one, a combination of both of them, or neither.
Fixed protection 2014 (FP14) allows you to keep the £1.5m LTA beyond 2014 (until a time, if ever, that the standard LTA increases above this). It is available to anyone who doesn't have any of the earlier forms of protection (such as enhanced, primary or fixed protection 2012). But there is a trade-off:
This means that in order to retain your FP14, you will likely have to opt out of any final salary pensions schemes and cease all contributions to personal or defined contribution pension schemes. Of note, it is the member's responsibility to tell HM Revenue & Customs (HMRC) if fixed protection is lost. Failure to do this within 90 days can result in penalties.
Fixed protection normally continues if pension benefits are transferred to another registered pension scheme. However, you need to check that this will be a permitted transfer to ensure the fixed protection isn’t lost as a consequence.
This is particularly relevant when pension rights are being transferred as a result of pension sharing. If you have fixed protection, then receiving pension credit rights could cause it to be lost. If the pension credit is paid from the original member's pension into an existing pension arrangement, the recipient's fixed protection isn't affected; but if a new arrangement is set up to accept the pension credit directly from the original member's pension, then the recipient will lose their fixed protection.
Individual protection 2014 (IP14) is available if the value of your total pension benefits on 5 April 2014 is more than £1.25m. This value, up to a maximum of £1.5m, will become your personalised LTA. This means that when you draw down any benefits, they will be tested against your personalised LTA, unless your standard LTA (the value your pension benefits can build up to before the lifetime allowance charge is applied) has increased above this level. Benefits that are above this allowance will be subject to the new lifetime allowance charge in the normal way.
The key difference from fixed protection is that your protection will not be lost if further contributions are made to money purchase schemes or if benefit accrual (accumulation) occurs under defined benefit schemes. New schemes can also be joined without fear of losing protection.
HMRC are currently consulting on this arrangement with the final legislation expected to appear in the Finance Bill 2014 which is being published on 27 March 2014.
Critically, this protection comes without the trade-off needed for fixed protection. So if you have this type of protection you can keep funding your pension after April 2014 (or, perhaps more importantly, continue to enjoy pension funding from your employer). If you are already above £1.5m by April 2014, then individual protection gives you a better deal than fixed – a £1.5m LTA with no requirement to give up on future pension saving.
It should also be noted that there is no downside to registering for individual protection, so anyone eligible may wish to consider applying, since they will get an increased LTA with no trade-off. IP14 can also be registered alongside FP12 or FP14 and therefore provides a safety net to fall back on if fixed protection is lost.
Applications for IP14 will be allowed until 5 April 2017. This will allow time for benefit values at 5 April 2014 to be calculated to establish your personal LTA.
The Annual Allowance will be reduced on the 6th of April 2014 from £50,000 to £40,000. If you are in a defined benefit scheme whose benefit accrual has not previously caused them to breach the annual allowance, you may now find that it does. It means you might need to think about what action to take to avoid this.
You may want to look at making one final pension contribution before applying for FP14 or IP14. Of note, careful planning means it is still possible to make a final gross pension contribution of up to £240,000.
For more information, please contact David Parks at dparks@pqr.uk.com or on 020 7630 0000. David is the Employee Benefit Consultant at PQR Financial Planning, an independent financial planning firm with Chartered status.
The content of this post is up to date and relevant as at 07/03/2014.
While every care has been made in preparing these articles to ensure their accuracy, they cannot be considered to be exhaustive and are no substitute for detailed examination of the relevant statutes, cases and other material when advising clients on particular matters. The opinions expressed herein represent the view of the authors at the time of preparation and should not be interpreted as advice. No responsibility can be accepted either by PQR Financial Planning or any of the authors and their representatives for any loss occasioned to any person acting or refraining to act in reliance on anything contained in these articles. No part of any of the above articles may be reproduced in any form without the prior written permission of the Author.
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