In the final Budget of the Coalition Government, George Osbourne announced the lifetime allowance would be reduced to £1 million from April 2016. We expect to see more about this change in the Budget on 8 July, including details of the protections people can apply for to safeguard the value of their pension savings.
Cutting the lifetime allowance further to 66% of its original starting level will create major problems for many middle income families that have saved diligently for retirement. We believe the lifetime allowance charge is an insidious tax. People save in good faith and are being encouraged to do so, and yet if they make good investment choices and achieve better than expected growth they could ultimately pay a heavy price. But they won’t necessarily see it coming.
Should people protect their pension savings?
A new set of protections will help people guard against the lifetime allowance. But deciding whether they need to take out fixed or individual protection can be a tricky decision. Even if an individual’s pension fund is currently some way below £1 million, good investment returns over several years could easily push them over the lifetime allowance edge by retirement as the table below shows.
One thing for sure is people will need regulated advice to help them make these judgements
Fund needed to exceed lifetime allowance at age 65* (assuming no further contributions are paid) | ||
Age in 2016 | Pension fund in 2016 | Lifetime allowance at age 65 |
55 | £667,334 | £1,195,093 (in 2026) |
50 | £550,572 | £1,319,479 (in 2031) |
45 | £454,241 | £1,456,811 (in 2036) |
*Assuming 6% growth (net of charges), and lifetime allowance increases in line with CPI from 2018 onwards, and assume CPI of 2% a year. No further contributions paid.
Checklist for trustees
Those that have a deferred defined benefit (final salary) pension and are now in a defined contribution scheme are particularly vulnerable to the hidden risks of a lifetime allowance charge. Defined benefit pensions will be valued 20 times the gross annual pension, but as pensions in deferment are subject to ongoing revaluation deferred defined benefit members could be unwittingly overfunding their defined contribution pension.
If employers and trustees allow defined contribution members to carry on paying higher contributions and by doing so they lose 55% of the excess, having got only 20% or 40% tax relief on their input, they will naturally be very upset that nobody told them they might be doing the wrong thing.
Employers and trustees have to think about what action they need to take to help their members before April. Their checklist should include:
o Offering members a pension ‘wealth check’ to give them the clarity needed to decide whether to apply for protection.
o Considering what alternative financial arrangements (if any) they are going to offer members who decide to stop contributing
o How to communicate these big changes to their members.
Example – Hazel
Hazel is 50 and has a deferred pension worth £30,000 in 2016, and a defined contribution pension valued at £250,000. She and her employer contribute 20% of her salary to her pension each year. Her salary is currently £80,000.
Her pension benefits are collectively valued at £850,000 (£30,000 x 20 + £250,000) for the purposes of comparing against the lifetime allowance.
The table below shows how Hazel’s pension benefits might grow if she continues saving to her pension and if she stops her pension savings. The table shows Hazel would become liable to a lifetime allowance charge at age 55 if she continues her pension savings. If she stops her pension contributions now, she would become liable to a charge at age 61.
The table also demonstrates how quickly the lifetime allowance charge can escalate with reasonable investment growth.
Age | Value of pension savings if continue to contribute (LTA charge at 55%)** | Value of pension savings if stop contributing (LTA charge at 55%)** | Lifetime allowance (assuming linked to CPI from 2018)** |
50 | £ 850,000 | £ 850,000 | £ 1,000,000 |
51 | £ 893,480 | £ 877,000 | £ 1,000,000 |
52 | £ 939,583 | £ 905,140 | £ 1,020,000 |
53 | £ 988,472 | £ 934,479 | £ 1,040,400 |
54 | £ 1,040,320 | £ 965,079 | £ 1,061,208 |
55 | £ 1,095,309 (£12,877) | £ 997,005 | £ 1,082,432 |
56 | £ 1,153,634 (£49,553) | £ 1,030,327 | £ 1,104,081 |
57 | £ 1,215,502 (£89,340) | £ 1,065,119 | £ 1,126,162 |
58 | £ 1,281,132 (£132,446) | £ 1,101,458 | £ 1,148,686 |
59 | £ 1,350,757 (£179,098) | £ 1,139,425 | £ 1,171,659 |
60 | £ 1,424,623 (£229,530) | £ 1,179,109 | £ 1,195,093 |
61 | £ 1,502,992 (£283,998) | £ 1,220,599 (£1,565) | £ 1,218,994 |
62 | £ 1,586,143 (£342,769) | £ 1,263,994 (£20,620) | £ 1,243,374 |
63 | £ 1,674,370 (£406,128) | £ 1,309,396 (£41,154) | £ 1,268,242 |
64 | £ 1,767,987 (££474,380) | £ 1,356,913 (£63,306) | £ 1,293,607 |
65 | £ 1,867,326 (£547,847) | £ 1,406,661 (£81,182) | £ 1,319,479 |
**Assuming defined benefit pension increases by CPI at 2% a year, 6% net growth on defined contribution savings and salary increases by 3% a year.
Adviser support..
In the coming weeks, we will be issuing an LTA technical guide and factsheets, including the various protections and financial planning angles. We will also be hosting two webinars on this complex area. If you are not registered to receive our updates, please email intelligentpensions@ipifa.com or watch this space!
