The country’s highest earners should be taking steps now to prepare for the forthcoming cut in the pension lifetime allowance.
In recent years this threshold has fallen from £1.8 million and is set to drop further to £1.25 million with effect from the beginning of the next tax year. Individuals with large pension pots need to be aware of the two ways in which they can avoid a significant tax charge being levied on any benefits in excess of this new threshold.
Those affected will be faced with a choice of opting for either ‘fixed protection’ or ‘individual protection.’ Although the precise details of the latter are still in the process of being finalised, we already have a good idea of the differences between them.
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The lifetime allowance is the maximum amount of tax relievable pension savings that can be built up during your lifetime. In the current tax year the allowance is set at £1.5 million but this will drop to £1.25 million from April 6 2014.
Any breach of the threshold will give rise to a lifetime allowance charge and the rate at which this is levied will depend on how the excess is paid. A lump sum will be payable net of tax at 55 per cent whilst those opting for income will be taxed at 25 per cent.
Given that the Government has already made quite significant cuts to the lifetime allowance over the past few years, a further reduction was unexpected. Although only a minority of people are likely to be affected, the estimated 360,000 savers with benefits in excess of the new threshold should understand the courses of action available to them.
The decision as to whether somebody should opt for fixed or individual protection will depend on their circumstances. It may even be appropriate for some people to apply for both.
It is worth saying at outset that the fixed protection which accompanies the forthcoming cut to the lifetime allowance, is different to the one introduced when the threshold dropped to £1.5 million two years ago. Indeed individuals who have any of the transitional protection from the 2012/2013 tax year (primary, enhanced or fixed) will not be able to apply for the 2014 version of fixed protection.
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The new iteration is likely to be most useful to those pension savers who will have benefits in excess of, or likely to exceed, £1.25 million on April 5, 2014. By applying for fixed protection, such individuals will be able to keep the existing lifetime allowance of £1.5 million.
The major caveat is that ongoing eligibility will be contingent upon all benefit accrual ceasing at the end of the current tax year. For people with defined contribution pensions this means that no further contributions can be made after April 5, 2014.
The situation for defined benefit members is slightly more complex but essentially there are limits as to by how much benefits can grow each year. This is likely to be the CPI measure of inflation, but it is important to check the scheme rules carefully.
Those wishing to register for fixed protection must do so before April 6, 2014. Applications can be made on paper or online and HMRC will issue a certificate to confirm the registration.
Individual protection is available to individuals with pension benefits in excess of £1.25 million as at April 5, 2014. Those who apply will receive a personalised lifetime allowance equal to the value of their benefits at this date, subject to a maximum of £1.5 million.
People who have primary or enhanced protection from 2012/2013 will once again be ineligible.
One of the main differences between individual protection and fixed protection is that the former will not be forfeited as a result of continued pension accrual. Therefore defined contribution members will still be able to make payments into their pension, and the above-mentioned restrictions for defined benefit members will not apply.
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The rules are still be finalised and will not become law until the Finance Act of 2014. As things stand, however, it looks as if it will be possible for people to claim both individual and pixed Protection. This will be most appropriate for pension savers with benefits in excess of £1.25 million as at April 5 2014.
Cases will vary but individuals likely to affected by these changes should start to consider their options now, in order to avoid a last minute rush as the tax year draws to a close.
* Trevor Law is a director with Merito Financial Services, chartered financial planners, based in Solihull.
E-mail: tilaw@meritofs.com