Higher earners expecting pensions of £65,000 a year or more are being urged to seek advice on claiming “fixed” protection for these savings, ahead of reforms that could put some at risk of large tax charges.
From April 6 next year, the Lifetime Allowance (LTA) – which is the overall maximum that can be drawn from a pension fund before tax penalties are imposed – will fall from £1.8m to £1.5m. Any pension benefits over and above the LTA will incur a tax charge of up to 62.5 per cent.
However, the government has softened the blow for those expecting to build up benefits worth more than £1.5m by allowing individuals to lock into the current £1.8m limit, by applying for “fixed protection”.
Fixed protection is a new transitional arrangement separate from the “enhanced” and “primary” protections offered to individuals when the Lifetime Allowance of £1.5m was first introduced in 2006.
According to the government, the reduction in the LTA from £1.8m to £1.5m will not affect the majority of individuals. However, HM Revenue & Customs has advised individuals in final-salary pensions schemes who are expecting pensions of £65,000-£75,000 a year to consider fixed protection – because the funds to produce these pensions could now be at, or above, the £1.5m mark.
“It’s not just high flying City executives who could get caught out but people like doctors, dentists and other career civil servants,” explains Jerry Mcloughlin, a director at Punter Southall Financial Management. “There are a lot of people whose current benefit levels will be hovering north of £1m who should be considering what they will be doing from April next year.”
Whether to apply for fixed protection will be a complex decision for many, say advisers, as it is a condition of protection that no more contributions can be paid into a money-purchase pension scheme – and the benefits that be built up in a defined benefits or cash balance scheme will be limited.
“This is going to be a hard call for some,” says Roger Breeden, principal with Mercer, the consultants. “Taking fixed protection means some will have to rely on investment returns to reach the £1.8m allowance if they have some headroom, or rely on other savings from net pay. However, for some people, just tipping over the new lower Lifetime Allowance and not taking fixed protection may not be the end of the world. They may decide that taking the tax charge at the back end is preferable, and manageable, if it allows them to carry on tax relivable pension saving up to their annual allowance of £50,000.”
This lower Lifetime Allowance also needs to be factored into future pension planning, says Breeden. Individuals may want to consider opting out of future pension contributions in favour of alternative compensation.
“Certainly, in some of the bigger organisations, employers are now talking about offering cash supplements in lieu of pension contributions,” notes Breeden.
HMRC said this week that the application forms for fixed protection should be available from next Monday. This is what savers need to know:
Who can apply?
You do not need to have already built up pension rights of more than £1.5m to apply for protection. However, if you already have either primary protection or enhanced protection you cannot apply for fixed protection. Primary protection and enhanced protection are the two methods individuals could protect pension rights accrued before April 6 2006. These protections won’t be adversely affected by the reduction in the lifetime allowance.
How long do I have to apply?
Until April 5 2012.
Can I lose this fixed protection?
Yes, if you do not comply with these conditions:
● You cannot start a new arrangement other than to accept a transfer of existing pension rights
● You cannot have benefit accrual
● You will be subject to restrictions on where and how you can transfer benefits.
What is the charge if I accrue more benefits?
If you take a lump sums having exceeded the LTA, the tax charge is 55 per cent. If you take the benefits as income, the charge is 25 per cent plus income tax levied at the member’s marginal rate. This could create a total tax liability of 62.5 per cent for a 50 per cent taxpayer.