It was announced in 2006 as ‘A-day’, the pension simplification act, to reduce the complicated patchwork of legislation built up by successive administrations which was seen as a barrier to the public when considering retirement planning. Broadly aimed at homogenising different pension regimes with HMRC, it promised considerable tax freedoms in contributions and investable assets. Over the last 10 years, however, there has been little to suggest that these changes have been successful in making pensions easier and clearer. Arguably it has resulted in additional complication and is now backfiring on the pension provisions it encouraged.
From this April, the amount that can accrue in pension arrangements, whether final salary or money purchase, will fall from £1.25 million to £1 million. Savings that break this level will trigger a penal tax charge of 55%. It is a relatively simple exercise to value and project forward the likely outcome of a money purchase arrangement; however final salary schemes are a little bit trickier. Using a simple formula of 20 times the pension payable today, plus the tax free cash, will give you a simple way of calculating the cash equivalent value of the benefits accrued so far. The impact of these changes may affect the long-term prudent saver, senior civil servants, doctors, teachers, policeman and many senior executives in occupational based schemes.
One of the ways to potentially avoid the tax is simply to draw benefits early or opt out of the scheme. An unintended consequence of this will be that many valuable, skilled professionals, particularly in the health service where resources are already stretched, could be lost through early retirement.
HMRC has announced that there will be some transitional protection to help shelter funds accrued. The protections are available for those who have funds above and below the £1.25 million limit; if you are prepared to stop funding by April 2016 you may retain the £1.25 million limit by applying for fixed protection. Alternatively, individual protection is available for those with pension pots between £1 million and £1.25 million. The value of the pension then becomes your lifetime allowance. Further contributions can still be made; however, there may be a tax charge at a later date.
Individual protection 2014 is still available up to April 2017, however pension values need to be established at a minimum of £1.25 million by 5th April 2014. If the values exceed £1.5 million then the £1.5 million maximum applies; contributions can continue.
Appropriate protection may need to be adopted before benefits are taken
The lifetime allowance test is triggered when benefits are taken, such as drawing tax free cash, annuity purchase or going into pension drawdown. A second test is then applied again at age 75. Whenever the check is made, the value crystallised is compared against the lifetime allowance in force in the year of testing. In some circumstances, it may be worth taking the tax free cash early, rather than waiting, when the tax free cash may represent a larger proportion of the overall allowance.
Another area of the changing pension legislation that savers must be aware of is the rate of accrual of new pension benefit or contributions that can be paid into a pension in any one financial year.
The government is dramatically reducing the allowances available for both individuals and employers to fund pension benefits. This reduction could, in the worst case, go from £40,000pa to £10,000 for high earners over £210,000.
This applies to both money purchase arrangements and final salary benefits. In some cases the tax charges triggered in final salary schemes, where the deemed contribution is in excess of the threshold, may be deducted from the benefits of the scheme.
As a financial planner, I would urge those who would want to capitalise on the tax recovery to do so at the earliest opportunity. There is still scope to contribute and indeed recover past allowances from previous years.
Tax Relief Rates
In addition to the change in funding level, it is very likely that the rate of receivable tax relief will reduce to a flat rate approaching 30% again, for higher rate taxpayers and additional rate taxpayers, which would be a large reduction in the relief available. There is no definitive guidance on the rate of relief that will be allowed we can only surmise, based on HMRC recovering more tax.
The lifetime allowance reduction appears to conflict the need for proper pension provision. With life expectancy ever increasing and the need for private wealth to fund care, it is important to maximise opportunities now. In short, save well, save wisely, but not too much!
This article is distributed for information and educational purposes and does not represent specific investment advice, strategy or product recommendation. It contains the opinions of the writer and is based upon understanding of current taxation rules which may change in the future.
Please remember that the value of investments can fall as well as rise and that past performance is no guarantee of future returns.
You are advised to always seek appropriate independent professional advice. If you would like to speak to a Quadrant Group adviser about the impact of pension changes, please get in touch.
This article does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections.