LTA Tax charges The clock is ticking

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1 LTA Tax charges The clock is ticking The LTA tax charges 1 of 12

2 Hundreds of thousands of pension savers in the UK risk being hit by hefty taxes as a result of the latest cut in the pension Lifetime Allowance (LTA). They are being urged to take urgent action to protect their pension pots, which are worth an estimated 250 billion. There s no underestimating the importance of saving into a pension and for most the amount they save will not reach the lifetime allowance. However for those who have contributed a significant amount towards their pension or are fortunate enough to have a defined benefit scheme with a long service record could unknowingly discover they could be at risk of exceeding the LTA.Failure to take out the necessary protection could lead to them being hit with an unexpected tax bill of 137,500. The LTA, introduced in 2006 as part of pension reform and simplification, is the limit on the amount of money an individual can save into their pension schemes before incurring a painful 55% tax charge. Next April the LTA will be cut to 1.25 million from the current level of 1.5 million. This will affect as many as 360,000 pension savers by the time they reach retirement. When the allowance was introduced on A Day (5 April 2006) the government pledged to maintain its real value. This was the case until 2011 when the LTA peaked at 1.8 million. Since then, however there have been several changes to the allowance. This decision has serious consequences for many pension savers who might need to review their savings as a result of the new lower lifetime allowance. To ensure they continue to save in the most tax efficient manner some people might need to consider their current level of contribution. Pension savers will get only 45% of any growth above their LTA as a result of the tax charge but will still suffer 100% of any investment loss. This is a risk that pension savers need to be aware of when they consider the pros and cons of protecting their lifetime allowance. In this paper we look at the impact of the LTA on savers, assess the various protections on offer and potential actions that could be taken now to mitigate risk, achieve the best outcome (relating to the LTA change) and provide confidence and comfort in the approach to retirement. From 1,500,000 To 1,250,000 2 of 12 The LTA tax charges

3 The impact on individuals The reduction in the LTA will radically change the retirement strategies used by pension savers impacted. People don t have to be close to the 1.25 million LTA for it to become a problem. Investment growth can quickly accelerate pot size and push them over the limit. For instance somebody 10 years from retirement with a current pension pot of 700,000 could exceed their allowance if their pot grows at 7% a year even if they stop paying into it now. The value of investments can go up or down and may be less than what was paid in. Its value at retirement depends on investment performance and is therefore not guaranteed. HMRC estimates that 30,000 people will be immediately affected by next year s LTA cut, with the much larger number of 360,000 expected to break the limit over the longer term. This takes the impact of the LTA way beyond the 1% of pension savers envisaged when it was originally introduced. The combined tax charges on savings above the LTA will be 55% whether taken as a lump sum or as income for a higher rate taxpayer. Getting this wrong could potentially expose up to 250,000 of a person s pension savings to a hefty tax charge. Anyone eligible to register for individual protection should do so as there is little to no downside involved. The LTA tax charges 3 of 12

4 Protecting your allowance There are two new protection options for 2014, allowing pension savers to lock into the current, higher LTA of 1.5 million beyond 5 April These are known as Fixed Protection 2014 and Individual Protection. The best option for somebody might be to elect for either, both, or even neither. The optimum course of action will of course depend on individual circumstances. However as a rule, Fixed Protection is considered one of the best options for pension savers with a benefit value of 1.25 million or less at 5 April Those individuals with a benefit value of more than 1.25 million at that date should consider claiming both Fixed Protection 2014 and Individual Protection. Fixed Protection 2014 allows pension savers to keep a 1.5 million LTA beyond This option is available to anyone who doesn t have any of the earlier forms of protection. As we have seen, even individuals who feel their pension pot is well below the limit could be affected in the coming years, especially as future reductions to the LTA cannot be ruled out. However there is a trade-off involved in securing this particular protection: Pension contributions to Defined Contribution (DC) schemes have to stop after 5 April 2014 while any increases in Defined Benefit rights can t exceed a given relevant percentage (normally CPI for the previous September) in any tax year. The deadline for fixed protection applications is 5 April Individual Protection is available only to people with pension savings worth more than 1.25 million on 5 April This gives individuals a personal LTA equal to their benefit value on 5 April 2014 (up to a maximum of 1.5m). So someone with pension savings worth 1.36m on 5 April 2014 can lock-into a personal lifetime allowance of 1.36m. But someone with savings worth 1.55m would only secure a 1.5m allowance. Crucially, this protection comes without the trade-off needed for fixed protection. Individuals in this category can keep funding their pension after April 2014 if they want to (or, perhaps more importantly, continue to enjoy pension funding from their employer). So, for individuals whose funds already exceed 1.5m by April, individual protection gives a better deal than fixed a 1.5m LTA with no requirement to give up on future pension saving. The deadline for fixed protection applications is 5 April of 12 The LTA tax charges

5 Anyone eligible to register for individual protection should consider doing so as there could be little to no downside involved for them. They ll get an increased LTA with no trade-off required on their contributions. Since savers can register for individual protection alongside fixed protection 2014 or 2012, they are effectively gaining a safety net to fall back on if fixed protection is lost. No protection might mean paying more tax. But it could still give the best result depending on personal circumstances particularly if it means continuing to buildup additional years of final salary benefits. Applying for protection might mean giving up on future pension saving either to safeguard fixed protection, or minimise tax charges under individual protection. But it could also mean giving up on free money in the form of employer pension funding. Some employers may offer alternative remuneration in place of the pension contribution. This is a possibility in the private sector, but unlikely for public sector employees. The Consolation of Consolidation An individual will work for an average 11 employers, which might see them accumulate many different pensions over the course of their careers. Consolidating these pensions can make it much simpler for savers to manage their pension fund in one place. It provides clarity and makes it easier to judge if they might be impacted by LTA changes. Regularly reviewing will become increasingly important after Consolidating pensions into a single, larger pot also allows savers potentially to reduce overall charges, achieve better investment performance and get a better deal on their annuity. Since savers generally need a larger pension pot (in a SIPP) for income drawdown to be possible, consolidation gives this option. However, before embarking on consolidation it s vital to consider any costs of transfer. In particular, savers should watch out for any guarantees under older plans that could be lost such as guaranteed growth on with-profits or guaranteed annuities. Individuals should balance such costs against the benefits of consolidating and consider what excess return would be needed to recover any transfer penalties. It is vital to beware of such exit penalties. Some policies set up in the 1980s and 1990s still carry exit charges. Standard Life stopped applying them for new pensions almost 20 years ago, but this is not the case with all providers Transferring pensions may not be the right option for everyone and there is no guarantee that what an individual will get with the new combined pension plan will be higher. It is a good idea to seek professional financial advice before deciding how to proceed. The majority of individuals with incomes of over 100,000 a year are not saving the full amount into their ISA. The LTA tax charges 5 of 12

6 Smart saving: wider strategies If individuals are compelled to give up funding their pension as a condition of lifetime allowances they may still want to invest that money somewhere. Luckily there is a wide choice of suitable alternative investment vehicles, and tax wrappers, available to them. Having a range of different investments, each delivering different benefits and tax advantages, greatly improves tax planning for individuals retirement. Several strategies merit close consideration. Use spouse s pension: High net worth individuals should consider contributing to a pension for a spouse or civil partner. This is particularly valuable for a working spouse, as you can pay up to the higher of 100% of the spouse s salary or 3,600 (less any contribution already being made by the spouse). The spouse will receive tax relief on the contribution. And the gift will be covered by the spouse exemption for Inheritance Tax. Maximise tax allowances: Realising capital gains on mutual funds on an annual basis ensures that you maximise the benefit of your annual exempt allowance for Capital Gains Tax (CGT) and the Income Tax Personal Allowance. If these are not used every year then they are lost and gone forever. Utilise gaps in tax wrappers: If there are gaps in your use of tax wrappers, redirecting money that can no longer be saved in a pension could prove an ideal opportunity to address this. Some gaps in investment may make perfect sense given the risk profile. For example, the EIS, SEIS and VCT schemes offer generous capital gains tax reliefs and/or income tax reliefs. However some pension savers may not be comfortable with this level of risk. Surprisingly, the majority of individuals with incomes of over 100,000 a year are not saving the full amount into their ISA. Certain funds held directly could be sold and repurchased using an ISA. Defer tax offshore: Tax deferred can mean tax saved. If you are a higher rate taxpayer now, it can be tax-efficient to invest through an offshore bond. You will not pay tax until funds are taken from the bond, allowing for planning such as taking gains when paying less tax in retirement, or assigning to a non-taxpayer. Spread tax exposure: Diversifying your investments across assets that are subject to income tax and those that are primarily subject to capital gains tax puts you in a potentially better position to weather any variations. The value of investments can go up or down and may be less than what was paid in. Returns are dependent on investment performance and are therefore not guaranteed. Tax rules and legislation can change and any information given is based on our understanding of law and current HM Revenue and Customs practice. 6 of 12 The LTA tax charges

7 Action required now Navy blue zone Amber zone Sky blue zone Pension funds already over 1.25 million Must register for protection before April Funds projected over 1.25 million Review position before April. Protection should be seriously considered Funds projected 1million to 1.25 million Monitor progress review regularly 1,500,000 1,250,000 Navy blue Existing pot very likely to breach current 1.5m allowance 1,000,000 Pot value ( ) 750, , ,000 0 Amber Risk of existing pot exceeding new 1.25M allowance 25 Sky blue Existing pot unlikely to exceed new 1.25m allowance Years to retirement 1) Protect allowances: Individuals have several big decisions to make ahead of next April s cut in the LTA. They must decide whether they are at risk and, if so, what type of protection they should choose. Taking expert and trusted professional advice now is essential to their financial wellbeing. Getting it wrong could cost 137,500. Pension savers can check to see if they might be impacted by changes to LTA by visiting We see three risk groups among pension savers who will be affected: the navy blue, amber and sky blue levels. 2 Maximise tax efficient savings: As well as the fundamental protect or not question, the potential need to cease, or cut back on, pension saving after April 2014 raises a host of other advice issues which should be urgently considered in order to try to ensure the best outcome. The decisions checklist is as follows: Decide whether to make a final pension top-up payment before the shutters come down in April Think about taking benefits early Review investments to eliminate unacceptable risk Consider target based investment solutions Consider consolidating pensions for easier monitoring Look at establishing alternative (non-pension) tax wrappers for future savings Assess the most efficient way to transfer wealth to the family To avoid the risk of missing the deadline, pension savers who are affected need to make their decisions swiftly, well ahead of the new tax year, as it is likely to take some time to get everything in place. The LTA tax charges 7 of 12

8 Appendix Case study one - The entrepreneur The client Nita is 50, single, and runs her own successful PR consultancy drawing a yearly salary of 40,000 plus dividends of around 50,000. She plans to retire at 60, so Nita has diligently saved into pensions over the years. Her main pension is a SIPP worth 450,000, into which she pays 2,500 a month ( 30,000 a year). Nita also has a couple of old pensions: a personal pension worth 40,000 and a company pension from her first job, which is now worth 110,000. The issue Nita has heard about the pension Lifetime Allowance cut from 1.5M to 1.25M from 6 April With pensions worth a total of 600,000, Nita doesn t think this will affect her. But the new limit could be closer than she thinks.there s a possibility that Nita s combined pension pots will exceed her allowance when she retires in 10 years time. Even if Nita stops paying into her SIPP now: 7.7%a year growth would take her combined pension savings above the new 1.25M allowance. 9.6% a year growth would take her through the current 1.5M barrier. These investment returns are demanding, but not impossible. And Nita faces a 55% tax charge on any pension savings above her allowance so the allowance cut could cost her up to 137,500 in tax. Nita needs advice to guide her through her options. Of course, the value of her investments can go down as well as up. Investment returns are not guaranteed. The value of advice how can an adviser help? Pension rules, and financial planning, are complicated. But a financial adviser can guide Nita through them, explain her options and help achieve her financial goals for later life. For example, her adviser can help: 1. Save tax Save Nita tax by explaining how she can lock into a higher Lifetime Allowance and the implications of doing so. 2. Plan pension saving Guide Nita on funding her pension tax-efficiently. 3. Bring savings together Help Nita decide if bringing her pensions together and making them easier to manage is right for her. 4. Review investments Review Nita s investments to make sure they re right for her. 5. Find other savings options Recommend other products for Nita to save into to help attain her goals tax-efficiently. 6. Keep plans on track Set up regular financial reviews with Nita to keep her plans on track.tax rules and legislation can change and the information here is based on our understanding of laws and current HM Revenue and Customs practice Setting up regular review meetings to review savings and monitor progress towards goals will help keep plans on track. 8 of 12 The LTA tax charges

9 Appendix Case study two - The family The client James (48) is married to Gill (46). They have 2 children in private school Fiona (16) and Sophie (14) and aim to put them both through university. James is a lawyer, typically earning around 200,000 a year (including bonus). Gill works part-time as a PA, earning 20,000 a year. They both plan to stop work when James is 55 and have been saving towards that goal. As a member of his employer s pension plan, James benefits from a 10% employer contribution in return for paying 5% himself. His pot is worth 800,000. James also has a 12,000 a year preserved Local Government final salary pension from his days as a council solicitor, which is due to be paid from age 60. Gill has minimal pension savings, having only recently returned to work when Sophie started secondary school. She pays 3% of her salary into a group personal pension, which her employer matches. Her pot is worth 3,500. As well as their pensions, they re already maxing out their ISA allowances and James has an extensive share portfolio. Their outstanding mortgage should be clear within the next two years. The issue The pension Lifetime Allowance is being cut from 1.5M to 1.25M from 6 April James doesn t think this will affect him. But he s wrong. James thinks his 800,000 pension pot is far enough below the new 1.25M allowance that he doesn t have to worry about it. But he doesn t know that HMRC put a value of 240,000 on his old 12,000 final salary pension (20 times the pension). Most importantly, James isn t aware that the new 1.25M allowance might not go up again before he retires. Even If he stops pension savings now, if it grows at 6% a year James main pension will already be worth over 1.2M by the time he s 55. His 12,000 annual final salary pension increases each year until retirement to help protect it against the effects of inflation. If these increases are 3.3% a year, this means it ll be around 17,700 by age 60. This would eat up about 354,000 of James allowance. Taking it at 55 would mean less revaluation, and an early retirement penalty of around 20%, reducing the value back to around 240,000. James doesn t plan to take his final salary pension until 60. But even if he took both his pensions at 55, they could be worth over 1.4M. Delaying taking his final salary pension until 60 could give a total value over 1.5M. Either way, there s a fair probability that they ll be worth more than 1.25M. James faces an avoidable 55% tax charge if he keeps saving into his pension. He and Gill need advice to make the right decisions to achieve their financial goals. Regular review meetings will help evolve, and adapt, the family s financial plans to cater for changing circumstances. The LTA tax charges 9 of 12

10 Appendix Case study three - The NHS consultant The client Brian, 61, is an NHS consultant earning 120,000 a year. He s worked for the NHS for 36 years and is a member of the traditional 80ths + cash section of the NHS Pension Scheme, which currently costs him 13.3% of his salary in contributions. Brian also has an additional voluntary contribution pot worth 150,000, which he pays 500 a month into. Brian plans to retire at 65, when he ll have completed 40 years service. The issue The pension Lifetime Allowance is being cut from 1.5M to 1.25M from 6 April Brian doesn t think this affects him. But it does. Brian knows he s built-up an annual NHS pension of 54,000 so far ( 120,000 x 36/80) plus a lump sum of 3 times this ( 162,000). But he doesn t appreciate that HMRC put a value of 1,242,000 on it (20 x 54, ,000)! Add in his 150,000 AVC pot and the value of Brian s pension is already at 1,392,000 well above the new 1.25M allowance. Brian needs advice to guide him through his options. With a potential 55% tax charge for going over his allowance, getting it wrong could be a very expensive mistake. The value of advice how can an adviser help? The reduced pension Lifetime Allowance raises big issues, and some difficult questions for Brian. A financial adviser can help guide him through this financial planning maze to take the right decisions for his financial future. For example, his adviser can: 1. Save tax Save Brian tax by helping him lock into a higher Lifetime Allowance. 2. Review pension options Help Brian take the right decisions about his pension to give him a good outcome in retirement. This is particularly difficult with a final salary pension like Brian s. 3. Choose other saving vehicles Help Brian find the right saving vehicles, and tax wrappers, to meet his financial aspirations. 4. Keep plans on track Set up regular financial review meetings with Brian to review progress towards his financial goals as he prepares for life after work. Tax rules and legislation can change and the information here is based on our understanding of law and current HM Revenue and Customs practice. The value of investments can go up or down and may be less than what was paid in. The value of a pension on retirement depends on investment performance and is not guaranteed. Any potential solutions highlighted in these case studies do not cover all options available and should not be regarded as financial advice. A financial adviser can help find the best solution based on personal circumstances. It is just as important to start thinking about wealth decumulation and family wealth transfer plans. 10 of 12 The LTA tax charges

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12 Lifetime Allowance The LTA tax bombshell 12 of 12 The LTA tax charges Standard Life Assurance Limited is registered in Scotland (SC286833) at Standard Life House, 30 Lothian Road, Edinburgh EH1 2DH. Standard Life Assurance Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority Standard Life, images reproduced under licence