Fixed Protection & Individual Protection 2014

Transcription

1 Fixed Protection & Individual Protection 2014 Introduction Act quickly to avoid 55% tax penalty From 6 April 2014 the Lifetime Allowance will be reducing from 1.5 million to 1.25 million, meaning that individuals who have not previously been granted either Primary, Enhanced or Fixed Protection will potentially face a Lifetime Allowance charge on pension benefits in excess of 1.25 million. HMRC have estimated that the reduction in the Lifetime Allowance could potentially affect around 360,000 individuals, around 30,000 of whom will have pensions with a deemed value of between 1.25 million and 1.5 million in the 2014/15 tax year. However, if individuals take action before the end of this tax year they can retain a Lifetime Allowance of 1.5 million and save up to 137,500 in tax. Who could be affected? As a simple guide, assuming that no further contributions are paid, an individual is likely to achieve a fund value of 1.25 million if the deemed value of their benefits exceeds the figures in the following table: Whole years to retirement 6% growth after 5% growth after 4% growth after 3% growth after 5 934, ,000 1,027,000 1,078, , , , , , , , , , , , , , , , , , , , ,000 Active members of defined benefit (DB)/final salary schemes will be affected if their projected pension at retirement exceeds 62,500 as the deemed value of a DB scheme is 20 x the pension. Members of public sector schemes (e.g. the NHS Pension Scheme) will be affected if their projected pension exceeds 54,347 (20 x the pension PLUS the tax free cash of 3 x the pension). 1

2 What action should individuals take? There are a number of different alternatives that could be taken: 1. Apply for Fixed Protection 2014 Fixed Protection 2014 (FP14) will enable the individual to retain a Lifetime Allowance of 1.5million. The Fixed Protection form (APSS228) is now available and can be found on the HMRC website at The form is not complicated, but HMRC have issued guidance on how to complete the form. The completed form must be returned directly to HMRC before 6 April It can also be done online at Once Fixed Protection has been applied for, HMRC will issue the individual with a Fixed Protection certificate (but not before 1 November 2013). The following conditions will have to be met to maintain FP14: no new contributions can be paid to a money purchase arrangement after 5 April 2014 the amount of benefits an individual can build up each year (NB each year is looked at in isolation, unlike the position under Enhanced Protection) under a defined benefits arrangement (or a cash balance arrangement) after 5 April 2014 will be limited to the relevant percentage which is either: an annual rate used to increase rights and which was specified in the scheme s rules on 11 December 2012 or, if none, the percentage by which the Consumer Prices Index (CPI) increased in the year ending in September of the previous tax year. If there is no increase or a fall in the CPI in this period, the percentage will be nil. no new pension arrangement may be started, other than to receive a transfer of rights from an existing pension arrangement. This includes joining a new Death in Service Scheme. If any of these conditions are broken, FP14 will be lost (which will mean that the individual s Lifetime Allowance will drop to the Standard Lifetime Allowance) and HMRC must be informed. In practice it is likely to mean that members of a DB scheme will need to opt-out if they want to retain FP14., even if their salary does not change, as can be seen from the following table, a member of a DB arrangement who has been a member of a 1/60th scheme for 20 years will see an increase in pension benefits of 5% as a result of one additional year s accrual. Years service at start of year Years service at end of year Benefit accrued at start of year Benefit accrued at end of year % increase in benefit % 10.00% 20.00% % 18.33% 10.00% % 26.67% 6.7% % 35.00% 5.0% % 43.33% 4.0% 2

3 As mentioned above the only way an individual in a DB scheme can be sure of retaining FP14 is to opt-out of the scheme. This will result in no future pension benefits building up within the scheme. Before making a decision on this basis, consideration should be given to the length of time before the individual wants to take benefits and the extent by which the deemed value of the benefits already exceeds the reduced 1.25 million Lifetime Allowance. Opting-out The decision to opt-out of a pension to maintain FP14 should not be taken lightly and anyone considering this action should first take advice from their St. James s Place Partner. Before considering forgoing future employer contributions to a defined contribution (DC) scheme, the individual will need to discuss alternative remuneration options with their employer. As the pension entitlement forms part of the individual s overall remuneration package, stopping the employer pension contributions may allow the individual to receive an alternative form of remuneration. It is likely to be rare for the reduction in benefits resulting from opting-out of an existing DB scheme to be offset by any alternative remuneration (even taking the Lifetime Allowance into account). Auto-Enrolment If an individual s employer is subject to automatic enrolment, the individual will be automatically enrolled into a pension scheme. To retain FP14 the individual will then have one month to opt-out of the automatic enrolment scheme, otherwise FP14 will be lost. NB: any employee with Protection should carefully check their contract of employment when joining a new employer. If the new employer puts an employee into a pension scheme as part of the contract, there is no refund option once the contribution has been paid, which would mean that Protection is lost. Any employee in this position should therefore renegotiate their employment contract before joining. Are Death in Service benefits affected? Although remaining an active member of a Death in Service Scheme should not invalidate FP14, the lump sum death benefit from a Group Life Scheme will be added to the lump sum death benefit (usually the fund value) of any DC Schemes and is tested against the Lifetime Allowance. This may mean that the reduction in the Lifetime Allowance is not a problem for an individual if they survive until retirement, but would be an issue if they died before crystallising benefits. It may be possible to take action to replace any existing Death in Service benefits with a different form of Death in Service benefit which is not tested against the Lifetime Allowance, but anyone affected by this should first take advice from their St. James s Place Partner. Alternatively, as death benefits used to provide an income for a dependants (which includes a dependant s drawdown pension) are not tested against the Lifetime Allowance, the tax charge can be avoided by using any excess over the Lifetime Allowance to provide an income for a dependant. Impact on individuals with Enhanced and Primary Protection Individuals who were granted (and have retained) Enhanced Protection, Primary Protection or Fixed Protection 2012 (FP12) will retain this form of protection and will not be permitted to apply for FP14. 3

4 Enhanced and Primary Protection generally offer better benefits than Fixed Protection (Enhanced Protection means that the Lifetime Allowance does not apply and Primary Protection gives a personalised Lifetime Allowance of at least 1.8 million). In addition, unlike the position under FP12 where Tax Free Cash (TFC) reduced to 25% of the reduced Lifetime Allowance, if an individual has Enhanced or Primary Protection but no protected tax free cash sum, the maximum tax free cash will remain at 25% of the existing 1.5 million Lifetime Allowance rather than 25% of the reduced 1.25 million Lifetime Allowance. 2. Apply for Individual Protection 2014 If an individual s deemed fund value on 5 April 2014 is 1.25 million or more, it will also be possible to apply for Individual Protection (IP14). At this stage HMRC have only issued a consultancy paper on IP14 (albeit one which contains draft legislation), with a view to introducing legislation in the Finance Act Although it is likely that some of the fine detail about IP14 will change, it is likely that the principles won t. Looking at the consultancy paper, it is HMRC s intention that IP14 will give individuals a personalised LTA equal to the value of their pension savings on 5 April 2014, but subject to an overall maximum Lifetime Allowance of 1.5million. Alex applies for IP14 and has pensions valued at 1.35 million on 5 April Alex will have a personalised Lifetime Allowance of 1.35 million. Louisa applies for IP14 and has pensions valued at 1.6 million on 5 April Louisa will have a personalised Lifetime Allowance of 1.5 million. The personalised Lifetime Allowance will be expressed as a monetary amount and will not increase unless the standard Lifetime Allowance becomes greater than the individual s personalised Lifetime Allowance, at which point the individual will revert to the standard Lifetime Allowance. Unlike FP14 or FP12, under IP14 there will be no restriction on making further contributions or accruing additional pension benefits/rights on or after 6 April This makes it an attractive solution for those individuals who will not receive any alternative remuneration from their employer if they opt-out of their pension scheme (e.g. the position for most individuals in public sector schemes). It is proposed that an individual with IP14 would be entitled to take up to 25% of their pension fund as tax free cash, subject to an overall maximum of 25% of their personalised Lifetime Allowance. William has a personalised Lifetime Allowance of 1.4 million under IP14, so will be able to take up to 350,000 as a tax free lump sum (subject to scheme rules so permitting). The intention is that the individual will have up to three years from 5 April 2014 (i.e. until 5 April 2017) to apply for IP14. 4

5 Similar to the position with Enhanced and Primary Protection, it is proposed that individuals will be able to hold both IP14 and one of the two forms of fixed protection FP12 or FP14. Where an individual holds a form of fixed protection and IP14, then fixed protection will take precedence. This means that as long as the fixed protection remains valid, the individual will be able to rely on the higher Lifetime Allowance provided by the particular form of fixed protection they hold. In practice, if they have a fund of over 1.5 million and don t already have FP12, an individual would only need to apply for IP14 as the level of the protected Lifetime Allowance is the same as that which would apply under FP14 ( 1.5 million) and IP14 would allow contributions to continue. It is proposed that individuals who have been granted Primary Protection and Enhanced Protection will not be able to apply for IP14. This is due to the fact that Primary Protection is based on the 1.8million Lifetime Allowance and Enhanced Protection does not have a limit. It will not be possible for an individual to lose IP14, other than where a pension debit occurs which takes the deemed value of pension benefits below 1.25million. 3. Do nothing and pay the Lifetime Allowance Charge This is likely to be the appropriate solution where the alternative remuneration offered by the employer does not offset the loss of future benefits. It may also be an appropriate solution for an individual who is receiving 45% tax relief on their contributions as it is possible that over the longer term a greater fund value could be achieved by making the contribution and incurring the 55% Lifetime Allowance Charge than by investing the net contributions into an alternative investment vehicle. The Lifetime Allowance Charge is 55% if the excess is taken as a capital sum. If the excess is taken as income, the Lifetime Allowance Charge will be 25% and the individual will pay income tax at their marginal rate on the resulting income. If the individual was a 45% tax payer when they take benefits, taking the excess as income would mean an effective tax rate of 58.75% ( % Lifetime Allowance Charge = 75; 75-45% Income Tax = 41.25). 4. Continue contributions to a money purchase scheme but adopt a more conservative investment approach Rather than giving up the benefit of the employer s contributions, some individuals may instead prefer contributions to be continued after 5 April 2014 and reduce the chances of breaching the Lifetime Allowance by choosing a more conservative investment strategy. 5. Consider crystallising remaining pensions When an individual s uncrystallised benefits exceed their remaining unused Lifetime Allowance, it may be considered more appropriate to crystallise the remaining benefits to meet the immediate Lifetime Allowance charge rather than paying an unknown liability in the future when the next Benefit Crystallisation Event occurs. Anyone considering this action should first take advice from their St. James s Place Partner. 5

6 Other issues How are pensions already in payment on 6 April 2006 taken into account? Although pensions that were already in payment on 6 April 2006 ( A Day) are not subject to the Lifetime Allowance, they are taken into account when determining the amount of the Lifetime Allowance available when benefits are crystallised after A Day. Although the deemed value of a pension that was already in payment on A Day is 25 x the value of the pension (or annuity) in payment, or the maximum permitted level for Drawdown Pensions, rather than using the level of the pre A Day pension at A Day, it is the level of the pre A Day pension payable at the first Benefit Crystallisation Event after A Day that is taken into account. Where the pension in payment increases, over time the deemed value of the pre A Day pension increases and therefore the value of the available Lifetime Allowance decreases. On A Day George was in receipt of a pension of 30,000pa from his final salary scheme. It has increased in payment by 3%pa and is now 38,000. George has not crystallised anything since A Day and still has an uncrystallised money purchase fund. Although the deemed value of the pension in payment was 750,000 ( 30,000 x 25) at A Day, its deemed value today is 950,000 ( 38,000 x 25). To prevent the deemed value of the pension in payment increasing further, individuals could crystallise a small portion of any uncrystallised money purchase scheme as this will fix the deemed value of the pension from pre A Day benefits. Anyone considering this action should first take advice from their St. James s Place Partner. How will the reduction in the Lifetime Allowance impact on benefits already in drawdown? Where an individual went into drawdown after 5 April 2006, the value of the drawdown arrangement will be tested against the Lifetime Allowance at age 75 (BCE 5A). If the value of the drawdown arrangements (after tax free cash) has increased since the original Benefit Crystallisation Event, the additional fund value will be tested against the remaining Lifetime Allowance. To prevent this creating a problem, it would be prudent to apply for Fixed Protection Kate is receiving a pension from a DB Scheme and is taking drawdown from a personal pension scheme. She has crystallised 85% of the Lifetime Allowance. She has been taking a low level of income from her drawdown pension that was worth 500,000 when originally crystallised. If she continues to take income at the current rate, her fund value is projected to increase to 700,000 by age 75. This would mean that a further 200,000 ( 700, ,000) will be tested against the Lifetime Allowance at that time. Assuming the Lifetime Allowance is 1.25 million, this would represent a further 16% of the Lifetime Allowance, meaning that a small part of her benefits (85% + 16% = 101%) would be subject to the Lifetime Allowance Charge. However, if Kate had been granted Fixed Protection 2014, this would only represent 13.33% of the 1.5 million Lifetime Allowance and consequently none of her benefits would be subject to the Lifetime Allowance Charge (85% % = 98.33%). 6

7 Conclusion Individuals who are affected by the reduction in the Lifetime Allowance will need to take action if they want to achieve the retirement income they desire. To obtain advice as to whether they should: do nothing and pay the Lifetime Allowance Charge continue contributions to a money purchase scheme but adopt a more conservative investment approach crystallise remaining benefits apply for Fixed Protection 2014 or apply for Individual Protection 2014 affected individuals should take advice from their St. James s Place Partner, who will need to: an up to date benefit statement from any active DB/final salary scheme up to date values of any DC/money purchase pensions the level of contributions being paid into any DC/money purchase scheme up to date benefit statement from any deferred DB/final salary schemes. confirmation of the individual s Selected Retirement Age - if this is earlier than the Normal Retirement Age of any DB schemes, any actuarial reductions that will apply to the DB schemes whether tax free cash is paid by commutation of final pension, or in additional to final pension the scheme commutation rates: - for payment of tax free cash - for payment of any Annual Allowance charge - for payment of Lifetime Allowance charge the amount of cash being offered as an alternative to remaining an active member. Remember that the need to fund for retirement remains; it may simply be that the investment vehicle used may change. The levels and bases of taxation and reliefs from taxation can change at any time and are dependent on individual circumstances. The St. James s Place Partnership and the titles Partner and Partner Practice are marketing terms used to describe St. James s Place representatives. Members of the St. James s Place Partnership represent St. James s Place Wealth Management plc, which is authorised and regulated by the Financial Conduct Authority. St. James s Place Wealth Management plc, St. James s Place UK plc, St. James s Place Unit Trust Group Ltd and St. James s Place International plc are members of the St. James s Place Wealth Management Group. St. James s Place UK plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. St. James s Place Unit Trust Group Ltd is authorised and regulated by the Financial Conduct Authority. St. James s Place International plc is authorised and regulated by the Central Bank of Ireland. St. James s Place Wealth Management plc Registered Office: St. James s Place House, 1 Tetbury Road, Cirencester, Gloucestershire, GL7 1FP, United Kingdom. Registered in England Number SJP4213-VIR1 (10/13)