Increasingly, we are coming across people who don’t fully understand the significance of the lifetime allowance, perhaps not realising that it has been reducing for the last four years, and, so, have missed the opportunity to “protect” themselves, resulting in unnecessary tax charges of up to £120,000.
With another cut on the horizon, it is important to take stock and act now to minimise tax.
A cornerstone of the Government’s 2006 pension simplification exercise, the lifetime allowance has been subject to much tinkering ever since. The premise is simple: everyone is allowed to accumulate tax favoured pension arrangements up to a limit (broadly 25% tax free; 75% taxed as income). Go over the limit and the excess is taxed at 55%.
Pitching the allowance at £1.5m in April 2006, the Government allowed pre-set increases over the following five years so that by April 2011 up to £1.8m could be built up.
National austerity then took hold. April 2012 and April 2014 saw the allowance systematically cut back to £1.5m and £1.25m respectively. April 2016 sees a third and hopefully final cut to £1m, albeit with the allowance then being linked to CPI from April 2018. CPI, by the way, is currently 0%.
Along the way, the Government has allowed people to lock in to a higher allowance before a cut came in, such protection being subject to timely application and generally conditional on no further pension contributions being paid. Beneficiaries of Fixed Protection 2012 or Fixed Protection 2014 will have a lifetime allowance of £1.8m or £1.5m.
In the same vein, the current £1.25m allowance is available to anyone applying for Fixed Protection 2016. HMRC has yet to confirm the procedure for this and it may be that 5 April 2016 is not an application deadline (as the two Fixed Protection precedents might imply) but it will definitely be conditional on no further pension contributions being paid after 5 April 2016. If applicable, this might entail leaving an employer sponsored pension scheme – not a step to be taken lightly, especially if there is no cash alternative to the employer’s contribution.
Those with pension funds of £1m or more may also apply for Individual Protection 2016, substituting the higher value of their pension arrangements as their own personal allowance, subject to a maximum of £1.25m. Individual Protection 2016 is not conditional on contributions stopping – potentially beneficial to members of employer sponsored pension arrangements.
Likewise, those with pension arrangements valued at £1.25m or more as at 5 April 2014 should consider applying for Individual Protection 2014 so as to secure a personal allowance of more than £1.25m (£1.5m maximum). The deadline for doing so is 5 April 2017, to allow the April 2014 valuations to be done.