I’ve been asked to write a case study on the issues people have as they approach retirement with well funded pensions and pension pots and plans put in place to combat the impact of the Lifetime Allowance (LTA). This is the story of a friend.
Claire is a scientist who has worked much of her life building up guaranteed rights to a pension with a couple of large pharmaceutical companies. She is 61, still working and she is drawing one of her guaranteed pensions.
She has had a separate career providing consultancy to companies and has a self-employed pension pot.
Having researched her tax position on pensions she found in early 2014 that for the purposes of her lifetime allowance, her “accrued” pensions were worth £900,000 (she had rights to £45,000pa). At the time, she had just over £400,000 in her self-employed retirement savings pot (a stakeholder pension).
She took financial advice and applied for 2014 fixed term protection which meant that even if the value of her pensions exceeded £1.5m, she would not have to pay penal tax at 55% on pension benefits. As the value of her total benefits at the time was “only” £1.3m, that meant that she needn’t breach the lifetime allowance (LTA).
The deal she made with the taxman, was that she wouldn’t accrue anything more in her DB plans (this was fine by her – she was no longer able to do so) and that she wouldn’t make further contributions to her stakeholder plan – also known as a DC or personal pension “pot”. For the last 9 years Claire has not used any of her pension allowances and not contributed a penny to her pot.
Meanwhile her pension pot rose at one point to £650,000, before falling back in 2022. It is still worth over £600,000. Her DB pension is now valued at £1.1m.
Claire thought she had done well by “freezing” her pension contributions. Had she lost her 2014 fixed protection, her total pot would have exceeded her protected LTA by £200,000- £250,000, giving her a much reduced “lifetime allowance charge” based on this amount rather than up to £626,900 above the standard LTA. This charge would have “crystallized” when she started drawing her pension pot and would have been at 55% . That seemed a huge tax-bill, avoided by good planning.
Then, in this year’s budget, Claire heard that her foresight appeared pointless. The Chancellor announced he was abolishing the LTA altogether, this left Claire feeling deflated.
She could have carried on saving into her pension pot as none of her savings or pension accrual was going to be subject to the lifetime allowance charge after April 2023.
When she read about the small print, she realized that her £1.5m 2014 fixed protection did have residual value. Without it, she would have been limited to taking tax free cash at 25% of the latest LTA of £1,073,100, this would have been £268,275.
But with her £1.5m protection intact, Claire can now take a quarter of her old protection limit as tax free cash. That means she can avoid tax altogether on a quarter of the value of her pensions from £1,073,100 to £1.5m. Her tax-free cash is now capped at £375,000 (25% of £1.5m). That’s over £100,000 of extra cash that is free of any tax – no matter her marginal rate
And Claire can now use her increased annual allowance to make a large single payment into her pot based on her earnings. Effectively using the full annual allowance of £60,000 in the next tax year (2023-24), she can carry forward any unused annual allowances from the previous three tax years, 2020-21 ,2021-22 and 2022-23. She’s also able to put more in, in future because she has not touched her pension pot and can benefit from the new uplift from the full annual allowance meaning (she is not earning enough to be caught by the annual allowance taper).
But things are never simple. Claire has also read about Labour’s plans to retrospectively reapply to the LTA should they become the Government after the next general election. Should she top up her pension with money from her earnings and savings, she feels there is a political risk that she will be caught by the old charge she had planned to avoid.
All of this is giving Claire a headache, a headache she doesn’t need. She feels she has done the right thing and followed the rules, never trying to outsmart HMRC. She is happy that she has more tax-free cash, pleased that she can save more and that she can backdate a big payment to make up for lost years saving between 2014-23. But she feels that whatever she does will continue to give her nagging doubts.
Is it any wonder that people find pensions too hard!
It is not just Claire who finds this hard. Some people will have taken a PCLS of over £268,275 many years ago when the LTA was much higher. They may then have saved into another pension scheme as they may have been well within the LTA limits. When taking money out of this new scheme, they will have expected to get 25% of it tax free. Looks like they won’t be able to do so now. Has anybody seen the detailed rules on the implementation of this change, which comes into force today?
Fundamentally the tax free cash rules have not changed for the 2023/24 tax year (with the exception of enhanced protection with lump sum protection). In the example, Claire is still limited to tax free cash rights of £375,000 (25% of her lifetime allowance of £1.5m). There’s reference to Claire lump sum rights being well over £400k. That’s not the case. Some useful examples can be found here https://www.gov.uk/government/publications/lifetime-allowance-guidance-newsletter-march-2023/lifetime-allowance-guidance-newsletter-march-2023
Hopefully Claire did not make the contribution in the 22/23 tax year that is referred to above as she would have invalidated her FP14 protection. The relaxation on contributions is from 2023/24 onwards…..
Thanks guys – updated