On a mission: Protecting clients from the lifetime allowance cut

The name's Webster, Lisa Webster. Here, the technical expert runs through some life and death pension protection scenarios in light of changes to the lifetime allowance

Daniel Craig is the seventh James Bond to protect the world from the bad guys.

In a rather more subdued opening scene than the typical Bond blockbuster we now have our seventh form of protection to protect our pensions from HM Revenue & Customs lifetime allowance charge.

The introduction at the start of the new tax year of fixed protection 2016 (FP16) and individual protection 2016 (IP16) on top of the five protections we already have brings us to protection 007.

And that’s ignoring any scheme-specific protections, pension credit or international enhancement factors (there are always exotic locations when Bond is involved).

While the FP16 and IP16 are relatively simple to understand, and work on the same basis as the 2014 versions, valuing rights for individual protection purposes can be complex, particularly when drawdown was in payment prior to A-Day.

To be eligible for FP16 you need to have stopped contributions from 6 April 2016, and cannot hold any other form of protection other than one of the individual protections (individual protection 2014 applications are still open until 5 April 2017).

To be eligible for IP16 you need to have funds valued above £1m as at 5 April 2016 and cannot hold primary protection or IP14.

This means anyone with enhanced protection or one of the fixed protections can still have IP16. In all circumstances the other protection will be at a higher level than the IP16, so really IP16 is insurance against the fund going down in value as you retain the ability to make contributions, allowing you to top the fund back up to the IP16 level.

Case study

Daniel is 56 and has £500,000 in a deferred final salary scheme from an employer he left a number of years ago.

He now has his own business, and has £700,000 in a SIPP. Total pension savings are valued at £1.2m at 5 April 2016.
With the security of his final salary scheme, Daniel had adopted a higher-risk strategy with his SIPP investments.

He decides to apply for both fixed and individual protection 2016.

In 2020, when Daniel reaches 60, he stops work and takes the benefits from his final salary scheme. He also decides to access his SIPP benefits by taking all his pension commencement lump sum and designating the rest of his fund for drawdown to be taken at a later date. At this point the lifetime allowance is £1,050,625*.

Scenario 1

At retirement Daniel’s pension savings are valued at £1.3m.He uses his fixed protection of £1.25m and has an excess fund of £50,000, which he opts to leave in his SIPP to provide an income after the 25% tax of £12,500 has been deducted.

If Daniel had not had any protection the excess would have been £249,375 and the tax charge £62,343.75.

Scenario 2

Unfortunately, Daniel’s higher risk funds have not all done well, and his total pension savings are now valued at £1m.

Daniel decides to maximise his pension contributions and pays in £160,000 gross using his £40,000 annual allowance and each of the last three years’ unused annual allowances.

He has the full carry forward amount available as he could not previously make contributions under his fixed protection. This is a combination of personal contribution and employer contribution as part of his retirement package and Daniel does not have income above £110,000 so is not affected by the annual allowance taper.

Daniel informs HMRC that he has revoked his fixed protection 2016 and will be relying on his individual protection 2016 instead.

Daniel then uses his IP16 of £1.2m which allows him to access his full fund of £1,160,000 with no excess tax charge.

Had Daniel not held individual protection he would only have been able to contribute £50,625 to bring his fund value up to the standard lifetime allowance without suffering an excess tax charge.

If pension savings are sufficient to be eligible to apply for IP16, I can see no reason why not to apply.

After all, this insurance is free of charge and if the worst happens, wouldn’t you like to have James Bond covering your back?

Lisa Webster is technical resources consultant at AJ Bell

* The lifetime allowance is scheduled to rise from £1m in line with the consumer prices index (CPI) from 2018 onwards. This figure is an estimate based on CPI of 2.5%.