The £1M LTA is fast approaching and that means decision time for those clients who believe that they may be caught by the latest cut. Should they stick or twist? The price for protecting funds from an LTA charge by locking into a higher allowance may be that pension funding has to stop. And that means it could be the last chance to boost funding.
Top-up before protecting?
Unlike previous protections, there’s no application deadline for fixed protection 2016 (FP16) or individual protection 2016 (IP16). But FP16 means stopping pension saving after 5 April, so time is running out to make a decision.
There’s only five weeks for clients looking to go down the protection route to maximise funding and build a bigger retirement pot to protect.
- For those opting for FP16, the run up to 5 April represents their final funding opportunity.
- Clients considering IP16 may want to make additional funding to boost their protected LTA.
Clients looking to use FP16 to lock into a £1.25M LTA going forward also need to think about the practicalities of stopping pension funding by the 5 April deadline:
- Opting-out of future DB accrual, or stopping contributions to a Workplace pension, often requires at least a month’s notice to the employer to allow the necessary payroll changes to be processed. This means employees may need to act soon, otherwise the decision will be taken out of their hands.
- Business owners who pay single rather than regular premiums may have a little more breathing space. By maximising funding before April, they can leave their options open a little longer.
Where to save after April?
Affected clients will still need to save for retirement after April. But a decision needs to be made on the best place to save, based on their circumstances. And the best place to save could still be their pension, even at the expense of missing out on fixed protection.
There’s a natural aversion to paying tax charges – that’s understandable. But what has to be considered is whether carrying on funding and paying the LTA charge will give clients more in their hand than their protected pension fund plus what can be saved outside of the pension wrapper.
Stopping pension funding – what to think about?
FP16 might mean that LTA charges are limited, or avoided completely, by increasing the LTA by an extra £250k. But a single pound of additional funding, or an extra day’s DB accrual, after 5th April could blow protection – potentially costing as much as £137,500 in LTA tax on a £1.25M pot. Of course, if retirement benefits only just creep over the £1M, the benefit of protection will be much lower.
And remember that the LTA will be indexed again from April 2018. This means the value of protection will begin to erode as the LTA starts to increase in line with CPI.
Clients with fixed protection will need to seek an alternative home for their retirement saving. But this will come from their income after both tax and NI has been deducted. And none of the investment alternatives will match the returns available in the pension as all but ISAs are likely to suffer some form of tax on the investment returns.
Carry on funding – what to think about?
The benefit of fixed protection has to be balanced against the potential loss of employer contributions for some clients. Employer pension contributions are essentially ‘free money’. Even if they suffer an LTA charge of 55% on their entire future employer funding, they’ll still be better off. They’re still receiving 45% of something they would otherwise miss out on.
But some employer contributions are only payable if the employee also pays into the scheme. Even so, depending on the ratio of employee to employer contributions, it may still make sense to continue their own funding and take the LTA charge on the chin to retain the funding from their employer.
Some employers may be prepared to offer some other financial incentive instead of making pension contributions. Most employers are only likely to provide the employee with a cash compensation which equates to the same net cost of the pension contribution (i.e. salary sacrifice in reverse). So the amount of additional salary will be reduced in line with the employer’s additional NI liability. And of course, any alternative package will be taxable in the employee’s hands.
So that leaves the employee with much less in their hand to invest, compared to what they would have received as an employer contribution.
A difficult decision
It’s only natural to think tax charges should be avoided – especially one designed to act as a cap on funding. But it’s always important to weigh up all of the options available. And the alternatives will generally have their own tax consequences to be worked through before arriving at the most suitable outcome for the client. With the outcome of the pension tax relief review expected on 16 March, it leaves only a very short window to crunch the numbers.