Pension Lifetime Allowance Is To Be Cut… Again!

Next April’s pension lifetime allowance (LTA) cut to £1.25M could hit as many as 360,000 pension savers by the time they reach retirement.

At the same time, it presents a rare opportunity to broaden your top-end client base.

The two new options to lock into a higher allowance, while welcome, serve to complicate decision making for your clients – decisions that many will not even realise are crucial to their future retirement planning strategy. And making the wrong decision could potentially expose up to £250,000 of their pension savings to a 55% tax charge. That’s 137,500 reasons why they need your professional advice.

There is much to consider in the coming months. But the first step is to identify those clients at risk, and alert them to this fact. 

Who is caught in the LTA net?

From 2014/15, the LTA will be lower than when it was introduced in 2006. Financial advisers must cater for the realistic possibility that the allowance will be frozen for the foreseeable future – and might even be cut again.

This could radically change the retirement strategies used by wealthier clients.

HMRC estimate that 30,000 people will be immediately affected by next year’s LTA cut, with 360,000 expected to break this limit over the longer term. This takes the impact of the LTA way beyond the 1% of pension savers envisaged when it was introduced. In all, it’s likely to represent clients with over £250Bn of accumulated pension wealth.

A £1.25M limit may not set alarms bells ringing for many clients just yet. But, with a frozen allowance a distinct possibility for those within sight of retirement, they don’t have to be close to £1.25M now for it to become a problem. Investment growth can quickly accelerate the size of the pension pot.

This table shows the current pension pot that will grow to £1.25M over various terms to retirement based on different growth rates:

Years to go/growth 4% 6% 8%
3 £1,112,000 £1,050,000 £993,000
5 £1,028,000 £935,000 £851,000
10 £845,000 £698,000 £579,000

And this assumes contributions stop now.

So someone 10 years from retirement with a current pension pot of around £700,000 will exceed their allowance if their pot grows at 6% a year – even if they stop paying into it now. Yet it’s unlikely they’ll think they have a problem at this time. Of course, growth could be higher or lower than shown in the table – depending on the client’s investment strategy.

It’s even trickier where defined benefits are concerned. Few people understand how valuable a DB pension is – or how it’s tested against the LTA. Many would be surprised to learn, for example, that their £25,000 paid-up pension from a previous job already eats up £500,000 of their allowance. Adding early leaver revaluation up to retirement, at say 3.3% over 10 years, takes the pension up to £34,590 – using up almost £692,000 LTA.

The big decision.

The LTA cut presents clients with some difficult choices before next April. To protect or not? Which type of protection? Getting it wrong could cost £137,500 in extra tax. The value of advice is obvious.

Before you can help your clients do the right thing, they need to understand there’s an issue that could be costly if not addressed. There’s a real communication challenge to raise client awareness of this risk and avoid them sleep-walking into a tax charge.

But get it right and word of mouth could bring the issue to the attention of others, many of whom will need financial advice for the first time. This could present a rare opportunity to broaden your top-end client base.

The starting point is to segment clients into risk groups:

  1. Already above £1.25M, with no existing protection. These clients need to register for protection. But which?
  2. At risk of exceeding £1.25M at retirement, even if pension saving stops now. These clients need to review their pension before April. Protection must be seriously considered.
  3. At risk of exceeding £1.25M at retirement if pension savings continue. These clients need to review their pension regularly, even if they don’t opt for protection now.
This brings its own challenge.

You’ll need up to date values, and ideally projections, for all their pensions. This should be relatively straightforward for active DC pensions. But it could be more difficult for legacy plans and defined benefits.

And aside from the fundamental ‘protect or not’ question, the potential need to cease, or cut back on, pension saving after April 2014 raises a host of other advice issues:

  • Pay a final pension top-up before the shutters come down in April?
  • Review investments to de-risk them and mitigate the 55% tax charge?
  • Consolidate legacy pensions for easier policing?
  • Establish alternative (non-pension) tax wrappers for future savings?
  • What strategies might be employed for wealth de-cumulation?
  • What is the most efficient way to transfer wealth to the family?

There’s a lot to think about, and a lot to talk about, before April 2014. But a great opportunity to reinforce relationships with your existing top-end client base – and build on it.