Category: Financial Planning for Lawyers

Lifetime Allowance Falls to £1m: Could you be caught?

Pension Lifetime Allowance (LTA) decreased to £1m on 6 April 2016. In combination with previous reductions, it has fallen almost by half from its 2012 high of £1.8m. High net worth professionals like solicitors, barristers and accountants often underestimate the risk of exceeding their LTA. That might become very costly in the future. Above LTA, pension income is subject to 25% tax and lump sum a whopping 55%.

Example
Consider George. He is an accountant and has his own accounting business. He is in his 40’s, approaching halftime of his career. His pension pot is worth about £400,000. George considers himself comfortable, but not particularly rich. He’s heard the news about the falling LTA, but £1m sounds like different world. He’s nowhere near a millionaire after all, so he doesn’t need to worry about LTA.

Truth is, if George continues to contribute to his pension plan at the same rate, or (more likely) increases his contributions a little bit in the later years of his career, he can easily get dangerously close to the £1m mark, or even exceed it. This does not mean that he should stop contributing, but the sooner he becomes aware of the issue and starts planning, the wider options he has.


What are the options for senior professionals at risk of exceeding the new LTA?

LTA Protection
First, if you are likely to exceed the new reduced LTA (£1m), or already have, you can apply for LTA Protection, which is a transitional scheme to protect taxpayers from the unexpected LTA reduction. Depending on your circumstances you have two main options:

  • Individual Protection for those with pension pots already worth over £1m. Your LTA will be set to the lower of 1) the current value of your pension 2) £1.25m (the old LTA).
  • Fixed Protection for those with pension pots below £1m at the moment, but likely to exceed it in the future. Your LTA will be $1.25m, but no further contributions are allowed.

Other conditions apply and many factors must be considered when deciding whether LTA Protection is worth it in your case. Also note that a similar LTA Protection scheme has been in place for the 2014 decrease in LTA (from £1.5m to £1.25) – you can still apply until 5 April 2017.

LTA Planning Options and Alternatives
If you have higher income and want to save more than the LTA allows, the first thing to look at is an ISA. It won’t help you reduce taxes now, because it’s always after-tax money coming in, but in retirement you’ll be able to draw from your ISA without having to pay any taxes – capital gains, interest and dividends are all tax-free within an ISA. There is no lifetime allowance on ISAs, only an annual allowance, currently at £15,240 and rising to £20,000 in April 2017. Furthermore, you don’t even have to wait for retirement – you can withdraw from your ISA at any time.

Another alternative is to invest in stocks, bonds or funds directly, outside a pension plan or ISA. Capital gains, interest and dividends are subject to tax in this case, but there are relatively generous annual allowances which you can take advantage of – the most important being the CGT allowance, currently at £11,100 (the first £11,100 of capital gains in a tax year is tax-free).

These two options alone provide a huge scope for tax-free investing when planned properly. Those on higher income may also want to consider more complex solutions, such as trusts, offshore pensions or offshore companies, although the use of these always depends on your unique circumstances and qualified advice is absolutely essential – otherwise you could do more harm than good.

Conclusion
LTA planning must be taken seriously even when it seems too distant to worry about at the moment. Pensions are the cornerstone of retirement planning, but not the only tool available. With careful planning, a combination of different investment vehicles and tax wrappers is often the most efficient, especially for higher net worth professionals.

New Pension Freedoms Bring Opportunities As Well As Risks

Recent years have seen some significant changes to the tax treatment and rules governing pensions and death benefits. Many of these changes have been quite favourable, bringing new freedoms and tax saving opportunities. However, these freedoms go hand in hand with responsibilities and risks. We will look at the most important challenges and ways to ensure your investments achieve the best possible performance, serve your income needs and at the same time remain tax efficient – both in retirement and when your wealth eventually passes to your heirs.

The Changes

The Government has recently changed financial and tax legislation in many areas, but there are two things which are particularly important when it comes to retirement and inheritance tax planning.

Firstly, you now have greater freedom to decide how to use your pension pot when you retire. You can take the entire pension pot as lump sum if you wish (25% is tax-free, the rest is taxed at your marginal rate), you can take a series of lump sums throughout your retirement, you can buy an annuity or get one of the increasingly popular flexible access drawdown plans.

Secondly, you now have complete freedom over your death benefit nominations. Before the reform, which came into effect in April 2015, you could only nominate your dependants (typically your spouse and children under 23). Now you can nominate virtually anyone you wish, such as your grandchildren, siblings, more distant relatives, or even people outside your family. Furthermore, the taxation of death benefits has become more favourable. If you die before 75, death benefits are tax-free (lump sum or income, paid from crystallised or uncrystallised funds). If you die after 75, death benefit income is taxed at marginal rate of the beneficiary (lump sum is subject to 45% tax, but that may also change in the near future). The reform has turned pensions and death benefits into a powerful inheritance tax planning tool.

The Challenges

While the above is all good news, there are some very important restrictions and things to watch out for. Neglecting them can have costly consequences. For instance, the Lifetime Allowance not only still applies, but has been significantly reduced in the recent years (it is only £1m now). Besides the annual pension contribution allowance it is one of the things that require careful planning long before you retire. In retirement, pension income is typically subject to income tax, which must be considered when deciding about the size and timing of withdrawals, particularly if you have other sources of income.

Asset allocation and investment management is another challenge. Maintaining a good investment return with reasonable risk is increasingly difficult in the world of record low interest rates. It is tempting to completely avoid low-yield bonds and other conservative investments in favour of stocks, but such strategy could leave you exposed to unacceptably high levels of risk, particularly in the last years before your retirement. A balanced portfolio of stocks and bonds is often the best compromise, but asset allocation should not be constant in time – it should be regularly reviewed and should reflect your changing time horizon and other circumstances.

Death benefit nominations are another area where changes in financial and life circumstances may require reviews and adjustments, particularly after the age of 75, when potential death benefits are no longer tax-free. For example, if your children are higher rate taxpayers, you may want to change the nominations in favour of your grandchildren, who may be able to draw the income at zero or very low tax rate, allowing you to pass wealth to future generations in a tax-efficient way. If you have other sources of income and are a higher rate taxpayer yourself, you may even choose to not draw from your pension at all and keep it invested to minimise total inheritance tax.

Conclusion

The above are just some of the many things to consider. Depending on your particular situation, there might be tax saving opportunities which you may not be aware of. Conversely, ignorance of little details in the legislation or mismanagement of your investments may lead to substantial losses or tax liabilities. The new freedoms (and related challenges) make qualified retirement planning advice as important as ever before.