There is an easily-forgotten pension entitlement which advisers may wish to look into on behalf of their clients before the end of this tax year.
Back in 2006, A-day brought about pension simplification and an end to some of the complexities of previous regimes. Today’s pension environment includes pension freedoms, a flat 25 per cent tax-free cash and auto-enrolment, compared with those employer-sponsored schemes based on an individual’s pensionable salary, service and, depending on the underlying regime, a further multiplying fraction.
These calculations often provided for tax-free cash entitlements of in excess of 25 per cent and could even be 100 per cent. Entitlements were able to be protected after A-Day as long as certain conditions were met.
In another part of the pensions world, the lifetime allowance (LTA) has fallen substantially since the dizzying heights of £1.8m in 2010. Three consecutive reductions have left it at a lowly £1m, but as confirmed in the Autumn Budget, the first rise is now imminent with a 3 per cent inflation-linked increase to £1.03m in April 2018.
So, what does the relationship between these two apparently alien concepts mean for clients with scheme-specific tax-free cash?
Mr Jones had a Section 32 contract valued at £300,000 with a tax-free cash entitlement of £150,000 as at A-day. To calculate what this is worth to Mr Jones this tax year, a two-stage calculation is needed:
- Mr Jones’ tax-free cash entitlement as at 5 April 2006 is revalued by 20 per cent (being the increase in the LTA as at A-day of £1.5m, and the underpinned LTA of £1.8m used in this part of the calculation formula).
- An additional amount of tax-free cash representing 25 per cent of the increase in value of the pension fund since 6 April 2006. This is applied after proportioning down the fund value as at 6 April 2006 to reflect the reduction in the LTA to below its value at 6 April 2006, and paid as a lump sum.
|Value of fund @ 5 April 2006||£300,000|
|Scheme specific tax-free cash @ 5 April 2006||£150,000|
|Value of fund today||£ 380,000|
Step 1: £150,000 x 120% (£1.8m / £1.5m) = £180,000
Step 2: (£380,000 - [£300,000 x £1.0m/£1.5m]) x 25% = £45,000
Total = £225,000
A planning opportunity
As the LTA is increasing to £1.03m from 6 April, Mr Jones’ cash entitlement will begin to reduce due to the second part of the calculation, where the uplift takes place looking at the LTA from A-Day and the LTA when benefits are taken.
In order to avoid an increasing LTA adversely affecting his tax-free cash, Mr Jones can take the tax-free cash this tax year. He can then designate the remainder of the fund to flexi-access drawdown and remain invested until he needs further benefits.
The chancellor by and large left pension policy alone in the Autumn Budget. But this does not mean there will not be changes in the future as the government look to stabilise the UK balance sheet. While there are always rumours about what these changes could be, any recommendations given should be on facts at the time rather than conjecture, and should be specific to your client’s aims and objectives.