Protecting your pension

With only a few months to go before people need to register for fixed protection, Adrian Walker says advisers should identify any individuals where this issue could be a key part of retirement planning

By registering for fixed protection, people can protect the value of their pension savings up to a crystallised value of £1.8m - i.e. the current lifetime allowance.

However, a lifetime allowance charge will still apply on the value of benefits exceeding that level when they crystallise their funds. Unlike the three-year window applied in April 2006, when the Labour government introduced primary and enhanced protection, people will only have until 5 April to register for fixed protection with HMRC.

Advisers and individuals could be forgiven for thinking this may affect only a few individuals with ¬urrent significant values within their registered pension scheme funds. This, of course, is a natural conclusion to come to.

However, the issue goes wider as many more individuals could be affected by the reduction of the lifetime allowance to £1.5m. There are a few key issues to consider when reviewing whether someone should register for fixed protection by the end of this tax year.

Key considerations

The first is to consider what the current value of the person's pension funds is combined within money purchase and defined benefit arrangements. Any projected pension rights from a defined benefit scheme will have a capital -conversion factor of 20:1 applied to determine the lifetime allowance value. If the scheme offers a tax-free lump sum as well as pension funds, then the face value of the tax-free lump sum in the calculation must be taken into account.

The second factor to consider is the future time period before a person is intending to crystallise the benefits they have built up in registered pension schemes by the end of this tax year.

The final issue is to consider the person's investment attitude to risk where they have money purchase funds built up. This will broadly fix the likely investment returns they could achieve and expect from their existing investments by the time they intend to take those benefits to provide retirement income.

The longer the future time horizon before a person intends to draw retirement income from their existing investments, the lower the current value of benefits becomes before fixed protection becomes a consideration.

The graph (see below) discounts a lifetime allowance of £1.5m by various rates of investment return (net of any underlying product or investment charges) over various timelines. This is intended to reflect potential time horizons someone may have before they will want to access their retirement funds to provide income.

It shows the current value of pension rights that, based on assumed future investment returns, could provide a retirement fund that could exceed a lifetime allowance of £1.5m.

The graph also shows that the longer the outstanding term before someone intends to draw their pension benefits, the lower the current capital value of rights will be where there is a future threat to exceeding the lifetime allowance that will apply from the beginning of next tax year.
This analysis does not advocate that everyone with a long-time horizon to retirement with current reasonable-sized values should register for fixed protection. But it does mean they need to review their long-term retirement income planning.

For those who decide fixed protection is appropriate for them, the rest of this tax year represents the last opportunity for payment of relievable pension contributions.

Anyone with high relevant earnings, or those able to benefit from employer contributions, should maximise the current year's allowance by carrying forward any unused annual allowance from pension input periods ending in the three previous tax years.

With clever use of pension input period planning, such funding could also include the using up of the annual allowance for the 2012-13 tax year by payment of contributions in this tax year.

For many others, the benefits of continuing to receive contributions beyond the end of this tax year, as well as the tax relief that will apply to those contributions, will outweigh the need to register for fixed protection.

They will need to regularly monitor the future funding they want to make, alongside projecting forward those values, taking into account the levels of investment performance achieved and the future returns they expect.
This planning will become very important with the introduction of auto-enrolment for many as they will not want to miss out on valuable employer contributions that will be included in such arrangements, alongside the tax relief that would be generated from contributions they wish to make in the future.

Flexible retirement options

When considering these issues, people will need to take into account the impact on their lifetime allowance of using the more flexible retirement options of capped and flexible drawdown.

They need to be aware that where they use such options before they reach their 75th birthday, their benefits will be tested twice against the lifetime allowance.

The first time will be when the tax-free lump sum is taken alongside the income withdrawal fund. The second time will occur either before age 75 when they purchase an annuity, or at their 75th birthday. Any increase in the capital value of their income withdrawal fund will produce a second benefit crystallisation event test against their available lifetime allowance.

This will lengthen the period of time over which their current fund value will need to be tested against the projected reduced lifetime allowance. It may also impact how they take their retirement income in order to avoid a lifetime allowance tax charge on part of their pension savings.

They may choose to extract income more quickly from their fund. Although this income will mean those payments will be subject to income tax, it will be at a lower rate than the 55% lifetime allowance charge on any excess growth above the remaining lifetime allowance.

Retirement income planning will need to include a more holistic approach using funds from other assets clients hold, such as ISAs and collectives, and the order in which they should be taken.

Adrian Walker is head of retirement planning at Skandia