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Lifetime Allowance cut: How to protect your pension pot from tax

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Written by: Paloma Kubiak
31/03/2016
The Lifetime Allowance will be cut from £1.25m to £1m next week but you may be able to apply for fixed protection or individual protection to shelter your retirement savings from the taxman if they go above this threshold.

The Lifetime Allowance is the maximum amount of pension savings you can build up without a tax charge and this figure will be cut from £1.25m to £1m on 6 April. At the time of the announcement, the government said it would only impact 4% of the wealthiest population, however it could also affect those working hard to save for their retirement.

There are currently three different ways to protect your money, depending on the amount and the date at which the sum was accrued.

Fixed Protection (FP) 2016

This will continue to give you a lifetime allowance of £1.25m and while there are no time or other restrictions regarding the size of your pension savings, you must stop contributions to your pot on or before 5 April 2016 if you want to fall back on this protection at a later date.

This includes both personal contributions into your defined contribution pension scheme, as well as the accrual of further benefits into a defined benefit pension scheme.

If benefits accrue or contributions are made after 5 April 2016, it could invalidate the FP 2016, meaning you could be charged either 25% on the excess when you withdraw the money as an income or 55% if it’s withdrawn as a cash lump sum.

Further, if you join or start saving into a new pension arrangement after this date, again you may invalidate the protection.

You can only apply from 6 April and can’t currently apply online at HM Revenue & Customs for the protection (it’s set to introduce an online portal in July). Instead you’ll need to write to it at Pension Schemes Services, Fitzroy House, Castle Meadow Road, Nottingham, NG2 1BD. You’ll be given a temporary reference number which is valid until 31 July 2016. After this, you’ll need to make a full online application to ensure your pension savings continue to be protected.

Individual Protection (IP) 2016

The main difference between FP 2016 and IP 2016 is that the latter allows you to continue to contribute into your pension pot but it will only protect the amount you’ve saved as at 5 April 2016 – anywhere between £1m and £1.25m.

In order to apply for IP 2016, you need to know how much your pension pot is worth as it stands on 5 April 2016. You should contact your pension provider or providers if you’ve several schemes to see the total value. If you go above the amount protected, it will be subject to tax as above.

IP 2014

This is basically the same as IP 2016 but is available to those who had over £1.25m at 5 April 2014 – when the Lifetime Allowance threshold was higher, and it gives protection up to £1.5m. Unlike the other two, there is a deadline to apply for this protection – 5 April 2017, but you can do it online at HMRC. Again, you may need to ask your pension provider to see how much your pensions were worth at that point and to check you’re eligible.

I’ve just over £1m in retirement savings, what should I do?

Claire Trott, head of pensions technical at Talbot and Muir, says it may be worth applying for both IP 2016 and FP 2016 as you’ll get the higher allowance of £1.25m.

Should you lose FP you will still have a Lifetime Allowance equal to the value of your benefits at 5 April 2016 under IP 2016.

As an example, if you have £1.1m in your pension and you cease contributions meaning you’re eligible to apply for FP 2016 and a Lifetime Allowance of £1.25m, if you’re accidentally auto-enrolled into a workplace pension, you’d invalidate the FP 2016, reverting back to a Lifetime Allowance of only £1m. However if you’ve both, you would only revert back to a Lifetime Allowance of £1.1m.

I’ve more than £1.5m in my pension pot, what can I do?

If this total sum was accrued after 5 April 2014, you could apply for FP 2016 although you will only have a Lifetime Allowance of £1.25m.

If the sum was accrued before 5 April 2014, you may be eligible to apply for IP 2014, but this will only protect the value of your benefits at 5 April 2015, up to a Lifetime Allowance of £1.5m.

If you plan to continue your pension contributions, IP 2016 may be for your consideration.

Anything above these thresholds would be subject to tax as noted above.

However, Trott says the Lifetime Allowance charge is “only designed to remove the benefit of tax relief received on funds over the threshold” so you’re “unlikely to be worse off even if you do go over it”. She adds: “I say unlikely because if there are changes to tax relief in the future on pension contributions or income tax on pension payments, then it may not quite work out that way.”

I’ve £800,000 in my pension pot but have a way to go till I retire, do I need to do anything?

Trott says this depends on how long you have until you retire, what you or your employer’s contributing, how you see your investments growing and ultimately, if there are any further changes to the Lifetime Allowance. “If you feel your pension may exceed £1m by the time you want to access it and you can redirect your personal and employer contributions then you may want to consider stopping and applying for Fixed Protection 2016, although there is no telling what will happen in the future.

She adds that you could just continue as you are and reassess nearer the retirement date or if your fund gets closer to £1m. “It means you won’t be able to apply for protection then but you may not need to and it could mean you’ve lost out on some tax relief and contributions.”

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