While more than 325,000 people have registered for protection against the lifetime allowance since its inception in 2006, more recently numbers have dropped significantly leaving some savers potentially exposed to unnecessary tax bills.
Just 4000 new applicants registered for lifetime allowance protection in the most recent year. It’s worth noting that we could reasonably have expected a drop in numbers due to the last lifetime allowance reduction taking place back in 2016.
This means that most eligible parties will have applied already and the number of people eligible will naturally reduce over time. However, this issue is still extremely important due to a number of external influencing factors.
Tax Relief Cuts and LTA Freeze
Firstly, we have the government’s five-year freeze in the value of the LTA to contend with. Announced in the March 2021 Budget, the LTA will be frozen at its current level of £1,073,100.
This comes after a number of pension tax relief cuts which means savers who planned when the limits were higher may need to reassess their situation to avoid high tax liability when they start to draw their pensions. For example – after the LTA was cut from £1.25m to £1m in April 2016, those with pots worth £1m+ needed to put protection in place.
HMRC has offered people two forms of protection after each cut, acknowledging that individuals will have made financial plans on the basis of the higher limit.
The Different Types of Protection
The first type of protection – Fixed Protection 2016 (FP 2016) – means that individuals can lock in the previous LTA of £1.25m but they cannot make any further pension contributions or they will invalidate their protection. To date, 44,800 people have locked in FP 2016.
The second form of protection is individual Protection 2016, designed for those who already had pension pots worth more than £1m at the time the LTA was cut. These individuals can use IP 2016 to lock in a personalised LTA of whatever their pensions were worth at the time.
More than 27,500 people have opted for this option, which is especially valued for the fact it cannot be lost except under exceptional circumstances. Under IP 2016, you can also continue saving more into a pension without losing the protected LTA.
To apply for IP2016, savers need a pension pot worth between £1m and £1.25m. They can continue to build up pension rights – perhaps through continued service in a Defined Benefit pension scheme. Their personal LTA would remain the value of their pension wealth in 2016 as opposed to the £1m figure.
There are conditions that mean individuals are ineligible for certain types of protection. For example, you cannot apply for fixed protection 2016 if you already have enhanced protection, primary protection, fixed protection or fixed protection 2014 in place. You also cannot apply for individual protection 2016 if you have either primary protection or individual protection 2014.
Should I apply for protection?
It’s not only those people whose pensions already exceed the lifetime allowance that should consider applying for your protection. If you think that you’re on a track where you might exceed the LTA in the future, we recommend considering the different types of protection available that might be worth taking out. It may also be possible to apply for protection posthumously – if somebody has passed away and LTA charges are due on the estate, a successful application for LTA protection could result in significant tax savings.
The risks of breaching the LTA
Even if protection is lost later, it’s well worth applying for. Current estimates suggest that 1,25 million non-retired people will breach the current allowance. Pension tax rules are strict and mean that those who breach the LTA face hefty retirement tax charges.
Once your pot exceeds the lifetime allowance, any withdrawals attract extra tax with income payments subject to 25 percent tax on top of your normal rate marginal rate and lump sum withdrawals incurring a 55 percent penalty.
Due to its complexity, we recommend taking professional advice especially as such a decision will be most effectively made within the context of wider pension savings and retirement planning.
An independent financial adviser can offer tailored guidance on your savings, including how investment growth might impact your pension pot and the type of protection that may work best for you. They can also review your retirement plans and ensure your goals remain aligned with your financial forecast.
For advice and support with navigating the LTA, contact our team at Broad Street today.
Risk Disclaimer: The information contained within this communication does not constitute financial advice and is provided for general information purposes only. . No warranty, whether express or implied is given in relation to such information. Broad Street Financial Planning shall not be liable for any technical, editorial, typographical or other errors or omissions within the content of this communication.