• Calculations may need to be carried out every year if Lifetime Allowance and Annual Allowance could be an issue.
• In 2016 there was another reduction in the Lifetime Allowance, new protections and a change to annual allowance with the introduction of the Tapered Annual Allowance.
• When undertaking a planning process there are considerations particular to whether Lifetime Allowance, Annual Allowance or both apply for a client.
• Even if lifetime allowance or annual allowance tax charges apply, pension saving could still be advantageous for your client.
• Alternative tax efficient strategies could involve vesting to drawdown and recycling income efficiently or using Enterprise Investment Schemes, Venture Capital Trusts, Open Ended Investment Companies, Bonds or an ISA.

There are lots of different types of clients who all have different circumstances, are members of different types of schemes and have a range of different benefits. Planning will be different for each of these clients but the process for all may be the same.

1. Calculate benefits based on existing arrangements projected to retirement
2. Calculate overall cost of maintaining existing arrangements
3. Calculate benefits payable net of any tax charge
4. Calculate the value of “paid up/deferred” benefits at retirement date with no further accrual or contributions
5. Identify the value of alternate arrangements
6. Add the value of “paid up/deferred” benefits to the value of any alternative arrangements at retirement date.

The process is logical, but there are considerations particular to whether Lifetime Allowance, Annual Allowance or both apply to a particular client.

The client is a 40% tax payer and has a level salary of £100,000. They are currently a member of their employer’s defined contribution pension scheme where the employer pays 6% of salary as standard and employee contributions are matched 1 for 1 up to 6%. They plan to retire in 5 years. The fund was valued at £900,000 on 6 April 2020. They are considering whether they should stay a member (and if so should they contribute or not) or opt out of the scheme.

_{*Assumptions: payments monthly in arrears, investment growth 5% net, future LTA increases at 2.5% per annum and any LTA excess taken as lump sum at 55% tax.}

_{** 6% of £100,000 less 40% tax relief for 5 years}

B is higher than A at “no cost” to the individual but this is only half the process. Step 5 is key. If the employer is willing to provide an alternate benefit e.g. a higher salary now, the client may value that more than the difference between A and B e.g. a higher salary, so the decision may change.

In this example the values for B&C work out the same if taking a lump sum, but if benefits were designated to income there would be a £51,004 greater pot after LTA charges in C to provide income.

Essentially you have to assess if higher benefits are worth the cost? Could an alternative strategy return something more valuable with the same outlay?

The logic behind case study 2 is exactly the same as the first, but the important fund value is the value as at 5 April 2016. Why is this date important? This individual could still apply for IP16. They can’t apply for FP16 as there have been contributions since 5 April 2016. Does the starting value of the fund make a difference?

_{*Assumptions: payments monthly in arrears, investment growth 5% net, future standard LTA increases at 2.5% per annum and any LTA excess taken as lump sum at 55% tax.}

_{** Based on a 2.5% increase the standard LTA would be £1,184,502, therefore the Individual Protected LTA will still apply.}

_{*** 6% of £100,000 less 40% tax relief for 5 years}

The same principle applies at higher starting points. But has pension freedom changed the dynamic?

If A, B and C are compared then in A the lump sum could be 25% of £1.2 million (£300,000) plus £153,014 LTA excess lump sum which is £453,014 with a remaining fund of £900,000 (total £1,353,014). Using the same theory, in B the total lump sum could be £468,315, with a remaining fund of £900,000 (total £1,368,315). In C the total lump sum could be £498,918 with a remaining fund of £900,000 (total £1,398,918).

Would the client value a higher lump sum and lower fund over a higher overall wealth? Could alternative remuneration arrangements create a higher return?  But would a client prefer pension, perhaps due to IHT issues?

C “beats” A, is equivalent to B in fund size but the lump sum after tax is higher – could the client do something better with an alternative non pension approach?

Prior to pension freedom, based on the options then available, a member may have preferred a higher LTA excess lump sum and a lower pension fund rather than  annuitising or entering drawdown with the relatively poor death benefits.

Pension freedoms have changed this dynamic. The ability to withdraw up to 100% of the pension pot could mean that the higher pension pot may be turned into a higher overall amount outside the pension.

In this case study the client is a member of a 1/60^th Defined Benefit scheme. They have a pensionable salary of £150,000, has 34 years service at 6 April 2020, retires in 5 years at Normal Retirement Age of 65. Pay rises of 2% per annum are assumed, deferred pension revalues at 2.5% per annum and commutation factor for LTA excess is 20:1. As at 5 April 2016 his salary was £150,000 and he had 26 years’ service. He applied for IP16 and was capped at the maximum of £1.25m.

_{*Assumptions:  future standard LTA increases at 2.5% per annum, LTA excess taken from income using a factor of 20:1
** Based on a 2.5% increase the standard LTA would be £1,184,502, therefore the Individual Protected LTA will still apply.
*** 6% of increasing salary less 40% tax relief for 5 years. Personal allowance tax trap ignored (this would lower the net cost).}

In essence, the same thought process applies where defined benefits are involved. Clearly, in the DB world pension freedom isn’t a factor.

There’s a “twist” though – the added consideration of the inherent value in a defined benefit pension arrangement and the likelihood of being able to replace any reduction in benefit.

B is higher than A even though it’s post tax – can £28,101 be invested, with or without a remodelled employment package to produce something more valued than the increase in pension of £17,299 per annum guaranteed for life?

For annual allowance it is the same thought process but different calculations.

In this case study the client is 45% taxpayer with a salary of £315,000 (as such AA has been tapered to £4,000) and has no carry forward available.

The comparison made below is:

• a member of a DB 1/60^th scheme, with employee contribution of 6% where the scheme pays the AA charge (based on commutation factor of 20:1).
• a member of a DC scheme where employer pays 6% of salary as standard, employee contributions are matched 1 for 1 up to 6%. Scheme pays AA charge

_{*Assumptions:  inflation ignored}

Therefore, the client of the DB scheme pays £10,395 net to generate an additional pension of £3,450 per annum and the member of the DC scheme generates an additional fund of £32,985 at the same net cost.

The calculations and value judgement to be made is perhaps easier where Annual Allowance is an “issue” – would a client pay £x to get £y.

If annual allowance and lifetime allowance are both an issue then the process is the same but the calculations are trickier.

Whether it’s DC, DB, Annual Allowance or Lifetime Allowance or a mixture the thought process should be broadly the same. Maths ability may be just as important as pension knowledge.

Alternative tax efficient strategies that may be suitable could involve vesting to drawdown and recycling income efficiently (but bearing in mind any potential reduction in the MPAA) or paying into others pensions, EIS, VCT, OEICs, Bonds or ISA?

The key point that clients need to remember is that tax is only bad if the net benefit is not deemed “worth it”. Opting out to save a tax charge, even if the net benefit is better, would be a bit like a client asking their employer to stop paying their salary because there is a tax charge.