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Lifetime allowance and annual allowance planning for the high net worth client

14 min read 6 Apr 22


Here’s what you need to consider in relation to the Lifetime Allowance and Annual Allowance to see if pension saving is still right for high net worth clients.

  • 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.

Tax charges may not always be a bad thing if the overall outcome is better for the client. What is crucial is that the relevant calculations are done so that the client knows what to expect. 

This article deals with planning for the high net worth client. 

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. These changes may have had an impact on high net worth clients. Calculations need to be carried out on an annual basis to decide if pension saving is still appropriate.

As there is no timescale for applying for Individual Protection 2016 (IP16) and Fixed Protection 2016 (FP16) then clients can apply at any point using the online system although it would be wise to do this before the next benefit crystallisation event (BCE).

It is also important to note that although there is no application deadline for IP16, the statutory obligation on scheme administrators to provide values at 5 April 2016 only applies for 4 years so, if you need pension values from your scheme, be sure to request these before 6 April 2020.

If clients have not yet applied for FP16 or IP16 then the key points to note are: 

  •  With FP16 clients will receive a £1.25 million Lifetime Allowance but they must have opted out/ceased paying into a pension as at 5 April 2016.

  •  With IP16, clients must have had £1 million or over in pensions savings as at 5 April 2016 and they will receive a personal lifetime allowance between £1m and £1.25 million but pension savings may continue.
"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."

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.

1. Calculate benefits based on existing arrangements projected to retirement

Considerations for Annual Allowance:

  • Defined contributions - levels of employee, employer and third party contributions

  • Defined benefit – benefit structure, accrual rates. Assumptions on salary increases and CPI for CARE schemes.

  • There will still be at least £10,000 tapered annual allowance available (or £4,000 for DC savings if the MPAA is triggered) so no need to fully stop pension saving

Considerations for Lifetime Allowance:

  • Considerations for defined contributions - contribution levels, term and anticipated investment return

  • defined benefit – assumptions on salary increases

  • Maximising PCLS when commutation less than 20:1 will reduce LTA usage.

  • CPI – for CARE scheme accrual and LTA increases (from April 2018 until April 2021  the LTA increased by CPI each year, this has now been frozen until the 2025/26 tax year)

  • Value of existing arrangements

2. Calculate overall cost of maintaining existing arrangements

Considerations for both Annual Allowance and Lifetime Allowance:

  • To allow fair comparisons the net of tax relief costs should be considered

  • There may be no/little cost to the individual if benefits are solely/mainly employer funded

3. Calculate benefits payable net of any tax charge

Considerations for Annual Allowance:

  • Scheme Pays – mandatory only or voluntary available?

  • Schemes arrangements for actuarial reduction of benefits including commutation factors.

Considerations for Lifetime Allowance:

  • Schemes’ rules may determine the basis on which any LTA excess can be taken

  • Where a choice is available consider the value of a lump sum after 55% tax, or a 25% charge and income thereafter at marginal rate tax.

Factor in any protections held

4. Calculate the value of “paid up/deferred” benefits at retirement date with no further accrual or contributions

Considerations for Annual Allowance:

  • Where pension contributions cease or member opts out of active membership there will be no more annual allowance usage

  • Carry Forward (for standard or tapered AA clients) will build up potentially allowing savings restarting in future (although re-joining is unlikely to be an option with DB schemes)

Considerations for Lifetime Allowance:

  • Deferred pensions revaluation rates will be needed for DB schemes

  • Money purchase pots will require the anticipated investment return

  • There could still be an LTA charge.

  • Factor in any protections held

5. Identify the value of alternate arrangements

Considerations for both Annual Allowance: and Lifetime Allowance:

  • What benefits would be provided by investing the net cost elsewhere?

  • There may be other losses through stopping e.g. employer matching contribution, employer sponsored life cover

  • Will the employer remodel pension / remuneration package and what are the tax implications?

6. Add the value of “paid up/deferred” benefits to the value of any alternative arrangements at retirement date.

Considerations for Annual Allowance:

  • Will clients want an increased salary now instead of a pension contribution?

  • Alternate benefits could be accrued in another tax wrapper

  • There will still be at least £4,000 tapered annual allowance available (or £4,000 tapered annual allowance for DC savings if the MPAA is triggered) so no need to fully stop pension saving

Considerations for Lifetime Allowance:

  • Will clients want an increased salary now instead of a pension contribution?

  • Alternate benefits could be accrued in another tax wrapper

Most clients will be unlikely to work through this process themselves and even where they could there’s still the need for advice to help them make the right decision.

If the client believes that the benefits payable (Step 3 of the process) represent value for money then the tax charge (Step 2) may be worth it.

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 1/60th 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
  Defined Benefit Defined Contribution

Pension accrued

£5,250 p.a.

£56,700

AA used

£84,000

£56,700

AA excess

£80,000

£52,700

AA charge

£36,000

£23,715

Benefit reduction

£1,800 p.a.

£23,715

Post AA charge benefit

£3,450 p.a.

£32,985

Net cost

£10,395

£10,395

*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.

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