Repurcussions of loss of Fixed Protection

[hiriskpaul]

I have a relative who has FP 2016 and fully crystallised her SIPP in September, using up about 38% of the LTA and just taking the 25% PCLS. She does not want to draw any income at present and would like to contribute £2880 (net) this year into a new SIPP. As I understand it she can do this and will not fall foul of the lump sum recycling rules, but she will lose FP 2016. I also believe that the 38% figure, based on the LTA of £1.25m will not change because she has lost her fixed protection.

Is all of this true?

[Taigo]

Hi There,

Just to confirm...

By fully crystallised do you mean that 100% of her SIPP is now in a flexi-drawdown less the 25% PCLS which has been taken and now sits in her estate (or has been spent)? The total pre-PCLS pension value was c.£475,000?

If so...

Her current age is a consideration as this would affect whether or not the FP2016 was likely to be needed in the future. FP2016 would be lost if she starts to pay in to a scheme now reducing her LTA to £1 million.

On face value, with the figures you have mentioned this doesn't seem to be too much of a loss as assuming she is now expecting to take an income from the pension at some point in the future and her drawdown funds are in a relatively low-risk portfolio so no massive gains expected, then arguably FP2016 is unlikely to have been of benefit anyway.

However, if she is a young retiree and/or has other sources of income and/or plans to leave this pension invested and not take an income there may be an argument for FP2016.

Using 3% compound growth the fund would exceed the new LTA in 2041 - 25 years from now

Using 4% compound growth the fund would exceed the new LTA in 2034 - 18 years from now

Using 5% compound growth the fund would exceed the new LTA in 2031 - 15 years from now

Using 6% compound growth the fund would exceed the new LTA in 2028 - 12 years from now

Any pension savings above the lifetime allowance are subject to the lifetime allowance charge. This charge will continue to be:
- 55% if the excess is taken as a lump sum
- 25% if the excess is taken as income, for example as a scheme pension, an annuity or drawdown. Income tax at your marginal rate will also be payable.

You are also correct that the LTA is %-age based.

The correct method for calculating LTA usage requires the past crystallised amount be indexed at the same rate the standard LTA has been indexed. This is done with the formula:

RUA x (CSLA/PSLA)

Where:

RUA - Relevant Untaxed Amount - the amount of the previous BCE
CSLA - Current Standard Lifetime Allowance - Standard LTA today
PSLA - Previous Standard Lifetime Allowance - LTA at the time of the previous BCE

[hiriskpaul]

Hi There,

Just to confirm...

By fully crystallised do you mean that 100% of her SIPP is now in a flexi-drawdown less the 25% PCLS which has been taken and now sits in her estate (or has been spent)? The total pre-PCLS pension value was c.£475,000?

Yes, she had about 480k pre-crystallisation, taking 120k PCLS, leaving 360k in drawdown. I think she is safe to contribute to a pension this year, but I am concerned I may have missed something such as a special rule that says if FP 2016 is lost in the same year benefits are taken the benefits calculation is redone. She would not want her 38% to suddenly become 48% just because she put £2880 into a SIPP this year.

Her current age is a consideration as this would affect whether or not the FP2016 was likely to be needed in the future. FP2016 would be lost if she starts to pay in to a scheme now reducing her LTA to £1 million.

On face value, with the figures you have mentioned this doesn't seem to be too much of a loss as assuming she is now expecting to take an income from the pension at some point in the future and her drawdown funds are in a relatively low-risk portfolio so no massive gains expected, then arguably FP2016 is unlikely to have been of benefit anyway.

However, if she is a young retiree and/or has other sources of income and/or plans to leave this pension invested and not take an income there may be an argument for FP2016.

Using 3% compound growth the fund would exceed the new LTA in 2041 - 25 years from now

Using 4% compound growth the fund would exceed the new LTA in 2034 - 18 years from now

Using 5% compound growth the fund would exceed the new LTA in 2031 - 15 years from now

Using 6% compound growth the fund would exceed the new LTA in 2028 - 12 years from now

Any pension savings above the lifetime allowance are subject to the lifetime allowance charge. This charge will continue to be:
- 55% if the excess is taken as a lump sum
- 25% if the excess is taken as income, for example as a scheme pension, an annuity or drawdown. Income tax at your marginal rate will also be payable.

Thanks for that, I worked out she would hit the LTA (index linked from 2018) with a 3.7% growth rate over inflation, assuming she took nothing out. Seems to be in line with your calculations.

You are also correct that the LTA is %-age based.

The correct method for calculating LTA usage requires the past crystallised amount be indexed at the same rate the standard LTA has been indexed. This is done with the formula:

RUA x (CSLA/PSLA)

Where:

RUA - Relevant Untaxed Amount - the amount of the previous BCE
CSLA - Current Standard Lifetime Allowance - Standard LTA today
PSLA - Previous Standard Lifetime Allowance - LTA at the time of the previous BCE

Thanks for pointing that out. I had forgotten that this was how subsequent BCE calculations were done. I thought that you just adjusted the percentage figure already crystallised, which is wrong. i.e. as she has taken 38.4% of the LTA, then the 2036 BCE 5 calculation would be done assuming she had taken 38.4% of whatever the LTA was in 2036. Just an extra bit of complexity to have to manage!

Either way I think she is in the clear putting £2880 into a pension this financial year. I will warn her of all the complexity though and I guess she really should review this every time the rules change and every year or so to make sure she is not likely to end up breaching the LTA.

[Taigo]

Quick question then, is the £2880 annual contribution valuable enough to lose the extra £250,000 that would come with FP2016? ISA allowances will grow to £20,000 from April 2017. Depending on her tax situation collectives may be tax efficient especially if CGT allowances can be used. Is there an argument for using a bond wrapper? If it were me, I would explore the alternative investment options before I lost the FP as this may end up proving more valuable than £2880 contributions ever could have!

Just a thought

[hiriskpaul]

Quick question then, is the £2880 annual contribution valuable enough to lose the extra £250,000 that would come with FP2016? ISA allowances will grow to £20,000 from April 2017. Depending on her tax situation collectives may be tax efficient especially if CGT allowances can be used. Is there an argument for using a bond wrapper? If it were me, I would explore the alternative investment options before I lost the FP as this may end up proving more valuable than £2880 contributions ever could have!

Just a thought

Yes, ISA is being considered as well. She already has a large ISA and her husband a big enough pension for them both to live off, so no real need to draw an income from her SIPP, or ISA at present. She will also have a small Teacher's pension, crystallisation value about £40k, starting in 5 years time and then both their state pensions. The main attraction of the SIPP route is the potential IHT saving. I think she is gradually moving towards not contributing the £2880 to a new SIPP.

Her SIPP is actually invested very aggressively. It is about 80% invested in US listed ETFs and the other 20% is in a iShares emerging markets ETF. She did have gilts and a corporate bond ETF but sold these to take her PCLS. Considering the fact that she does not need to draw an income, I see no reason to not continue investing her SIPP assets aggressively. So growth might easily be sufficient to use up her remaining LTA by her 75th birthday.