The impact of Coronavirus and lockdown on investment markets is there for us all to see. For clients who had pension funds around the Lifetime Allowance (LTA) limit, it is entirely possible that they may find themselves, albeit temporarily, below that level.
For clients in this position now is exactly the time when a reshaping of their pension and personal investments may yield benefits. Statements frequently heard such as “hang in there” and “keep your tin hat on” are emotional responses and do not project a proactive response to the situation. The case study below shows the importance of getting timely advice whilst highlighting that something positive can result from what is a negative situation.
JAMES & HIS LIFETIME ALLOWANCE
In February of this year, James had two pension arrangements: his SIPP which was valued at £1,260,000 and an historic Defined Benefit scheme with a value (for LTA purposes) of £130,000 (deferred pension of £5,000 p.a. and tax-free cash of £30,000). He has Fixed Protection 2016 meaning a Protected LTA of £1,250,000. James was not intending drawing benefits for 5 years and had been looking at a Lifetime Allowance tax charge at some point in the future which could be as much as 55%.
The equity market falls reduced the value of his SIPP to £950,000 and on first impression, the LTA issue has gone away, but only temporarily, as if markets recover before James draws benefits, the problem could return.
A movement of some of the pension assets to a personal environment allows for some future investment gains to be outside of the LTA remit. Whilst on face value this appears to put James in the same position he was before the global pandemic, it actually significantly increases the overall tax efficiency of his affairs.
As shown below in Scenario 1, if James draws his tax-free cash sum (£237,500) from the SIPP now, when markets are at their depressed levels, and adds them to his personal investments, he crystallises only 76% of his Lifetime Allowance. This means that James retains £300,000 (24% of £1,250,000) of LTA headroom for when his Defined Benefit scheme comes into payment and for investment gains on his residual SIPP funds.
|Value of SIPP||£950,000||(76% crystallisation)||Residual SIPP|
7% inv return)
Value of DB pension can be up to £300,000 before LTA charge.
The DB pension and tax free cash will likely be increased in the deferment period, by inflation or possibly more, but in James’ case the headroom created of £300,000 should be more than sufficient to wipe out any LTA tax charge, leaving the DB pension benefits to be paid in full.
Had James not drawn at the depressed levels of the market and identical investment returns had been obtained, the combined values of his SIPP and Defined Benefit scheme would have exceeded his protected Lifetime Allowance by £50,000 as shown in Scenario 2.
|Draw in four years||£950,000||Residual SIPP|
|Year 2||£1,067,400||(assume 7% inv return)|
Value of DB pension over £50,000 subject to LTA.
Time to reshape savings & investment plans
James’ overall position needs to be considered in the planning, to look at the potential taxation implications of his personal investments and also the early increase in value of James’ estate for purposes of IHT planning.
The proposal does demonstrate the value of assessing alternative strategies even when others might just be riding out the storm. In addition to reducing the potential LTA charge payable on his pension assets, James can now utilise his ISA allowances in conjunction with his annual capital gains tax exemption to manage the potential tax liability associated with his personal investments.
Should this expertise be of importance to you or your clients please contact Julie Sebastianelli or Martin Collins by e-mail or visit our website at hurleypartners.co.uk.
Hurley Partners strongly recommends that individuals should seek suitable professional advice regarding the matters referred to in this document, which has been prepared for general interest only. Nothing in this document constitutes advice. Hurley Partners Limited is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No. 8401891. Registered Office; 12 Conduit Street, Mayfair, London, W1S 2XH. © Hurley Partners Limited 2020