Why I have applied for Fixed Protection 2014

23rd Mar '14 by fek47

12 comments 8433 reads

As most readers will already be aware, the aggregate amount that can be saved in an individual's registered pension plans is subject to a limit known as the Lifetime Allowance (LTA). If at the date of your retirement (or certain other “benefit crystallisation events”) the total value of your registered pensions exceeds the LTA, the excess is subject to a tax charge of 55% if taken as a lump sum, or a 25% surcharge on normal income tax rates if taken as pension income.

At present, unless you have previously applied for Basic/Enhanced/Fixed Protection, the default Lifetime Allowance is £1.5m. As part of the measures introduced by Finance Act 2013, with effect from 6 April 2014 the default LTA is being reduced to £1.25m. However, anyone who is already a member of a registered pension scheme may apply for “Fixed Protection” up until 5 April, which locks in the existing LTA of £1.5m for the future. The ‘cost’ of applying for Fixed Protection is that you may not make any further pension contributions after 5 April 2014, and if you do make a pension contribution after this date then Fixed Protection is irreversibly lost and your LTA reverts to the default that is in effect at the time.

My SIPP is currently worth just shy of £45,000. I’m clearly therefore some way short of either £1.25m or £1.5m, so hardly an obvious candidate for applying for Fixed Protection. However, as I’m not yet 30, this means I have at least another 25 years of investment time before I’m allowed to access the funds in my pension at age 55. By my calculations, to reach £1.5m from a starting point of £45,000 over 25 years requires an average compound growth rate of 15.06% per year. A relatively ambitious growth target perhaps, but bear in mind this by definition includes re-investment of all income & gains produced by the investments within my SIPP.

However, there was a sting in the tail buried deep within the Budget papers which most commentators seem to have missed. The Government now intend to link the age at which a private pension can be accessed to the planned increases in the State Pension age which come in from 2028 onwards. Someone of my age who is not expected to qualify for the State Pension until age 68 will therefore…

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emptyend

24th Mar '14

I shall be doing the same, even though I am on the cusp of retirement and the total of my pension entitlements falls significantly short of either the 2014 limit or the new one. But it ain't so significantly short that I couldn't exceed the LTA by the time I might actually want to use the pension fund.

I just need to wait for confirmation that my final pension contribution has cleared.

pooledaniel

Interesting! I applaud your confidence in starting with just a £45,000 pot. Definitely achievable, but I'd be a little cautious; it's hard to know what the next 20-30 years may bring. Things may go well and you'll be in a strong position, but if there were significant downturns you could get caught short.

I'd also fully expect the LTA to actually rise in future given the push for pensions provisions to increase. If you assume around 2.5% pa inflation over the next 30 years, the 'real' LTA is only ~£600k. This, in reality, is too low. With life expectancies also rising - I don't see that it will be sustainable to keep the LTA at such a low level.

As an aside... the changes to pensions are actually very very interesting. The whole industry is going to be going through some substantial changes over the next couple of years. DC is suddenly a lot more attractive, and I'd be conscious of ensuring that you have a high probability of a decent sized pot when you hit your desired retirement age.

Best of luck whatever you choose!

pka

25th Mar '14

I am not an expert on pensions, but what you are doing does not seem very wise to me. By applying for Fixed Protection 2014 with a SIPP worth just £45k, you are preventing yourself from making any future contributions into your SIPP. This means that, in future years, if you will be in one of the higher rate bands for income tax, you will not have the ability to use pension contributions to make large savings in income tax in those years. You are therefore voluntarily giving up a huge amount of flexibility in your future options for financial and tax planning. The only benefit I can see from doing this is that you are protecting yourself against the possibility of your current £45k SIPP eventually growing to £1.5m, rather than £1.25m, by the age when you are able to withdraw money from your SIPP. But this increases your maximum pension pot by just 20%, and it would only be of benefit to you if you are actually able to achieve the compound annual growth rates that you are projecting over the next 25 years, which in my opinion would be an outstandingly good investment return over such a long period. I think you are being misled by the unusually high stock market growth in the recent bull market. Over the next 25 years, there will no doubt also be several bear markets, when you might watch your pension pot fall dramatically in value.

peterg

I'd agree, PKA. While it may well make sense for someone about to retire to do so, for someone early in their working life with a relatively small current pot to do so seems foolish. For it to make sense you have to be absolutely confident that you are going to achieve the projected returns, that will take you over the 1.25m limit. Returning 13%+ cagr for 25 years is not impossible, but no one should be confident they can achieve that - the world is full of investors who haven't.

If you succeed, and exceed the lifetime limit then you are in a good financial position and one in which you can easily afford whatever extra tax you would pay as a result of the change in lifetime limit. OTOH, if you fail to make those returns you are going to be a looking at being in a less secure financial position, and - worse - then having to pay additional tax to top up your pot at a later stage. So the risks of exceeding or underachieving your targets are not symmetrical in terms of their effects on you. The risk in terms of potential gain simply isn't worth taking.

Peter

fek47

pka, peterg,

I think you may have misunderstood one of the key aspects of Fixed Protection. It is possible to abandon Fixed Protection at a future date (to do so is simple - I would just need to make a contribution to my SIPP and inform HMRC that I had done so). This would then allow me to make contributions in the future, albeit reverting to the default LTA available at the time.

However, if I don't apply for Fixed Protection before 5 April, I lose the opportunity to do so forever. So, as far as I can see it's a one way bet: I can always back out later, but for the time being it makes sense to me to get the protection in place while it's being offered.

I agree that it's as certain as night follows day that the Government will change the rules many more times before I reach retirement. However, in the context of the regulatory framework as it exists right now, I believe applying for Fixed Protection is the best option for me.

In a sense yes, but by the same token you are then implicitly missing out on a number of years of returns on any contributions you make. If you keep your fixed protection in place for, say, 10 years before you decide it isn't going to play out as you'd hoped - you are then behind on both contributions and time. The compounding effect that you are using to justify this approach will indeed work against you!

Again, not offering advice or suggesting this is a bad idea, but do take care with this one.

garbetklb

I applied for fixed protection a couple of years ago - I'm away from home this week, so don't have the details to hand. I had roughly £1m in my SIPP and about 2 years to go until I'm 55 and got protection at £1.5m - I thought it unlikely I'd hit the limit, but am semi retired so didn't want/need to make contributions.

I'd be with pka & peterg. I think the chances of exceeding your lifetime allowance starting with £45k are slim - I v much doubt that the lifetime allowance will be in place/in place at the current level when you retire. And the ability to back out that currently exists might disappear - just look what happened in this budget with no warning.

You may have decided that going the ISA route is better than the SIPP route - and there is something to be said for that. But, personally I'd not apply for Fixed Protection in your position without a lot more in your SIPP - to protect a relatively remote risk, you lose flexibility.

Not advice etc, just my opinion
Garbetklb

Hi fek47

I think you may have misunderstood one of the key aspects of Fixed Protection. It is possible to abandon Fixed Protection at a future date (to do so is simple - I would just need to make a contribution to my SIPP and inform HMRC that I had done so). This would then allow me to make contributions in the future, albeit reverting to the default LTA available at the time

Yes, I accept your point - for some reason I was under the impression that there were additional costs to pay in the future (other than just accepting whatever LTA is defaut at the time). That undermines my view to an extent. However, I would still think, that unless you are in a very unusual position (e.g. have had high earnings up till now but are likely to have considerably lower ones for the reamaing 25 years or so of your workling life) that you would be better off foregoing Fixed Protection at this stage and intstead keeping up regular contributions to you pension - taking the tax relief on offer. You are much more likely to run the risk of your pension pot overflowing that way than if you rely on capital growth from your existing pot. And there are certainly worse problems you could face in the future than exceeding the LTA for your pension!

Peter

The key point for the OP to consider is the total prohibition on his ability to make further contributions to his pension fund. That point alone makes it unwise (or redundant) for someone early in their working life to claim Fixed Protection 2014, IMO.

I am claiming it - but only after I've made a final contribution. And I've been drawing down on ISAs for years.

IMO the flexibility of ISAs still trumps pension contributions for younger savers, unless you can get higher rate relief on pension contribs. Ideally one would have the cash to do both, but I have to say that it is around 20 years since I last made a pension contribution - and I then maxed out ISA conributions for a number of year before I started to withdraw cash from my ISAs (to bridge an income gap pre-pension).

Having recently paid for some quite expensive advice, I would say that the situation is pretty complex for those of us who have both Defined Benefit and Defined Contribution elements in their pensions. I've got a handful of Defined Benefit schemes coming into payment - and a similar number of DC pots - so the potential for confusion is quite large. It seems to me quite possible that a £1.25mn cap/LTA might be breached over 10-12 years of investing the DC elements, not least because the DB pensions are assumed to run for 20 years when assessing how much of the LTA has been used up.

......so, if you happened to be in the fortunate position (which I'm not) of having DB pensions of £50k pa, that would be £1mn of your £1.25mn LTA used up before any account is taken of the potential investment returns on DC pension pots.

Better to be safe than sorry though, if you are sure you have finished contributions, and claim Fixed Protection 2014.

snaj

Hi ee

Just to be clear, as has been mentioned above, there is no prohibition on making further contributions if one chooses to apply for Fixed Protection 2014 - they are allowed and the only consequence of doing so is that the Protection is revoked (the individual does have a responsibility to notify HMRC that they have resumed making contributions).

Unless the OP is a higher rate taxpayer or is receiving contributions from his employer, his approach isn't necessarily unwise - however with the onset of auto-enrolment, it will become a matter of attention to detail to ensure that he opts out at each and every point where he would otherwise be auto-enrolled into a pension scheme, as by failing to do so, he would revoke his Protection.

Regards
S

jseth123

I'd also fully expect the LTA to actually rise in future given the push for pensions provisions to increase. If you assume around 2.5% pa inflation over the next 30 years, the 'real' LTA is only ~£600k. This, in reality, is too low. With life expectancies also rising - I don't see that it will be sustainable to keep the LTA at such a low level.

This is an interesting point. I recall, perhaps erroneously*, during one of the budget speeches when the LTA was reduced that the chancellor (or a news commentator) highlighted that only ~1-5% of pensions funds had a value of above ~£45,000. I have since been unable to find reference to this, but I think its an interesting point and one that was a little concerning - I recall thinking that lowering the LTA could very much be seen as low hanging fruit for a "tax" that can be directed at "the 1%", winning a few votes and not generating much sympathy for those fortunate to have large pensions savings.

As you allude to, these amounts really are not very large when taken in the context of providing your main income in retirement.

I very much welcome the changes made in the recent budget and I hope that it paves the way for less restrictive LTA conditions in the future - what does it matter how big the pot is if all the tax relief applied at source is repaid on drawdown? The chancellor giveth and the chancellor taketh away.

*If anyone remembers something similar or can point me to a reference I'd be much obliged, I had tried to scan the budget speeches since 2010 without luck.

26th Mar '14

Just to be clear, as has been mentioned above, there is no prohibition on making further contributions if one chooses to apply for Fixed Protection 2014 - they are allowed and the only consequence of doing so is that the Protection is revoked (the individual does have a responsibility to notify HMRC that they have resumed making contributions).

My point was that they are incompatible. There is simply no point in applying for Fixed Protection 2014 if you expect to make further contributions - and, as you rightly point out, you would need to keep a close eye on auto-enrolements.

What is worse is that, due to some inadvertent oversight 20 years ago, you may arrive at retirement date only to discover you have breached the terms of the Fixed Protection and find it removed without any notice or opportunity to rectify the situation. You only actually get tested on the LTA at the point when you start to draw down your first pension pot!

Why I have applied for Fixed Protection 2014

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Fek47

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