The LTA and the AA were created as part of the pension simplification regime that came into existence on ‘A-Day’ in 2006. (To clarify, the AA is the maximum you can put into a pension each year and get full tax relief. The LTA is the maximum tax relievable fund at retirement.)
Great in theory, but in practice it was never going to be that easy. Our desire not to retrospectively penalise people meant that rules to protect existing funds were needed, and the idea of a protection regime was devised.
This might have been okay if the LTA had followed its proposed profile, but instead constant tinkering has been the norm. The LTA started at £1.5 million and went up incrementally to £1.8 million. Then in 2012 it was cut to £1.5 million, with a further cut to £1.25 million due from April 2014.
Now, with the further proposed changes to the LTA scheduled for 2014, there will be five different protection regimes, with the ability in some circumstances to double up on the various options.
I am not going to go into the detail of each regime, but the big difference is that two of them allow you to continue making contributions (Primary Protection and Individual Protection 2014), while the others require a cessation of contributions and a restriction upon the amount of benefit accrual in a Defined Benefit (DB) scheme (Enhanced Protection, Fixed Protection 2012 and Fixed Protection 2014).
This, to me, is a problem in itself. The progress of the LTA since 2006 has not been as expected or hoped, so how can we be sure what the profile of the LTA will be going forward? Surely it will have to change to at least be indexed in line with inflation at some point and, when it does, will the missed contribution years be a missed opportunity?
Depending on the length of time to retirement and the potential annual rate of investment return, some individuals with pension funds that they may not view as large now could actually be subject to the LTA.
A fund value of, say, £400,000 rolled up for 20 years would not need a great investment return to reach the LTA, and the question is, should a client be asked to take a reduced investment return, or should they maximise returns and pay the tax – following the maxim that a taxed benefit is better than no benefit at all?
The problem for members of DB schemes is even greater. Ceasing contributions is relatively easy (other than the unfortunate issue of potentially getting caught up in any auto enrolment exercise), but the rules do not end there, as any increased accrual above the permitted maximum (normally CPI) will invalidate the protection.
Ceasing contributions and staying in the scheme becomes difficult, but so does advising people to opt out of such a scheme. There will undoubtedly be employer contributions and the scheme could even be non-contributory. One of the first questions must be whether the employer is prepared to offer these contributions in another form of remuneration?
DB schemes can also offer salary-related ‘death in service’ benefits and even ill-health benefits linked to prospective service. Both of these benefits could prove costly or impossible to replicate, particularly in the case of ill health.
Individual Protection 2014 allows the setting of a personal LTA between £1.25 and £1.5 million and allows continued active membership of a scheme, albeit with a tax charge on any excess.
So, the LTA leaves us with a multitude of options and confusions, which leads in to my final point. Why do we need an LTA when there is an AA? It is, and always has been, possible to measure the input of an individual into a scheme, and the AA is no exception. The whole administration regime that has built up around the LTA confuses and costs money. Clients may well not remember what they have or where their protection certificate is.
It is frustrating to note that prior to A-Day the maximum contribution that someone over 60 could make to a pension scheme was 40% of their earnings cap, and as the earnings cap was just over £100,000 this meant their maximum contribution was just over £40,000. From 2014 the Annual Allowance will be £40,000, meaning that eight years and a huge amount of legislation and complexity later, we are pretty much back to where we started!
Mike Morrison
Head of Platform Technical
AJ Bell