People with ‘enhanced protection' on pensions valued up to £1.8 million could benefit from switching to fixed protection before the tax year end deadline.
If they continue with enhanced protection, their maximum tax-free cash allowance will fall to £375,000 from 6 April, which is 25% of the reduced £1.5m Lifetime Allowance (LTA). However, if they switch to fixed protection then the maximum tax-free cash available would remain at £450,000, which is 25% of the current £1.8m LTA, resulting in an extra £75,000 in available tax-free cash.
The great benefit of enhanced protection is the ability to have unlimited, tax-efficient, pension growth, unrestricted by a LTA. This enables a pension fund to grow to amounts far exceeding the current LTA of £1.8m without incurring the 55% tax charge, making enhanced protection extremely valuable. However, some pension funds have not grown as high as expected, especially given the recent stock market volatility. With the fixed protection deadline fast approaching, people in this situation have just a few weeks to decide whether it is more beneficial to keep the enhanced protection or switch to fixed protection.
Keeping enhanced protection would mean maintaining unrestricted fund growth with no LTA. Switching to fixed protection would mean limiting the fund growth to a LTA of £1.8m in return for a greater tax-free cash allowance.
Those aged over 55 could actually achieve the best of both worlds by moving £1.8m into drawdown before 6 April 2012. This would provide them with a higher tax-free cash amount and an unlimited LTA. However, this will involve moving high sums of money into an environment which has a 55% tax charge if they die.
Even if someone's pension fund is expected to go slightly over £1.8m, they could still consider the benefits of switching from enhanced protection to fixed protection. The extra they would gain in tax-free cash could be greater than the 55% tax charge they would incur on the amount which exceeds £1.8m, especially if they are a higher rate tax payer.
If people decide to cancel their enhanced protection, this creates a small window of opportunity to top up the pension before applying for fixed protection. They can utilise any unused allowances from up to three previous tax years, use this year's allowance, and even invest next year's allowance through the clever use of pension input periods. This will help boost the pension fund, and fixed protection will then help protect the benefits going forward.
There is no set science for evaluating whether someone would benefit more from enhanced protection or fixed protection. It is a case of assessing the benefits they could lose compared to the benefits they could gain, most of which are subjective, as no one knows how stock markets will perform in the future.
Adrian Walker, Skandia's pension expert, comments:
"The incentive of up to £75,000 extra in tax free cash is appealing, but this needs to be weighed up against the loss of an unlimited lifetime allowance, something that can be extremely valuable depending on how the stock market performs over the coming years.
"There are numerous factors that need to be considered to fully assess the value of the benefits someone currently holds compared to what they would have if they switch to fixed protection. Anyone with enhanced protection and pension savings currently worth less than £1.8 million should seek professional advice urgently to assess whether it would be more beneficial for them to switch to fixed protection.
"The deadline for applying to HMRC for fixed protection is 5 April, so there isn't much time left. People should send their instructions by recorded delivery to ensure it is received by the deadline as HMRC may not acknowledge all applications due to volume."
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