Partners at risk of exceeding the lifetime allowance should act now, warns Mike Fosberry.

The reduction in the lifetime allowance from £1.8m to £1.5m from 6 April 2012 means some partners could end up with a 55% tax charge on benefits over this amount unless they take urgent steps to register for 'fixed protection'.

Who will be affected?

Under current pension rules, the value of an individual's pension arrangements must be measured against a lifetime allowance. If the value exceeds the lifetime allowance, a 55% tax charge is levied on the excess.

The lifetime allowance for the current tax year to 5 April 2012 is £1.8m, but it will reduce to £1.5m from 6 April 2012. It is quite possible that the new £1.5m threshold will be in place for a while, drawing more and more people into the 55% tax net.

The new limit does not apply to those who elected for 'enhanced protection' before 2006. But it will potentially affect everyone else, including individuals who are already taking pension income through drawdown rather than an annuity purchase.

This could be a ticking time bomb for young partners in their 30s or 40s in particular. Their pension savings may be below the £1.5m mark right now, but this may not be the case by the time they retire. It may be a good idea for these individuals to elect for fixed protection now and consider other investments for building up their retirement funds.

What should you do if you might be affected?

There are three key ways in which people can take advantage of the current higher lifetime allowance.

  1. People can still elect for fixed protection for funds up to £1.8m and avoid the 55% tax rate. Any election must be made by 5 April 2012. From this date, individuals who take this route will have to stop all pension contributions.
  2. Another option for those aged 55 or more is to start drawing benefits before 6 April 2012, while the current £1.8m lifetime allowance is still in place. If pension income is taken through drawdown rather than by purchasing an annuity, it may still be worth considering fixed protection in order to keep the current lifetime allowance when the value is measured against the lifetime allowance at age 75.
  3. An alternative is to make extra contributions before 5 April 2012 and then take up one of the above options. Given that individuals can now get tax relief on contributions of up to £50,000 per year and, in addition, can carry forward unused contribution allowances from the previous three years, maximising contributions now and then electing for fixed protection or taking benefits may prove valuable for high earners.

What next?

Before taking action, partners should review their total pension investments. This can be a complex and lengthy process, so it is important to start now or risk losing out substantially.

Anyone who elects for fixed protection will not be building up funds through their pension in future. So thought needs to be given as to where future retirement savings should be invested.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.