Miles Hendy, pensions and divorce specialist and Chartered Financial Planner with Fraser Heath Financial Management Ltd, writes this guest blog for us.
The clock is ticking for divorcing couples with large pension funds. Without careful and expeditious planning and an understanding of tax and pension rules, Pension Credits received following a divorce can ruin attempts to protect your Lifetime Allowance. At stake for handling it badly could be a tax bill of £62,500.
The Lifetime Allowance
At present we can all have £1.5M of value in a registered pension scheme. This is known as the Lifetime Allowance. As soon as you crystallise benefits from a pension and go over the Lifetime Allowance you lose the current entitlement to a tax free lump sum on that part and all benefits in excess incur a Lifetime Allowance tax Charge of 55%.
From 6th April 2014 the Lifetime Allowance reduces to £1.25M. It is possible to apply for Fixed Protection 2014 prior to that date which means that providing that you make no further contributions to a pension and do not create a new pension arrangement then you can retain a personal Lifetime Allowance at the £1.5M level.
Pension Credits and HMRC’s Stance with Fixed Protection
HMRC’s stance with regards to Pension Sharing Orders and Fixed Protection is that if a Pension Sharing Order is implemented in a new arrangement after 6th April 2014 this will break the Fixed Protection and you would revert to a £1.25M Lifetime Allowance. However, providing the Pension Credit is received by an existing arrangement after 6th April 2014 then Fixed Protection can remain in place.
Where a Defined Benefits pension scheme allows the Pension Credit member to become a member of the Defined Benefits scheme in their own right, receipt of the Credit after 6th April 2014 could also result in the creation of a new arrangement and the loss of Fixed Protection. If you are in this position you should aim to conclude matters in good time or be left with a conundrum in the new tax year; either apply the Credit to the Defined Benefits plan to enjoy the higher, known income but minus a Lifetime Allowance Charge or transfer the Credit to an existing money purchase arrangement and retain Fixed Protection.
It should be kept in mind that negotiations taking place today could well result in the Pension Credit being received after 6th April 2014.
Action Needed Prior to 6th April 2014
Many occupational pension schemes insist on the Pension Credit being transferred to a different plan. It is imperative that where your pension funds will be close to £1.25M after the divorce that you have an existing arrangement that is suitable for receiving the Pension Credit by the end of the current tax year. You also have to apply for Fixed Protection 2014 prior to the 6th April 2014 deadline.
Consequences of Losing Fixed Protection 2014
The consequences to a higher rate tax payer of not applying for or losing Fixed Protection 2014 on the £250,000 between £1.25M and £1.5M are as follows:
Accessing under the Lifetime Allowance (such as using Flexible Drawdown)
•£250,000 X 25% tax free lump sum = £62,500
•Remaining fund [£187,500] less 40% income tax = £112,500
Accessing over the Lifetime Allowance Charge
•£250,000 – 55% Lifetime Allowance Charge= £112,500
Planning ahead in good time could therefore save £62,500 in tax. The tax saving may be greater than this if the pension holder has some of their basic rate tax band remaining.
A Suitable Existing Arrangement
Even where you have no suitable pension plan currently you can put one in place ahead of time. People with no earned income can make a pension contribution of up to £3,600 gross each tax year. The sum you invest to create the new plan should be sufficiently small to minimise the amount of your pension expected to be over the Lifetime Allowance in the future. However, you also need to be mindful that pension plans suitable for pension funds of this size, such as those that allow Flexible Drawdown, have minimum contribution levels.
Miles can be contacted here