Jack and Jane are advised to crystallise their savings to protect their lump sums from hefty tax charges.
Jack is a senior consultant for a pharmaceutical firm in the East Midlands. He is approaching his 65th birthday. When Jack reaches 65, he plans to retire and emigrate to Spain with his wife Jane, however, only once they have their financial affairs sorted.
Jack's company bought a small biotech firm that was established by Jack and his wife Jane in 1998. Jane, 63, is still employed by the biotech subsidiary. Both are members of the firm’s SSAS and have accumulated pension rights amounting to £9 million and £5.5 million, respectively.
At the time of finalising the company acquisition, Jack accepted full-time employment with the pharmaceutical company, including enrolment to the employer’s financed retirement benefits scheme (EFRBS), in respect of his service to this firm. Jack’s lump-sum pension entitlement from his EFRBS is valued at £3 million. Jane has also been contributing to a personal pension; valued at £500,000.
Both Jack and Jane were members of the biotech SSAS prior to 6 April 2006 (a date commonly referred to as A Day, marking the enforcement of significant tax changes). At this time, their adviser recommended they apply for both enhanced and primary protection (EP and PP).
Provided their benefits do not increase beyond the parameters set out in the legislation, the EP will ensure they are not subjected to a lifetime allowance (LTA) charge, irrespective of the value of their benefits entitlements on retirement.
In certain cases, as here, the EP is lost and the PP is activated based upon an LTA factor of the value of their respective pension rights. This is as of 5 April 2006 and using a formula outlined in the legislation: (RR-SLA)/SLA. RR is the value of the individual’s pension rights at 5 April 2006 and standard lifetime allowance (SLA) is £1.5 million.
As Jack and Jane’s pension rights were £6 million and £3 million on this date, their factors based on a formula outlined in the legislation would be 3 and 1 respectively. In the event that EP is lost, they default to the lesser protection of PP.
Since 2000, Jack has not made new pension contributions. However, as Jane has been contributing to a PP, the EP threshold under the legislation has been exceeded causing Jane to lose her EP protection. Jane will therefore have to rely on the lesser protection of PP.
On retiring and taking pension benefits from the SSAS, Jack will not be subject to an LTA charge in excess; in respect of his rights that exceed the current LTA of £1.03 million (namely £7.97 million).
Jane on the other hand is now relying on PP, which means she can protect her pension rights from LTA charges, up to a value of £3.6 million, based on a factor of 1. As her aggregate pension rights are currently £6 million, Jane would be subject to an LTA charge of £2.4m (£6 million minus £3.6 million). Jane’s adviser has recommended she take the LTA excess as pension, rather than as a lump sum, so the tax charge is 25% of the excess amounting to £2.4 million, which is £600,000.
Their adviser further recommends both crystallise their entire pension entitlements, prior to emigrating to Spain, to ensure they both receive their lump-sum entitlements, tax free. Jack and Jane will then be able to receive their pension income payments to be paid exempt from UK taxation, subsequent to their move to Spain and under the provisions of the UK/Spain double taxation agreement.
Jack’s prospective lump sum rights from the EFRBS fall outside the LTA provisions, however subject to tax under Income Tax (Earnings & Pensions) Act (ITEPA) 2003. The adviser has checked the terms of the EFRBS and advised Jack to withdraw it as a lump sum paying 45% income tax and 2% national insurance contributions, before moving to Spain.
John Lovatt is a UK pensions taxation specialist at Montfort
This article was edited on 1 November to refer to the biotech SSAS.