With effect from 1st March 2015 Fraser Heath Financial Management Ltd will join SIFA Professional.
SIFA was set us in 1992 by former Law Society Director Stuart Bushell and Ian Cockerill, former Head of Financial Services Compliance at The Law Society.
SIFA Professional involves the facilitation of professional connections, through the Law Society recognised SIFA Directory of Professional advisers, to bring about stronger working relationships between financial adviser and solicitors.
The SIFA Directory is the only Law Society endorsed directory of financial advisers in the UK.
This move signals our intention to continue to work with and support law firms to provide a greater level of services to our respective clients. Joining SIFA will also enable us to work closer with our professional connections to help develop their businesses during a period in which their will be numerous changes and challenges within the legal sector.
For more information please contact Richard Ellis , Financial Planner and Head of Professional Business Development at Fraser Heath
The Taxation of Pensions Bill lays out the framework for 2015's new flexible era. There are no great surprises. But it still contains several changes from the earlier draft which are worthy of note. Here are ten key points of interest:
55% tax charge on death
Capped drawdown retains £40,000 annual allowance
Capped drawdown transfers
£10,000 reduced annual allowance
Tax free cash recycling
Triviality and small pots
Valuing pre April 2006 pensions in payment
Protected low pension ages
Temporary non-residence rules
The March 2014 budget has changed the financial planning landscape dramatically with the single biggest shake up to pensions in our lifetimes. The announcement that “no one will have to buy an annuity” turns the personal pension plan from an intangible and illiquid future income stream into a savings account with unrestricted access.
For people negotiating their divorce now, there needs to be an immediate re-evaluation of your pension’s worth. This article summarises our view of the paradigm shift in pensions and divorce.
Unrestricted Access and Off-setting – Is 15% the new 25%?
From 27th March 2014 anyone over 55 with a secure pension income of £12,000 per year can have unrestricted access to their remaining pension pot. The government are also consulting on legislation that if passed would see savers able to fully liberate their pension funds from April 2015 regardless of the size of their pension income. Pension funds can be withdrawn completely with the first 25% paid tax free and the excess added to taxable income.
When offsetting a money purchase pension plan during divorce negotiations a starting point is typically a 25% reduction. This figure in part reflects a deduction for valuing a gross pension fund knowing that it would suffer income tax in the hands of the receiver. It also factors in the willingness of the parties to trade off the pension fund’s uncertain future income stream for the certainty of cash in their pockets today. The change announced in the budget means that one need no longer regard a pension fund as an income product but more like a readily realisable liquid asset.
Peter is 54, earns £25,000 per year and has a pension valued at £100,000. Under the proposal, in a year’s time he could access 25% as a tax free lump sum (£25,000) and have the remaining £75,000 paid over five years at £15,000 per year so that only the 20% basic rate tax is deducted (five instalments of £12,000 is £60,000). In total his £100,000 pension fund can be converted relatively quickly into £85,000 in his pocket.
So shouldn’t the starting point for offset negotiations on money purchase pensions now be 15%?
Divorce Settlements with New Pension Contributions?
The increased flexibility provides divorcing couples with an opportunity to enhance their overall financial position through making new pension contributions.
Julia earns £81,865 per year and is getting divorced from Chris who earns £25,000 per year and is over 55. Julia invests £40,000 into a new pension at a cost of £24,000 (as the full sum enjoys higher rate tax relief). The couple apply a 100% pension sharing order on the new plan. Under the proposed legislation Chris then cashes in the investment over two years. Each instalment of £20,000 is returned 25% tax free (two lots of £5,000) and the remaining instalments of £15,000 has 20% basic rate tax deducted (two lots of £12,000).
In total, Chris has withdrawn £34,000 into his bank account over a period of one year and a day at a cost of £24,000 of marital assets.
Triviality, Small Pots and Help with Buying Two Homes
Also from 27th March 2014 people with a pension pot worth less than £10,000 who are over 60 can ask for the pot back as a lump sum. The lump sum will be paid 25% tax free and the rest added to taxable income. They can use this small pot rule three times. If after completing this exercise their remaining pots are valued at under £30,000 they can access them under the triviality rule as a lump sum too.
Richard and Tracey each earn £15,000 per year, are 60 and have combined personal pension pots totalling £120,000. There is £200,000 equity having sold their home but they both consider that they need £150,000 now to set them up in new homes.
They split the pension pots evenly to have an equal £60,000 and arrange for a partial transfer so that there is £30,000 in one pension pot and £30,000 in another. The first pot is set up in three segments of £10,000. They exercise their right to withdraw the three segments as lump sums using the small pots rule. They then exercise their right to triviality with the remaining £30,000 pot in the next tax year. After 25% tax free lump sums and after 20% tax on the remainder, Richard and Tracey have £51,000 each in the bank account from their pension funds to add to the £100,000 each from splitting the equity from the sale of the home.
Help with Legal Fees
The small pot rule of £10,000 (and the ability to segment or partially transfer into up to three pots of less than £10,000) means that the over 60s have a new option for paying legal fees. They simply cash in a pension plan. The same rule also presents an opportunity for the tax man to make a small contribution as the following example shows.
John is 60 and his lawyer has presented him with a bill for legal advice of £8,500. He makes a pension contribution of £8,000, grossed up by basic rate tax to £10,000. He uses the new small pot rule and takes 25% tax free (£2,500) and the remaining £7,500 is added to taxable income and after 20% tax is deducted has a further £6,000. He now has the £8,500 to pay his fees.
For Defined Contribution Plans Only
The planned changes relate to Defined Contribution (Money Purchase) pensions only. The government are concerned that the increased attractiveness of Defined Contribution plans could lead to transfers out of Defined Benefit plans and that this might have unintended consequences to the wider economy. Consequently they are consulting on various options, one of which is to ban transfers from Defined Benefit plans to Defined Contribution plans. The consultation paper does not discuss whether any potential ban on transfers might influence whether Defined Benefit schemes will be prevented from insisting on an external transfer to a Money Purchase plan on receipt of a Pension Sharing Order on divorce.
Assuming that external transfers will continue to be allowed for Pension Sharing Credits, the increased access could give rise to planning opportunities for divorcing couples that may not be available to non-divorcing couples.
Jim and Alison are 65, retired, and after selling the marital home and a recent payment of a tax free lump sum they have cash of £500,000. Jim has the only pension; a Defined Benefit pension in payment valued at £500,000. They would ideally like £300,000 of cash each and to equalise the pension. For simplicity we’ll assume the CEV generates the same level of income for each. They apply a 62.5% sharing order so that Alison has £312,500 of CEV and Jim has £187,500. In return, Jim has £300,000 of cash and Alison £200,000.
Alison uses £187,500 of her pot to generate an income for life commensurate with Jim’s income. She uses the remaining £125,000 to withdraw tax efficiently at 20% basic rate over a few years and it generates £100,000 of cash after tax.
Greater Demand for Multi-Disciplinary Collaborative Practice?
Buying an annuity meant that people had an income guaranteed for life and didn’t need to worry about whether they might run out of money. They also didn’t need to worry that they might be too cautious and die leaving too much money that they could have enjoyed. That’s ultimately the area where modern financial planners thrive – helping people make informed decisions about how best to spend their wealth, to manage investment risk and to manage their wealth tax efficiently. Now there will be an increased number of people needing to manage their pots into retirement, many of whom would unquestionably benefit from a Financial Planner helping them manage their finances.
The government recognise that this change will introduce more choice and complexity for citizens and part of their announcement included a guarantee that pension savers will have access to face-to-face, impartial financial advice at the point of making a decision. This advice could include a suggestion to seek further full independent financial advice.
The government also cite Australia and the United States as countries with similar unrestricted access to pension funds as is proposed to apply here. In both countries financial planners often play a more integral role in collaborative divorces than has been the case in the UK. These changes could be a catalyst for greater involvement of financial neutrals in collaborative cases, and even greater desirability for collaborative divorces, in a world where personal finance choices, options and complexity have increased considerably.
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)
Accessing over the Lifetime Allowance Charge
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.
As a Pension Specialist, Divorce Specialist and Chartered Financial Planner I would be happy to provide further information or advice if you are effected by this.