20th May 2011

LV= The eye of the storm?

From my limited meteorological knowledge - mainly gleaned from watching Hollywood blockbusters, I believe there is a period during this type of event when everything becomes calm as the eye of the storm passes overhead. Then it all kicks off again!

So as the dust settles after the frenzied activity of April, are we enjoying the calm after the storm, or stuck in the eye of it?
Looking forward I'm guessing that with NEST, auto-enrolment and RDR on the radar we can expect some further pensions turbulence. For now I'm just enjoying the relative tranquillity for a short period. Even the government seems to have laid off a little, announcing in the last few weeks that they will not be pursuing early access to pensions at this point. Opinions across the industry remain divided on this one. Personally I think they've missed a trick and that early access might remove one of the barriers associated with pension saving, but that's for another day...

So what do we do in this period of relative calm in the world of pensions? Make hay while the sun shines of course, and consider the opportunities that the recent legislative changes have provided. Putting aside Flexible Drawdown, where the target audience may be a little limited, perhaps one of the biggest opportunities is around effective tax planning using phased drawdown.

The big change here is around the hike in tax on lump sum death benefits for pension pots that have been crystallised (vested) before age 75. Prior to 6th April these benefits were taxed at 35%, now the tax rate is 55%.This makes it even more important that any drawdown strategies are considered not only with income
and investment in mind, but also a clear picture of what the situation would be if the worst were to happen and the customer died.

Each situation will vary according to specific circumstances and customer needs, but this tax hike has cast a greater spotlight on the potential to use phased drawdown to help mitigate some of the potential tax charges. Perhaps the best way to illustrate this is with a simple example.

‘John Fish' is 63 and has a SIPP fund of £230,000. He has just taken retirement from his job at the Met Office, but is planning to continue working in a consultancy capacity. He doesn't have a pressing need to take income from his plan, but does need £10,000 immediately to cover some refurbishment to his property that was damaged in a recent, unexpected, storm.

The key opportunity here is to consider phased drawdown as an alternative to simply crystallising the whole fund. It provides the ability to closely match John's specific needs, but, more importantly, the ability to shelter (sorry) his fund from a potential 55% tax charge should John die.

So what do we do in this period of relative calm in the world of pensions? Make hay while the sun shines of course.
If the fund were fully crystallised he could take a tax free lump sum of £57,500 - more than he needs, and possibly tempting, but the remainder of the fund if paid as a lump sum would be subject to 55% tax on his death - a potential tax charge of £94,875.
By using phased drawdown, John could crystallise just £36,000.This would provide a tax free lump sum of £9,000 plus income (based on max GAD) of £1,000 after tax, giving him the £10,000 required. Most importantly in the event of John's death, the uncrystallised fund of £194,000 can be paid tax free, with the tax charge on the crystallised fund being only £19,800. Meaning a potential tax saving of over £75,000!

So as we take stock after the recent legislative changes it is worth remembering that every cloud has a sliver lining - in this case phased drawdown provides an opportunity to brighten up a weatherman's day!
Notes:
1. Any similarities in the article to persons living or dead is entirely coincidental
2. No weathermen were harmed in the writing of this article
3. The amounts quoted in the phased example have been rounded for simplicity.

Ray Chinn is Head of Pensions at LV=

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