The order of benefits and buyer's regrets

We often hear about the reluctance of pension scheme members to pay for advice in order to access their “own money”, particularly in relation to final salary benefits and transfers. However, there is a danger that their reluctance to take advice on how exactly to access their pension funds could turn into a feeling of regret.

Let’s consider this in the context of Simon, who has always looked after his own arrangements and has been reluctant to seek financial advice.

Simon would like to draw his defined benefit pension now that he has reached the scheme’s retirement age, along with 25% of the value of his SIPP as a tax-free pension commencement lump sum (PCLS).

  • Final pension entitlement £40,000 p.a.
  • SIPP value £240,000.
  • As at 5 April 2016, Simon’s SIPP was worth £199,000 so he is unable to apply for individual protection 2016 as the total value of his benefits was less than £1 million.
  • He is also unable to apply for fixed protection 2016 due to a SIPP contribution after 6 April 2016.

Without advice, it is likely that he would not know that the order in which he takes benefits could affect his ability to maximise his PCLS and how he may be able to avoid a lifetime allowance (LTA) excess charge altogether.

  1. If Simon takes his defined benefits first, this could restrict the value of PCLS available from his SIPP.

    Even if he chose to take no PCLS (believing he could access 25% of his SIPP later), the way the benefits are valued for lifetime allowance (LTA) purposes reduces the availability of the tax-free lump sum in other schemes.

    Taking his full pension entitlement results in Simon using 80% (£40,000 x 20) of his lifetime allowance of £1 million, leaving 20% of his LTA left for when he crystallises his SIPP.

    The maximum PCLS available from his SIPP would be £50,000, (i.e. 25% of his available LTA) rather than the £60,000 tax-free he thought he was entitled to.

    Simon would have used 100% of his LTA and taking the excess as a lump sum would mean he faced a tax charge of £22,000 (55% of the excess).

  2. If Simon had taken benefits from his SIPP first, he would be able to draw the full £60,000 PCLS, leaving 76% of his LTA remaining for his final salary benefits.

    Taking the full pension entitlement of £40,000 would again lead to an LTA excess charge. This would usually be deducted by an actuarial adjustment to the actual pension payment, in order to recover the 25% tax charge on the excess.

    Rather than face an actuarial reduction to his benefits, Simon’s adviser would have explained how he could elect to commute some of his pension for a further PCLS payment, bringing the notional value of his benefits in line with his available LTA.

    Assuming a commutation factor of 12:1, the value of Simon’s final pension would be reduced for every £1 of PCLS he took. If Simon elected to receive a PCLS of £60,000, this would reduce his starting pension to £35,000 p.a., meaning that the notional value of his benefits would be £760,000 (£60,000 plus 20 x £35,000) equalling the 76% of his LTA that he has remaining.

There is no doubt that advice in these situations is extremely valuable, but questions remain about how exactly potential clients will be able to see this value until it is too late.

Senior Technical Consultant

Charlene is a Chartered Financial Planner with over 10 years' experience in financial services. She joined AJ Bell in 2014 after relocating to Manchester from Bristol, where she held financial planner and paraplanner roles at leading firms. In addition to analysing and commenting on technical and regulatory issues, Charlene is also responsible for designing and providing technical training for AJ Bell staff.