- RESOURCES
- Important Tax Dates
- Tax Jobs
- Tax Books
- Tax Events
- Tax Software
- Tax Reviews
- Tax Glossary
- Newsletter
- ABOUT US
- About Us
- Advertisers
- PressRoom
- Contact Us
- RSS
OUR BOOK SELECTION
1 Minute Guide to ... Pension Simplification
by Bob Fraser, MBA, MA, FSFA (September 2005)
Introduction
There are currently eight different tax regimes covering personal and occupational pensions, with the result that there is considerable complexity. The Chancellor announced in the Budget on 17 March 2004 that a new simplified tax regime for pensions will be implemented from 5 April 2006 to replace all existing regimes.
It must be noted that where an individual is in an occupational pension scheme, the rules of that scheme may impose restrictions over and above what the legislation allows. Thus whilst retirement may be permissible from age 55 whilst drawing full pension benefits, the company's scheme rules may not permit this. Individuals in occupational scheme must also check what their scheme permits.
10 Key Points
-
What is Pension Simplification?
It is a single tax regime for pensions which will come into force on 6 April 2006, which is known as 'A Day'. It will attempt to simplify most aspects of the current pension tax system. It will introduce new contribution limits, a new lifetime allowance, an increased minimum retirement age, and relaxed investment restrictions.
-
Contribution Limits
All the current rules restricting contributions into pensions will cease to apply on 6 April 2006. From that date an Annual Allowance of £215,000 will apply to all contributions or increases in the value of benefits. This allowance will increase to £255,000 by 6 April 2010 and will be subject to review after then. Individuals will obtain tax relief on personal contributions up to 100 per cent of earnings. Low or non earners will continue to be able to obtain tax relief on contributions up to £3,600 per annum as at present, even if earning less than this. Employers will be eligible for tax relief on all contributions, irrespective of how much they pay into an employee's pension scheme. However, any contributions in any tax year that exceed the Annual Allowance will be taxed on the member at 40 per cent on the excess. This will also apply to a member of a Final Salary scheme where any increase in benefits takes the value of the benefits over the Annual Allowance.
The Annual Allowance does not apply in the last year before retirement.
-
The Standard Lifetime Allowance (SLA)
The amount that can be saved into pensions will be limited from 6 April 2006 to a maximum of £1.5million (initially). This figure is known as the Standard Lifetime Allowance (SLA) and will increase to £1.8million by 6 April 2010. Thereafter it will be subject to regular reviews.
-
The Excess Tax Charge
If the value of the pension fund exceeds the SLA when benefits are taken the excess will normally be subject to a tax charge. If an individual takes an income from a fund above the SLA, there will be an immediate tax charge of 25 per cent of the excess over the SLA with the remaining pension being taxed as income. If the excess is taken as a lump sum, this will be taxed at 55 per cent.
-
Transitional Protection
- Primary Protection. In order not to penalise individuals who already have funds above the SLA, primary protection is available. If these funds are registered with HM Revenue & Customs before any benefits are drawn and at the latest by 5 April 2009, the actual value of the fund as at 5 April 2006 will become their personal lifetime allowance and will increase by the same percentage terms as the SLA. Any funds that exceed this increased personal lifetime allowance will still be subject to a tax charge of 55 per cent.
- Enhanced Protection. Where an investor feels that investment growth over time may take his pension fund over the SLA, an application can be made for enhanced protection. This applies equally to funds over or under £1.5million on 5 April 2006. This protection will ensure that there will be no future tax charge, irrespective of by how much the total fund exceeds the SLA. However, the decision to apply for enhanced protection should be taken now, since an individual will not be able to register if any contributions are made after 5 April 2006. Provided the rules have been complied with, the latest date for registering with HM Revenue & Customs is 5 April 2009.
-
Tax–free Cash
25 per cent of the value of the pension fund will be available as a tax-free cash lump sum, subject to a maximum of 25 per cent of the SLA meaning that the maximum tax-free cash allowance as from 6 April 2006 is £375,000. This tax free cash will also be available from plans which did not previously allow this, such as Additional Voluntary Contributions (AVCs), Free Standing Additional Voluntary Contributions (FSAVCs), and from an Appropriate Personal Pension policy (contracted-out benefits).
Individuals who transferred from occupational pensions and have a restricted tax free cash certificate (i.e. less than 25 per cent) applying to their pension will lose this restriction after 'A Day'. Equally, individuals who currently have a right under their old rules to more than 25 per cent of the fund as tax free cash will maintain this right. Unless the tax free cash is worth more than £375,000 it will not be necessary to register with HM Revenue & Customs, but records need to be kept to prove the entitlement since the Revenue will ask to see this when benefits are taken.
-
Minimum Pension Age
The current minimum retirement age (50) will be increased to 55 from 2010. Individuals in an occupation where there is an existing contractual right to retire before 55) will be able to retain this right provided that they were documented before 10 December 2003. However, when benefits are taken at an age less than the new minimum pension age, a lower lifetime allowance will apply. One easement that has been allowed is that under the new rules an individual will be able to carry on working for his employer and still take the benefits from his pension scheme.
-
Permitted Investments
The new regime will allow all pension schemes to invest in all types of investment, including UK and overseas residential property.
One of the biggest changes is a removal of the existing ban on transactions with connected parties, although there will be a specific requirement that all investments must be acquired, disposed of or leased on commercial terms.
Schemes will be permitted to borrow for any investment purposes. The amount of the borrowing will be limited to 50 per cent of the net value of the fund at the date of the borrowing. This is a much lower amount than is currently the case for SIPPs.
Trustees' borrowing will continue to be permitted, but will be restricted to 50 per cent of the value of the scheme assets.
Members will be permitted to make use of the assets in the pension fund, but where such use is not on commercial terms, a tax charge will be applied.
-
Taking Pension Benefits
The type of pension benefits available will depend on which sort of pension it is and what options the pension scheme or pension provider decides to offer. There will be four main types of income:
- Secured Income. This is where the pension funds are used to buy an annuity from an insurance company. This guarantees an income for the rest of life which may include a residual pension to be paid to a spouse or dependant.
- Scheme Pension. Alternatively, an income can be paid directly from the company pension scheme (which will usually be a final salary scheme).
- Unsecured Income (previously known as Income Drawdown) where the individual takes an income directly from the pension fund without buying an annuity. This will be available only until age 75. It will also be possible to take the tax free cash as a lump sum, and defer taking an income altogether.
- Alternatively Secured Pension. It remains the case that pension benefits have to be taken by age 75. However, this can be in the form of "alternatively secured income" which is similar to Income Drawdown, but without the option of cash on death.
Commutation of Trivial Pension Fund
Individuals with total pension funds worth less than 1 per cent of the SLA in total value (i.e. £15,000 at 6 April 2006) will be able to surrender these for a lump sum. 25 per cent of the fund will be tax-free and the balance will be subject to income tax at the marginal rate of tax. This opportunity can only be taken between the ages of 60 and 75 and all benefits must be taken within a 12-month period.
-
Death benefits
Pension benefits paid out on death before retirement will be calculated against the SLA with any excess being subject to the 55 per cent tax charge. However, where the excess is used to purchase a spouse's pension (normally only available under occupational schemes) no tax charge will apply.
When an annuity is purchased, a guarantee period of up to 10 years can be selected. If death occurs during this time, payments will be made to the estate as income rather than as a lump sum. Alternatively, it may be possible to choose an annuity protection lump sum, where the death benefit is a return of the original cost of the pension fund as a lump sum less any gross pension payments made. This is payable only on death before age 75 and will be subject to a tax charge of 35 per cent.
Finally, as mentioned previously, this '1 Minute Guide' provides only a short outline of Pension Simplification. Despite the name, the rules are, and professional advice is recommended based on particular circumstances.
More Information
For more information, contact Bob Fraser
Disclaimer
The content of these guides is based on tax legislation in operation at the time of publication, which may subsequently have changed. Whilst every care has been taken in its production, no responsibility can be accepted for any action undertaken or refrained from as a consequence of this material. This information is for general guidance only. Specific professional advice should always be obtained based on personal circumstances. TaxationWeb Limited accepts no responsibility whatsoever for any action undertaken or refrained from as a result of the information contained herein.