"The replacement of eight tax regimes to simplify pensions"
A-Day went a long way to simplify the UK pension regimes by introducing lifetime and annual allowances as controls. Although defined benefit and contributions schemes remain with
many different pension product types, they now all operate with the same
annual
and lifetime contribution limits.
Introduction The
Chancellor announced in the Budget on 17 March 2004
that the tax simplification proposals from HM Revenue
& Customs will be implemented from 6 April 2006. This created a single universal regime to replace
the current eight tax regimes and the changes affect savers in occupational and personal pension
schemes, employers and financial advisers.
Pension simplification introduces
two new controls, the pension lifetime allowance
and pension annual allowance replacing all eight
current tax regimes with their numerous controls.
The other main changes allow all schemes to offer
a tax free cash of up to 25%, to allow employees
the opportunity to continue working for their
employer while taking benefits from their occupational
pension scheme, pensions schemes are to be
allowed to invest in all types of investments
including residential property and the complex
approval process for pension schemes will be replaced
with a simplified registration procedure.
In 2014 Budget the Chancellor introduced new allowance limits from 27 March and 6 April 2014 and a radical pension change from April 2015 where people are no longer required to purchase annuities. Instead they can now take their 25% tax free lump sum and the remainder of the fund as a cash sum less tax at their marginal rate.
Law revisions Previous to A-Day there were eight different tax regimes
that govern UK pensions and each of them had their own complex
rules that limit the amount an individual and contribute to
their pension scheme as well as the benefits at retirement
age.
As a consequence there were differences in the contribution
amounts required and benefits derived between defined benefit
schemes and defined contribution schemes.
An example given by HM Revenue & Customs was that although
all pension schemes were subject to the same earnings
cap (£105,600 in the 2005-06 tax year) schemes were
allowed different contribution levels as follows:
•
For occupational pension schemes (1989
regime) could contribute up to 15% of earnings up to the
earnings cap and receive tax relief while the employer
contributions are limited to the earnings cap;
•
For personal pensions plans (1988 regime)
an individual can contribute up to £3,600 per annum
of a percentage of capped earnings from 17.5% to 40% depending
on age and receive tax relief;
•
There were different rules applying
to pre-1970 schemes, post-1970 schemes, 1987 regime and
retirement annuity contracts. For the latter the individual
can also use carry back and carry forward for any unused
relief.
•
In addition the regimes had different
rules regarding the benefits that can be taken from the
schemes. Therefore an occupational pension scheme is limited
to 2/3rds of final salary after 20 years service whereas
there is no limit imposed on the benefits from a personal
pension plan.
•
There are also different rules that
applied to the tax free lump sum from these schemes. An
occupational pension scheme is limited to 3/80ths of final pensionable
earnings for each year of service whereas a personal
pension plan can take 25% of the total fund value.
Lifetime allowance
A standard lifetime allowance is the maximum amount of pension
savings that can benefit from tax relief and has been initially
set at £1.5 million. This figure will rise over time
and the proposed amounts are as follows:
•
2006/07 - £1.5 million
•
2007/08 - £1.6 million
•
2008/09 - £1.65 million
•
2009/10 - £1.75 million
•
2010/11 - £1.8 million
•
2011/12 - £1.5 million
•
2011/12 - £1.5 million
•
2012/13 - £1.5 million
•
2013/14 - £1.5 million
•
2014/15 - £1.25 million
•
2015/16 - £1.25 million
•
2016/17 - £1.0 million
•
2017/18 - £1.0 million
•
2018/19 - £1.0 million
The standard lifetime allowance is based on the approximate
amount of money that would be needed to purchase a pension equal
to the maximum HM Revenue & Customs (HMRC) would permit
under the tax regime. Funds in excess of the lifetime allowance
are felt to have benefited unduly from pension scheme tax advantages
and therefore a tax charge is made.
In terms of occupational scheme benefits the HMRC have determined
that the lifetime allowance of £1.5 million is broadly
the amount required to provide maximum benefits for a 60 year
old with earnings at the earnings cap of £105,600 in 2005/06.
The HMRC are using a valuation factor of 20:1 for converting
a defined benefit scheme to a cash equivalent. Therefore the
£1.5 million lifetime allowance represents a gross income
of £75,000 per annum.
Funds that exceed the lifetime allowance can be taken as a lump
sum and in this case the lifetime allowance charge would be
at 55%. There is a lifetime allowance charge of 25% on pension
funds that exceed the lifetime allowance and are used to provide
a pension income. The income would also be subject to income
tax at the individuals marginal rate and probably this would
be a 40% higher rate tax, therefore the likely overall effect
would be a tax rate of 55%.
Annual allowance
The annual allowance was initially set at £215,000
rising to £255,000 and this figure has been reduced to £40,000 for payments to a defined
contribution scheme or as accrued benefits within a defined
benefit scheme.
•
2006/07 - £215,000
•
2007/08 - £225,000
•
2008/09 - £235,000
•
2009/10 - £245,000
•
2010/11 - £255,000
•
2011/12 - £50,000
•
2012/13 - £50,000
•
2013/14 - £50,000
•
2014/15 - £40,000
•
2015/16 - £40,000
•
2016/17 - £40,000
•
2017/18 - £40,000
•
2018/19 - £40,000
When you crystallise your benefits, taken your tax free lump sum, your annual allowance remains at £40,000 as long as you do not take any tax able income. Once you take taxable income your annual allowance reduces to £4,000 effective from the 2017/18 tax year.
The limit for contributions such as 17.5% for personal pensions
for individuals under age 36, or 15.0% for members of an occupational
money purchase scheme have been replaced to allow individuals
to make contributions subject to the annual allowance and this
gives the individual the opportunity to contribute considerably
more to their retirement planning.
However, tax relief on the contributions is to be limited to
the higher of 100% of relevant earnings or where tax relief
is given at source, limited to £3,600. Where funding exceeds
the annual allowance an annual allowance charge of 40% is levied
on the excess in contributions. Any investment growth or loss
in the value of the fund for all money purchase schemes, whether
private pensions or occupational pensions, are not included
in the annual allowance.
Where an individual has no earnings it is possible to contribute
up to £3,600 per annum (£2,808 net of basic rate
tax) to a personal pension or stakeholder pension where tax
relief is received at source.
For members of a defined benefit final salary pension scheme
the value is to be calculated as the increase in value of the
employees' pension benefits accrued during the year using a
valuation factor of 10:1, as opposed to the factor 20:1 used
at retirement.
Carry forward
For any unused annual relief from the previous
three years it is possible to use this in the current year. The maximum single contribution with tax allowance being claimed (subject to taxable earnings) is £140,000 where there have been no previous contributions based on the following tax years.
•
2012/13 - £50,000
•
2013/14 - £50,000
•
2014/15 - £40,000
Small pots
The size of small stranded pension pots that can be taken as a lump sum increased to £10,000 from 27 March 2014 from the previous level of £2,000. Three pots of this size will be able to be taken by an individual, an increase from two.
Retirement age There is no longer a maximum age when benefits need to be taken, previously it was 75 for pension annuities.
The minimum pension age was 50 years. Pension simplification
from 6 April 2006 increased this retirement
age to 55 from 6 April 2010 and it is up to the schemes
to decide how to implement the change. This
applies to taking the tax free lump sum, purchasing an annuity and income drawdown.
Between 6 April 2006 and 5 April 2010
it was possible for those aged 50 years and over to take pension
benefits. This applies to existing pension arrangements that
currently have a higher minimum retirement age, such as protected
rights benefits where the minimum age was 60.
From 6 April 2010 it will not be possible for individuals under
the age of 55 to take pension benefits. The only exceptions
are the following:
•
People who retire due to ill health;
•
Members of occupational pension schemes
that already have contractual rights to retire early;
•
People with special occupations with
lower retirement ages such as sports people.
Any occupational pension scheme member with contractual rights
at 9 December 2003 to take benefits from age 50 can retain this
right.
For special occupations where individuals have low normal retirement
dates (NRD) and are allowed to retire and take benefits before
the minimum pension age, they can do so however there will be
a 2.5% discount to the lifetime allowance for each year before
age 55.
Cash-in pension fund
From April 2015 the Chancellor will allow people retiring to take their 25% tax free lump sum and with the remainder as a lump sum less tax at their marginal rate.
This is intended to give people the greatest flexibility to use the pension fund in the best way possible. The minimum age remains 55 an opens up the possibility of the fund being used for any purpose to generate alternative income, such as purchasing a buy-to-let property.
Trivial pensions
Trivial pension rules aim to increase the number of options
available where an individual has a smaller fund by taking
this as a lump sum with bigger allowances from 27 March 2014. There are a number of conditions that
the individual must comply with as follows:
•
The member must take the trivial pensions
within a 12 month period;
•
The total amount taken as a cash sum
has been increased from £18,000 to £30,000 from 27 March 2014.
•
Pensions already in payment are valued
at £25 capital for every £1 per annum gross
pension;
•
The fund to be used for the trivial
pension must be commuted in it's entirety;
•
Commutation must occur from the
member's age of 60;
•
Pensions in payment may also be commuted
but will be taxed in full as earned income.
From the amount commuted 25% can be taken as a tax free lump
sum and the balance is taxed as earned income. The following
example shows the tax implications for a basic rate tax payer
that has a fund of £30,000.
Fund
£30,000
25% tax fee
cash
£7,500
Taxable fund
£22,500
Basic rate
tax (20% 2014/15)
£5,500
Net lump sum
£18,000
Total pension
lump sum
£25,500
Where no trivial fund exists and earnings supported a gross
pension contribution of up to £15,000, an individual
can plan a single contribution to a pension prior to retirement.
In the above example a payment of £12,000 is required,
and this benefits from tax relief at the outset so £15,000
is invested in the fund. The individual can immediately encash
the fund under the trivial rules realising after tax a sum
for £12,750 making a once only net profit of £750.
There is a penalty of up to £3,000 for individuals who
negligently or fraudulently obtain an unauthorised payment.
This includes trivial commutation payments when the value
of benefits from all schemes exceeds the £30,000 limit.
Tax free lump sum
Previous to A-Day the the tax free cash entitlement from a
pension differs between defined benefit and defined contribution
schemes. Under pension simplification rules all schemes will
be able to pay a tax
free lump sum of up to 25.0% of the fund value and to
a maximum of 25% of the lifetime allowance irrespective of
the type of pension. This includes protected rights portion of a pension, AVC,
FSAVC's and transfers received from occupational pension schemes.
For defined benefit schemes such as final salary pensions
the scheme must calculate the value of the pension to determine
the maximum tax free cash. The calculation used by the HMRC
is a 20:1 value for converting a defined benefit scheme to
cash. Therefore assuming a pension accrued of £15,000
per annum, this would represent a cash value of £300,000
which would produce a tax free cash sum of £75,000.
Prior to A-Day where a scheme member has rights within an
occupational pension scheme greater than 25.0% tax free cash,
these rights are automatically retained within the pension
scheme. They will also be uplifted in line with the standard
lifetime allowance. Benefits accrued after 6 April 2006 must
apply the 25.0% maximum tax free cash and this applies to
all occupational pension schemes on transfer to another scheme
irrespective of any retained rights. If the tax free lump sum in total exceeds 25.0% or more than
£412,500 (25% of the £1.65 million lifetime allowance
for 2008/09) a tax charge would be made.
The balance of the pension fund must still be used to purchase pension annuities at retirement. The individual has the option to search for the highest annuity rates using an open market option, however, before making a decision at retirement, learn more about annuities, compare annuity rates and secure a personalised annuity quote offering guaranteed rates.
