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Pensions Simplification Leaflet Shortly before Christmas the Government published the follow-up to its first Green Paper on the tax simplification proposals that were first issued in December 2002. The underlying objective for pensions simplification is to introduce a single, simple and transparent tax regime for pensions which everyone can understand. In his Budget Statement on 17 March, the Chancellor announced the Government’s plans to overhaul the present system and introduce a new set of rules which will come into force on 6 April 2006; a year later than originally expected. Main Proposals This article sets out the key changes of pension simplification and although the finer details have yet to be announced, it is clear that there will be winners and losers. Careful planning now can take full advantage of the existing and new rules. Pension simplification will replace the existing eight tax regimes with a single universal tax privileged pension savings regime. The numerous controls in the current regimes to avoid tax leakages will be replaced by two key controls. These are:
Lifetime Allowance The value of the lifetime limit will be £1.5m rising as follows:
It is not clear how the Lifetime Allowance will increase after 5 April 2011. The main objection to simplification has been the introduction of a maximum lifetime pension fund limit of £1.4m (which has since increased to £1.5m). Unsurprisingly, this limit is not an arbitrary amount. Indeed, quite the opposite as it broadly equates to the fund needed to provide the maximum annual pension of £66,000 to a member of an occupational pension scheme who is subject to the earnings cap. This is the same figure that was set out in the original proposal, and had not been amended by the Inland Revenue despite considerable lobbying by pension industry specialists. As a consequence it has slightly devalued with the passing of time which is probably why it has been increased to £1.5m. Similarly, the Lifetime Allowance was going to be increased each year in line with RPI, rather than National Average Earnings. The increases are now in a prescribed format for the following four years. Annual Allowance Pension contributions in a tax year will now be limited to the lower of 100% of earnings or £215,000 and will increase each year such that in 2010 it will be £255,000. For all those caught by the current earnings cap this is a significant advantage allowing large pension funds to be built up much more quickly and maintained at the maximum level. The level of annual allowance will be reviewed quinquennially. Taxation of Fund Above The Lifetime Limit The tax charge on the fund above the lifetime limit depends on whether the excess is taken as cash or used to provide income. If the excess is taken as cash, it will be taxed at 55%. If it is taken as income, there will be an initial tax charge of 25% and then as the income is paid it will be taxed at the individual’s marginal rate. For a higher rate taxpayer, this equates to an overall tax charge of 55%. Transitional Protection The change to a new single tax regime will apply to everyone from 6 April 2006 or ‘A Day’. However, pension rights built up prior to A Day can be protected from the recovery charge in one of two ways provided the pension rights are registered within three years of A Day. Primary Protection - Individuals who have built up pension rights in excess of the lifetime allowance of £1.5m on A Day, and who register those rights as their personal lifetime allowance, will have those rights protected. Pension benefits from defined benefit schemes will be valued using the factor of 20:1 based on the accrued pension at A Day. Enhanced Protection - As an alternative, members of registered pension schemes may opt out of making any further contributions or accruing further pensionable service after A Day. This will then provide an exemption from the recovery charge on all benefits coming into payment after A Day. Enhanced protection can be used whether or not the lifetime allowance is exceeded as at A Day. Under this approach there is a complete ring-fencing of existing benefits. Tax Free Cash Tax free cash will be 25% of the fund value which is the current position for personal pension plans but members of an occupational pension scheme could see a substantial increase from £148,500 to £375,000 Pension Age The earliest age from which schemes may pay pension benefits will increase from 50 to 55 by 2010, with each scheme being able to decide on whether this increase will be phased in over the period to 2010. Deferred pensioners and active members who have a right to draw benefits prior to 55 have that right protected. Occupations which currently allow younger retirement ages will no longer apply but individuals who are already in schemes where there is a low normal retirement age (e.g sports people) may retain this after A Day. It is proposed that it will no longer be a requirement that an employee has to retire before pension benefits can be taken from their employer’s occupational pension scheme. People will have the flexibility to be able to combine work with drawing pension benefits. Investment Powers There will be a single set of investment rules rather than the current system which differentiates between certain types of pension arrangements. Subject to Department for Work and Pensions requirements, residential property will become a permitted investment. Annuities It will continue to be a requirement that an annuity is purchased by age 75. However, pension income may be delivered after age 75 through Alternative Secured Income, an alternative method to provide benefits via an income for life which may be used by those with principled objections to the pooling of mortality risk inherent within annuities. What Next? It would be easy to assume that only those with large pension funds will be affected by the changes but this is not the case. We would be delighted to discuss individual situations with you and explain what the changes will mean and what you should do. Further Information Further information about Pensions Simplification can be obtained from:
Ashcourt Investment Advisers Limited Registered Office: 11 Tower View, Kings Hill, West Malling, Kent ME19 4UN. Registered in England and Wales with company number 1491795 | ||
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