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1. Registered Pension Schemes

Background

In December 2003 the Government set out its proposals for reforming the existing pension regime. These were incorporated into the 2004 Budget and Finance Act and subsequently clarified and updated in the 2005 and 2006 Finance Bill.

The general principle was to introduce greater simplicity and transparency into the pension system and to do this eight previous regimes have been simplified into one single tax system covering all registered pension arrangements. Whilst the new system should benefit many investors, there will be those with substantial funds already accumulated who will need to consider claiming transitional protection. These changes came into effect 6 April 2006 (A - Day)

Existing pension schemes already in force at A-Day automatically became Registered Pension Schemes as of 6 April 2006.

Lifetime Allowance

This is the level against which pension funds will be tested at crystallisation (vesting) date. If the fund exceeds this level, a substantial tax charge will be levied. Table A Below illustrates the limits that have been set

Funds exceeding this level will be subject to a tax charge of 55% if the excess benefits are taken as a lump sum or 25% if taken as income. The income will then be subject to income tax at the individual’s highest rate.

Annual Allowance

The maximum contribution eligible for tax relief is 100% of earnings subject to a maximum of the annual allowance. A 40% tax charge is levied on contributions in excess of this amount. The contributions can be made into any type and number of schemes.

Employers can contribute any amount into a pension and will usually receive 100% tax relief on the whole amount. The scheme member will be subject to the tax charge if the employer contributes an amount in excess of the annual allowance.

Individuals can contribute the greater of £3,600 and 100% of earnings. Tax relief will only be available on contributions below the annual allowance or 100% of earnings whichever is greater.

Table A – Lifetime Limit and Annual Allowance

Tax Year Lifetime Limit Annual Allowance
2006/07£1,500,000£215,000
2007/08£1,600,000£225,000
2008/09£1,650,000£235,000
2009/10£1,750,000£245,000
2010/11£1,800,000£255,000

Benefits

Benefits can be taken from age 50, even if you are still working but this age will increase to 55 from 2010. Allowances will be made for people taking ill health early retirement also for those with current entitlements to take benefits early. There will be a significant reduction as to the level of benefits that can be taken where these rights are utilised.

Benefits must be taken prior to age 75; however, the new legislation has introduced some more flexible options for taking benefits after this age.

Tax-free cash will be payable from all plans at a rate of 25% up to a maximum of 25% of the Lifetime allowance. Tax-free cash must be paid by age 75.

Income can be taken as secured income either by way of a lifetime annuity or a Scheme pension, or unsecured income (essentially the same as income drawdown) with flexibility to take income at any rate up to a maximum limit. This limit is based on tables produced by the Government Actuaries Department. and will vary depending on age, gender and fund value.

The final option is Alternatively Secured Pension (ASP).

The latter is only available after age 75 and was originally paid at any rate up to maximum of 70% of the single life level annuity available at age 75. However, the Government made it clear throughout the development of the new pensions tax regime that ASP’s are specifically designed for those who have a principled religious objection to purchasing an annuity. As such, in order to prevent the misuse of ASP, it was announced in the Pre Budget Report (PBR) 6 December 2006 that changes will be made to the tax rules surrounding ASP.

These changes came into effect 6 April 2007 and:

  • introduce a minimum income requirement of 65% (pre PBR there was no requirement to take any income) and a maximum income of 90% of the annual amount of a comparable single life level annuity for a 75 year old.
  • Impose heavy tax penalties (70% followed by IHT of 40%) where ASP funds pass on death from the member to a non-dependant member of the same scheme (this tax charge can be avoided if the funds are left to charity).

Triviality

Individuals whose total pension funds are valued at less than 1% of the lifetime allowance can commute their benefits and take them as a lump sum under the revised triviality rules. 25% of this will be free of tax. This is available to individuals aged between 60 and 75 although there are restrictions placed on when and how benefits can be taken.

Protection

This is available for individuals holding funds in excess of the Lifetime allowance or with eligibility for tax-free cash in excess of 25%. Registration for both types of protection must take place within three years of A day.

Primary Protection is available to people with benefits within HM Revenue & Customs limits at A day but whose benefits are valued in excess of the lifetime allowance. The protection will entitle people to a personal lifetime allowance that is enhanced by the percentage by which the fund currently exceeds the allowance. Benefits can continue to accrue after A-day, but if these and/or any investment growth take the fund value over the elevated allowance, the lifetime allowance charge will apply.

Enhanced Protection allows any level of fund to be protected as long as it complies with HM Revenue & Customs limits before A Day. There is no limit on the investment growth that can be added to the plan, but all contributions must cease at A-day.

The entitlement to tax free cash above 25% on its own can be carried forward after A day without formal ‘Protection’, but will then be scheme specific and is likely to be lost on subsequent transfer.

Ill health benefits

Pensions benefits may be taken early on grounds of ill health, or, where life expectancy is less than one year, serious ill health. The ability to take benefits due to ill health/serious ill health will be subject to the scheme administrator accepting suitable medical evidence from a registered medical practitioner.

Death Benefits

Death benefits remain dependent on whether the fund is crystallised (vested). Prior to crystallisation the value of the fund will be returned as a lump sum up to the Lifetime Allowance. Benefits in excess of this will be subject to a 55% tax charge. In addition or instead, dependants’ pensions can be paid as secured income, unsecured income or alternatively secured income (if over 75). Post crystallisation, the benefits available will depend on the type of benefits that have been taken. Secured income can provide dependents pension, guaranteed payments for up to 10 years or in some cases, a return of the remaining fund less 35% tax. Unsecured income will not provide any form of guaranteed benefits, however, income can continue in various forms to dependants or a lump sum can be returned less 35% tax. Alternatively Secured Pension (post 75) will offer dependant’s pensions, charitable donation or potentially reallocation of funds to another person’s pension plan. This last option will be subject to inheritance tax.

As mentioned earlier, at A-Day the eight existing regimes were replaced by one single regime. Of these occupational pension schemes fall into one of two categories; final salary/defined benefit or money purchase/defined contribution. .Money purchase schemes can be further broken down to cover Executive or Personal Pensions. A summary of the different schemes follows

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