Pensions
The normal minimum pension age went up from 50 to 55 in April 2010. The Government has announced in the Emergency Budget that the requirement to purchase an annuity or take alternatively secured pension (ASP) by age 75 has been extended temporarily to age 77 from 23 June 2010, and that the age limit will be abolished from 2011-12.
There have been some important restrictions on the amount of tax relief available for pension contributions for high earners, introduced in Budget 2009 and tightened up further in the Pre-Budget Report 2009. You will find details below. In the Emergency Budget 2010 it was confirmed that the 'anti-forestalling' measures introduced to restrict tax relief will remain in place in the 2010-11 tax year, but that the complex rules that were to be introduced in April 2011 will be reviewed and replaced by simpler rules which are likely to consist of reducing the annual allowance for pension contributions to £30-40,000.
The single tax-regime for pensions was introduced in April 2006, so-called A Day. It completely changed the way pensions are managed. Before then, the amount you could contribute to an occupational pension was based on the maximum amount of the pension benefits you were allowed to receive. Now the amount you can contribute in any one year is much larger, but the total amount you can accumulate in a pension is restricted to the Lifetime Allowance, currently £1.8m in 2010/11. The lifetime allowance will be frozen at that level until 2015/16.
For people who had accumulated more than the lifetime allowance before April 2006, it was possible to protect that, and this had to be done by 5 April 2009. Under primary protection, the value of the pension on 5 April 2006 is revalued in line with the rise in the lifetime allowance. Under enhanced protection, all pension benefits accrued up to 5 April 2006 are free from the lifetime allowance charge, but no further contributions to pension can be made from that date on, and active membership of the pension scheme must cease. Enhanced protection can be revoked at any time, if it is not required.
Contributions
Contributions are limited by the Annual Allowance, which is £255,000 for 2010/11. This is the maximum amount that can be contributed from any source (employer or employee) and benefit from tax relief. Contributions above this amount are subject to a tax charge on the member, except in the last year when benefits are taken. It is actually the maximum amount that can be contributed in the scheme's input period, which may not coincide with the tax year. It is possible, therefore, to make two contributions of the annual allowance in one tax year, in certain circumstances.
Contributions to pensions can be made up to age 75. You have to be resident in the UK at some point during the tax year, and have earnings chargeable to tax in the UK. If you have been resident in the UK in the last 5 years, then you can obtain basic rate tax relief on the first £3,600 gross of a pension contribution, provided the pension was set up when you were resident.
Personal contributions to pensions are limited to 100% of your earnings in the UK; or £3,600 gross per year if less. They are normally paid net of basic rate tax, so a contribution of £2,880 is grossed up by the pension provider to £3,600. Any higher rate tax relief can be obtained through your self-assessment tax return, or it can be obtained through an adjustment of your PAYE tax code. Some occupational schemes and retirement annuities still receive gross contributions. Employers can contribute any amount to your pension, but above the annual allowance you will be subject to an annual allowance tax charge of 40%. To be allowable as deductions from the company's profits, the contributions must be ‘wholly and exclusively' for the purposes of the trade. This is normally taken to mean that the employer's contribution should not exceed the salary being paid. Directors who reward themselves almost entirely from dividends will find they are restricted in the amount that can be contributed to their pension as a result of this rule.
In the budget 2009, changes were introduced that affect the contributions of people with gross income (including employer pension contributions) of more than £150,000 per year and relevant income of more than £130,000. These were confirmed in the budget 2010 and will come into force from April 2011.
For the intervening period, high income individuals will have restricted higher rate tax relief on pension contributions above £20,000, called the 'special annual allowance'. Only if regular contributions were greater than this will higher rate tax relief continue to be available until 2011; or if the average over 2006/07, 2007/08 and 2008/09 of an individual's infrequent (i.e. less than quarterly) contributions is greater than £20,000, then the maximum special annual allowance is £30,000. Otherwise, any regular or single contribution above £20,000 will attract a special 20% tax charge in 2009/10, and 30% in 2010/11.
Relevant income includes pension income, interest on savings, dividends, rental and trust income, and chargeable event gains on a life policy. Personal tax-relievable contributions of up to £20,000 gross and charitable donations that qualify for gift aid are deductible before arriving at the relevant income figure.
From 6 April 2011 the complex rules that had been announced will be replaced by simpler rules that are being reviewed by the coalition government, and are likely to include a reduction of the annual allowance to £30-40,000.
Tax-Free Cash
The way that maximum tax-free cash was calculated has changed, and is now 25% of the value of the benefits, and is called the pension commencement lump sum (PCLS). Because of the way it was calculated before April 2006, it was possible to accumulate rights to more than 25% tax free cash in an occupational scheme, in which case this can be preserved. Directors of smaller companies often used Executive Pensions (EPPs) and Small Self Administered Schemes (SSAS) for this purpose, to ‘fund for cash'. This is no longer possible, and there are now lower cost alternatives available that are generally simpler to administer. These are Group Personal Pensions (GPPs) and Group Self-Invested Personal Pensions (SIPPs). This is an area that any company operating an old-style occupational scheme should look at carefully, because the performance of the pension scheme can be enhanced greatly by lowering the costs, to the benefit of the employees.
The PCLS must be paid before age 75, even after the recent change to age 77 for taking an income. Any remaining capital on death after age 77 will be treated as alternatively secured rights, and if paid out will be subject to an unauthorized payment charge, and possibly inheritance tax as well, in which case the total tax charge will be up to 82%. This is an area that requires specialist advice, which we would be pleased to provide.
Taking the Benefits
There are currently four ways of taking the pension: scheme pension; lifetime annuity; unsecured pension (used to be known as income drawdown); and alternatively secured pension. Trivial commutation is available from age 60, if the value of all your pensions does not exceed 1% of the lifetime allowance. In this case, you can take 25% tax-free, and the rest will be taxed as employment income. The Treasury has issued a consultation on changing the rules, to allow a continuation of unsecured pension after age 77.
Unsecured pension allows you to keep the pension fund fully invested, after taking the PCLS, withdrawing an income from it in the same way as you would from any other investment. You are allowed to withdraw more than the income, drawing down on the capital, up to a maximum set by the Government Actuary's Department (GAD). The maximum withdrawal depends on your age, sex, and the yield on 15 year gilts. If you die before age 75, you can pass on 100% of your pension fund to your spouse or dependant and they can continue drawing unsecured pension. Alternatively, there is the option of a return of the fund value, subject to tax of 35%. It is possible to set up a trust to receive the death benefit, to avoid it being included in your spouse's estate for inheritance tax.
A lifetime annuity is much less flexible, and there will normally be no capital remaining after the death of yourself, your spouse or dependant. It is suitable for smaller pensions, and where there is a need for a guaranteed level of income. There are now some so-called third way products available, that offer a lifetime guaranteed income, but with some of the flexibility and opportunities for investment growth available from unsecured pension. These third way products are gaining popularity in the current downturn, because of the guarantees they offer.
Scheme pension comes into its own after age 75, when it may be a better option than alternatively secured pension (ASP). It offers the potential to run the fund down to zero, which is not really possible with ASP.
SIPP and SSAS
There has been a lot in the press about SIPPs, because of the wider choice of investments available. A SIPP is only worth having if you make use of the wider investment powers, otherwise any extra cost is not worth paying for. Having said that, the cost of some SIPPs is now very low, for example from SIPPCentre, and you then have the choice to invest in things like gilts and ETFs (a quoted tracker fund – see Equities page) that could reduce the overall cost of the fund substantially. The alternative of using a Personal Pension or Stakeholder Pension is fine for smaller funds, but you are restricted to the choice of funds offered by the provider. A SIPP is ideal if you plan to take the benefits using unsecured pension. It is extremely flexible, allowing you to take the tax-free cash (PCLS) from some or all of the fund, and take an income that can vary from zero to the maximum allowed.
SSAS offers the same investment flexibility, but is an occupational arrangement typically for a small number of company directors. It offers the additional facility of being able to provide a loan-back of funds to the company. A SSAS is also sometimes used to purchase the property in which the business operates. A SSAS cannot currently hold protected rights, whereas a SIPP can, since October 2008. At retirement, the choices are the same as for the SIPP.