Pensions
The normal minimum pension age went up from 50 to 55 in April 2010. The Government announced in the Emergency Budget 2010 that the requirement to purchase an annuity or take alternatively secured pension (ASP) by age 75 was extended temporarily to age 77 from 23 June 2010, and that the age limit would be abolished from 2011-12. This was confirmed in the Finance Bill 2011.
The State Pension age will rise from 60 to 65 by 2018. It will increase to 66 between November 2018 and October 2020. In the Autumn Statement it was announced that the pension age will increase to 67 between 2026 and 2028, eight years earlier than before. This means that people born after 5 April 1961 and before 6 April 1969 will have a pension age of 67.
A new 'flexible' drawdown has been introduced from April 2011, that allows any amount to be withdrawn from a pension provided you have sufficient secured pension to meet a Minimum Income Requirement (MIR) of £20,000 per year.
The tax on lump sum death benefits for pensions in drawdown has been increased from 35% to 55% for people under age 75, and the same tax charge of 55% will apply for funds remaining after age 75.
A potential issue with carrying forward unused contributions is the interaction with pension input periods (PIPs). If the PIP is not aligned with the end of the tax year, you could potentially lose the option of using carry forward from 2008/09 if you do not act before the end of the PIP which ends in 2011-12.
The lifetime allowance will be reduced from £1.8m to £1.5m in April 2012. Fixed protection will be available to protect up to £1.8m. The rules are:
- no new contributions can be paid to a money purchase arrangement
- the amount of benefit that can accrue in a defined benefit pension is limited to the 'relevant percentage', which is the rate of increase specified in the scheme rules as at 9 December 2010, or CPI in the year ending in September of the previous year
- no new pension scheme can be established unless it is to receive a transfer of existing pension rights
- National Insurance rebates will not be regarded as a contribution and so will not break fixed protection.
For people in defined benefit schemes, it may be possible to remain a member without breaking fixed protection. If your pensionable income is frozen, then the future accrual may be within the relevant percentage. This will need to be carefully monitored so as not to lose the fixed protection. On the other hand, early leaver revaluation of the pension may be worth more than further benefit accrual.
For people who had accumulated more than the lifetime allowance before April 2006, it was possible to apply for transitional protection. 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 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.
Comparisons between benefit values and the available lifetime allowance are made whenever a benefit crystallization event (BCE) occurs. If the lifetime allowance has been exceeded, the charge will be 55% on any excess drawn as a lump sum, and 25% on any excess used to provide additional pension income.
The State Pension is likely to be reformed, with proposals for a single pension of around £140 per week for people reaching state pension age from 2016 onwards. The proposal will end contracting out for defined pension schemes and will end the State Second Pension (S2P). Pensioners will benefit from a big cash increase to the State Pension from next April as it goes up by September's Consumer Price Index (CPI) of 5.2%, an increase of £5.30 per week.
The Pension Act 2011 (3 November 2011) introduced automatic enrolment of employees to pensions, and minimum contributions by the employer and employee which will be phased in over 5 years from October 2012. Eligible jobholders, aged between 22 and the state pension age, must be automatically enrolled if they earn above a threshold, equal to the personal income tax allowance of £7,475 in 2011-12. Non-eligible jobholders have the right to opt into the scheme, and the same minimum employer contributions will apply as for eligible jobholders. Entitled workers are very low earners, earning less than the NIC primary threshold. They have the right to ask the employer to make pension arrangements for them, but the employer will not have to contribute.
For defined contribution pensions, the minimum contributions will be 8% of qualifying earnings, with at least 3% being paid by the employer. Qualifying earnings will be between £5,715 and £38,185. Qualifying earnings include bonuses, overtime and commission.
The disclosure rules will not require a comparison with stakeholder pensions for a GPP being used for automatic enrolment.
NEST accepted its first employers in 2011. The default option is target-date funds, with investments based around the expected retirement date.
Contributions
Contributions are limited by the Annual Allowance, which was £255,000 for 2010/11 and £50,000 from April 2011. 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. 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.
For defined benefit schemes, an increase in pension benefit was multiplied by 10 to calculate its value. For example, if the pension entitlement increased by £5,000 in a year, perhaps as a result of a promotion, its value would be £50,000. From April 2011, the multiplication factor has been increase to 16, so the same pay rise would result in a value of the increased pension of £80,000, which will exceed the annual allowance.
In the budget 2009, changes were introduced that affected 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. High income individuals had restricted higher rate tax relief on pension contributions above £20,000, called the 'special annual allowance'. Only if regular contributions were greater than this would 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 was greater than £20,000, then the maximum special annual allowance was £30,000. Otherwise, any regular or single contribution above £20,000 wouldl attract a special 20% or 30% tax charge in 2010/11.
Relevant income included 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 were deductible before arriving at the relevant income figure.
From 6 April 2011 the complex rules for high earners were replaced by simpler rules that include a reduction of the annual allowance to £50,000. Unused contributions up to that amount from tax years 2008/9, 2009/10, and 2010/11 can be carried forward.
You can receive up to 50% tax relief on contributions into pension. It is possible, however, that the Government will scrap top rate, or even higher rate tax relief in the Budget on 21 March 2012. It is advisable, therefore, to make any lump sum payments before then.
HMRC has announced changes to its interpretation of the carry-forward rules. The previous interpretation was that contributions greater than £50,000 in 2009-10 or 2010-11 used up some of the annual allowance from earlier tax years, reducing the amount that could be carried forward. The new interpretation means that the annual allowance from earlier tax years is not used up when more than £50,000 has been contributed in 2008-09, 2009-10 or 2010-11. The extra funding opportunity from 2008-09 is only available until the end of this tax year (2011-12).
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.
Death Benefits
On death before taking the benefits, the death benefit is normally free of tax and payable to the nominated beneficiaries, which may be a Trust.
Any remaining capital on death after taking the benefits is currently sibject to a tax of 35%, and this is increasing to 55% from April 2011. The tax charge for lump sum death benefits will be the same after age 75 (55%) from April 2011.
Taking the Benefits
There are currently three main ways of taking your pension: scheme pension; lifetime annuity; income drawdown.
Trivial commutation is available from age 60, if the value of all your pensions does not exceed 1% of the lifetime allowance (£18,000). In this case, you can take 25% tax-free, and the rest will be taxed as employment income. The Government has recently announced an extension to the rules, allowing small pension pots of £2,000 or less to be taken as cash, even if you have other pensions with a value greater than £18,000. You need to be at least 60 years old to take advantage of this, and you can only commute up to two pensions of £2,000.
Income drawdown allows you to keep the pension fund fully invested, after taking tax-free cash, withdrawing an income from it in the same way as you would from any other investment, or leaving the income to accumulate within the fund. 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%, going up to 55% in April 2011. 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.
The drawdown (GAD) tables have been reviewed recently, and extended to age 85. The maximum withdrawal will be determined by the equivalent level annuity rate rather than 15 year gilt yields. This will result in a reduction of the maximum amount that can be withdrawn, from the next review date of your pension.
Under the new rules, recently announced, people with at least £20,000 of secured lifetime pension income will be able to take flexible drawdown, which will enable them to withdraw some or all of their pension fund, subject to income 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 variable annuities that offer a lifetime guaranteed income, but with some of the flexibility and opportunities for investment growth available from unsecured pension.
Scheme pension may be an alternative to unsecured pension in some circumstances, and is regarded as secured pension, which may be useful in order to qualify for flexible drawdown.
Protected rights will be abolished from April 2012. From that date they will be treated the same as non-protected rights, meaning that there will be no requirement to provide a spouse's and children's pension. There will be no further contributions from contracting out of the State Second Pension (S2P). This may mean increasing your personal contributions to make up the difference.
SIPP and SSAS
A SIPP is worth having if you can make use of the wider investment powers. The cost of some SIPPs is now very low, and you have the choice of investing in gilts and ETFs (a quoted tracker fund – see Equities page) and individual equities, 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. At retirement, the choices are the same as for the SIPP.