Simplifying the taxation of pensions: the Government’s proposals
The proposals contained in the second round consultation document “Simplifying the taxation of pensions: the Government’s proposals” are summarised very briefly below. A more detailed analysis will be available shortly.
Implementation
A-Day to be 6th April 2005. -
Some doubt is cast on implementation based on the following extract from the document “The National Audit Office will report in advance of the Budget 2004, in order to allow an announcement to be made in the Budget on whether or not the Government will introduce the simplified regime. If it is decided to proceed, the measures will be in the 2004 Finance Bill and will be introduced in April 2005. Otherwise the current 8 regimes will remain in place”.
Lifetime Allowance
Lifetime allowance for tax-privileged pension savings to be £1.4m indexed in line with RPI. Tax free lump sum will be the lower of a) 25% of the value of the pension fund and b) 25% of the lifetime allowance. Transitional protection will be available for large tax-free lump sums. There will be a single valuation factor for valuing DB (Defined Benefit) schemes against the lifetime allowance at £20 for every £1 of pension. The recovery tax charge on funds in excess of the lifetime allowance is to be 25%. All funds in excess of the lifetime allowance can be taken as a lump sum, subject to a recovery charge of 55% (a combination of 25% recovery tax and 40% income tax). Alternatively such excess funds, subject only to the recovery charge, can be used to provide an income. Pensions credits granted under a pension sharing order post A-Day, will count against the recipient’s lifetime allowance but the pension debits will not be counted towards the donor’s lifetime allowance. Neither pension credits nor debits will count towards the annual allowance. FURBS will be outside the simplified tax regime.
Contributions
Annual contribution and DB benefit increase allowance will be £200,000 indexed in line with RPI. There will be an exemption for contributions and benefit growth in the final year provided that benefits are vested in full. Personal contributions will receive tax relief on the higher of £3,600 and 100% of UK earnings. There is no limit on the amount of contributions that employers can pay with full tax relief, in relation to current and former employees.
Benefits
The minimum benefit age will increase from 50 to 55 by 2010. There will be protection for those with contractual (employment) rights to retire before age 55. The armed forces, police and fire services will be exempt from this requirement. Benefits must commence by age 75. No return of capital on death after age 75. Up until age 75, pension benefits may be unsecured (i.e. similar to income withdrawal) subject to the following:
- Minimum income is £1 p.a.
- Maximum income is 120% of FSA single life level annuity rate
- Reviews at least every 5 years
Pension benefits must be secured before age 75 by one of the following:-
- A pension – guaranteed by an insurance company i.e. an annuity
- A pension – promised by an employer
- Alternatively Secured Income (ASI) – where security is gained by reducing the maximum income that can be taken. The maximum income is 70% of the FSA single life annuity rate (for ages over 75, the age 75 annuity rate must be used). Minimum income is £1 p.a. Maximum income is reviewed annually.
Lump sum commutation on serious ill health to be available if expectation of life is less than 1 year. This will be tested against the lifetime allowance for the recovery tax. Otherwise funds can be paid as a lump sum with no income tax. Benefits can commence before the minimum pension age on the grounds of incapacity.
Death Benefits
On death before vesting, a tax-free lump sum will be available up to the lifetime allowance. Any amount paid as a lump sum over and above the lifetime allowance will be subject to 55% tax. There will be no test against the lifetime allowance where the death benefits are paid as dependants’ pensions. On death after vesting, the benefits will depend upon the means of providing pension benefits. As long as pension income hasn’t been secured (e.g. using the equivalent of income withdrawal), the full value of the fund will be available as a lump sum on death, subject to a tax charge of 35%. If pension benefits are being provided using ASI, any funds remaining on death after age 75 must revert to the scheme and must be used to provide dependants’ pensions. Where there are no dependants, the scheme may use the funds to either augment existing members’ benefits (which will be subject to the annual allowance), contribute towards a surplus (and ultimately refund to the employer net of 35% tax) or pay to a registered charity. Lump sums payable on death will continue to be free from Inheritance Tax in most circumstances.
Scheme investments
Holding of shares in the sponsoring/associated/connected companies restricted to 5% of the fund value. Loans to members will not be allowed Loans to employers will need to be secured with a first charge on assets that remain of at least equal value to the face value of the loan. Maximum term is 5 years, interest at least rate base rate plus 1%. Scheme borrowing restricted to 50% of the scheme assets at the date the loan is taken out. A pension benefit in kind tax will be introduced to be levied where assets of the scheme have been used by the member, the employer or their associates on a non-commercial basis. Pension funds will be able to hold assets capable of being enjoyed by the members, including residential property.
Transitional protection
Increased transitional protection for those who cease contributions and pensionable service will be available. Falls into two categories, the first is protection against the recovery charge, the second is protection for tax-free lump sums.
Recovery charge
Primary protection – protection will be given to the value of pre A-Day pension rights and benefits in excess of £1.4million. The pre A-Day value will be indexed in parallel with the indexation of the statutory lifetime allowance up to the date that benefits are taken. Enhanced protection – this will be available to individuals who cease active membership of approved pension schemes before A-Day. Provided that they do not resume active membership in any registered scheme, all benefits coming into payment after A-Day normally will be exempt from the recovery charge.
Individuals with enhanced protection can revoke this at any time up to age 75 in favour of primary protection. Amounts in occupational schemes and buy-out contracts above Inland Revenue limits must be excluded from valuations for the purpose of protection from the recovery charge.
Lump sum protection
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