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13. Pensions

There is no surprise that the Budget contains little new on pensions as the major changes have already been set out in the Finance Act 2004 and the Pensions Act 2004.

The Finance Act 2004 sets out the new simplified tax regime that starts on 6 April 2006 (A-day). The Revenue recently issued a Technical Note indicating that after consultation some changes were going to be made to provide additional flexibility, clarifying aspects of the new rules, smoothing the transition from the current regimes to the new regime and introducing further anti-avoidance and compliance rules. These have been acknowledged in the Economic and Fiscal Strategy Report (published by the Treasury) which states that the Government will introduce a package of supplementary measures, which will come into effect from April 2006. Additionally, the Revenue has indicated that schemes will have until 6 April 2011 to make changes to their rules to cope with the new simplified regime rather than the previously understood 6 April 2009.

The Revenue has also acknowledged that the tax-free lump sum rules under the simplified regime need to be reconsidered because of the different calculation routines applying to scheme pensions and lifetime annuities. Further consultation will now take place and an announcement will be made by the 2005 pre-budget report with the intention to change these rules in the Finance Bill 2006.

13.1 The Earnings Cap

The earnings cap has been increased to 105,600 for tax year 2005/06.

In the past where directors have been unable to pension their earnings over the cap by means of an approved occupational scheme (as they are neither pre-87 nor 87/89 regime members) serious thought has been given to the use of a Funded Unapproved Retirement Benefits Scheme (FURBS) to pension these. While previously this has offered a number of attractions there are a number of new aspects that need to be considered before FURBS contributions are paid in 2005/06.

FURBS benefits accrued prior to A-day will be subject to special transitional arrangements, which will normally permit such benefits to be paid tax free where paid as a lump sum and to retain the pre A-day inheritance tax treatment. However, a members accumulated FURBS investment fund will, from 6 April 2006, lose its favourable income tax treatment and be subject to the normal tax rate for trusts (i.e. 40% and in respect of dividends 32.5%). The rate of tax on capital gains rose to 40% from 6 April 2004 in line with the general increase in the rate of tax applicable to trusts. This is likely to mean that FURBS contributions in 2005/06 may prove attractive for those individuals who are looking to draw their benefits shortly after A-day but far less attractive to individuals who do not wish to draw their benefits for some time thereafter. This is because the effect of the increased tax liability on the invested FURBS fund will become increasingly important the longer the fund remains invested.

It should be noted that the definition of final remuneration for pre 87 and 87-89 members will also be changed from 6 April 2005 to tie in with the increase in the earnings cap to 105,600 from that date.

At present where an individual subject to the pre 87 or 87-89 regimes has remuneration exceeding 100,000 subsequent to 5 April 1987, which is used for the purpose of calculating benefits, their final remuneration must be determined as either:

– the average of the best 3 or more consecutive years total emoluments from the employer ending in the 10 years before the members retirement date, or

– 100,000, if greater.

In addition a 87-89 member may only have his/her tax-free cash determined using a maximum final remuneration of 100,000.

In each case from 6 April 2005, the definitions will be amended so that the 100,000 is increased to 105,600 to tie in with the increase in the earnings cap from that date.

13.2 The New Simplified Tax Regime

On A-day the Government will be introducing the new simplified pensions tax regime. All the existing pension tax regimes for occupational pensions, personal and stakeholder pensions, and retirement annuity contracts will be swept away and replaced by one new tax regime.

The changes mean that all clients will need to review their existing pension provision in light of the changes and, where appropriate, take action both before and after 6 April 2006 in order to maximise their benefits.

The key changes are:

One new pensions tax regime will apply to members of all approved schemes (henceforward to be called registered schemes)

All existing approved schemes (occupational, personal, stakeholder and retirement annuity contracts) will be subject to the rules of the new tax regime.

A single Lifetime Allowance limiting the total amount of pension savings that can benefit from tax relief will be set. In tax year 2006/07 this will be 1.5 million. This will be increased in each subsequent tax year as indicated by the Treasury.

Special transitional rules will enable members, where appropriate, to protect their entitlement to pension and tax-free cash benefits secured prior to 6 April 2006.

Where the value of an individuals retirement benefits exceeds the Lifetime Allowance a charge of 25% will be levied (55% where the excess is taken as a lump sum).

There will be an annual limit of inflows of value to a members pension funds. As at 6 April 2006 this will be 215,000. This amount will be increased each tax year as indicated by the Treasury.

The maximum members personal contribution in each tax year will be limited to the greater of 3,600 gross and 100% of earnings.

Up to 25% of the capital value of a members benefits within the Lifetime Allowance may be taken as a tax-free cash sum. The balance will be used to provide taxable annuity or income benefits. There is no specific limit on the maximum pension/income that can be provided other than that available from the capital value of the members fund within the Lifetime Allowance.

Where a member dies before drawing benefits a lump sum of up to the amount of the Lifetime Allowance can be paid free of IHT to one or more beneficiaries. Where a lump sum exceeds the Lifetime Allowance, the excess will be subject to tax at 55% on the recipients of the death benefit.

Provision may also be made for a spouse/dependants pension/income payments in the event of the death of the member before or after drawing benefits.

Benefits may be drawn from age 50 onwards (age 55 from 6 April 2010). A member may be able to draw their benefits in full or in part without having to retire from their employment.

Employer contributions will normally be allowable as a business expense in the accounting period in which they are paid. Tax relief will be available on the members own contributions at the members highest rate(s).

The introduction of the new pensions tax regime in April 2006 is not, however, a reason for stopping or delaying pension contributions. Full advantage should be taken of the favourable provisions of the current pension tax regimes while they still exist. The ability of an individual to elect for enhanced transitional protection under the new regime should mean that he/she, where able, can safely maximise their pension benefits under current rules without running the risk of suffering a Lifetime Allowance charge under the new regime.

13.3 Planning For The New Simplified Tax Regime

During the coming year clients will be seeking advice on what action they should be taking on pensions before the introduction of the simplified regime.

For many individuals the introduction of the new tax regime will have little, if any, impact as their retirement fund is never likely to exceed the Lifetime Allowance. These clients should
continue with their current pension arrangements, perhaps considering an increase in their contributions where they can afford this.

However, where an individuals retirement fund is close or already exceeds the initial 1.5 million Lifetime Allowance, or can be reasonably expected to exceed the Lifetime Allowance in the future after taking account of potential future contributions/benefit accrual/fund growth, advice will be needed on their future pension planning. The following is a list of some of the potential actions/considerations pre A-day. It will, of course, be dangerous to provide advice on how to deal with the new regime until the proposals are finalised.

1. Pre A-Day Valuation

Before an individual can consider what action to take he/she will need a valuation of his/her pre A-day pension rights in accordance with the provisions of the new regime. Without this he/she will not be in a position to determine whether to elect for primary or enhanced protection, or whether to elect for enhanced protection where his/her benefits are currently below the initial Lifetime Allowance.

Occupational scheme members will also require details of their maximum allowable tax-free cash sum under their current scheme(s) to establish whether they should seek to protect their pre A-day tax-free cash entitlement. This will be required irrespective of whether such members are electing primary or enhanced protection or are not seeking any transitional protection in respect of their pre A-day pension benefits.

2. Primary Or Enhanced Protection?

Where an individual wishes to protect their pre A-day pension rights they can opt for either primary or enhanced protection or, where their pension rights exceed 1.5 million at A-day, both.

Primary protection is only available where the capital value of the individuals pre A-day benefits exceeds the Lifetime Allowance. The capital value of the individuals pension benefits at A-day will be protected from any subsequent recovery charge provided the capital value of the members pension benefits at the time benefits are drawn does not exceed the original capital value increased in line with the increase in the Lifetime Allowance over the period up to when benefits are taken.

Enhanced protection can be elected irrespective of the capital value of the members fund at A-day. It provides full protection from any recovery charge but can only be elected where no further pension accrual and/or no further pension contributions are payable in respect of the member after A-day.

Although an individual has three years from A-day to elect for primary or enhanced protection, in practice, where they intend to elect for enhanced protection they must ensure that they stop contributions and pension accrual before A-day.

Perhaps the most difficult decision will be for those individuals who have accumulated significant pension benefits prior to A-day, but with a capital value of less than the Lifetime Allowance. They will have to choose between enhanced protection and no protection. They can either opt out of pension accrual/ further pension contributions at A-day, or continue to accrue benefits/pay contributions beyond A-day and risk paying a recovery charge on eventual retirement. Careful analysis will be required to determine the most appropriate option, particularly for members of money purchase schemes where the likely rates of future investment return will be a primary consideration.

3. Maximise Contributions

The ability to opt for enhanced protection, which will ensure that none of a members accrued pre-A-day pension rights will be subject to a recovery charge, means that a member can safely maximise his/her pension contributions under existing pension arrangements prior to A-day. Note however that the existing rules will be applied to determine the amount to be protected on the assumption that the member left service on 5 April 2006.

Such maximisation could take advantage of carry back in respect of personal pensions, carry back/carry forward in respect of retirement annuity contracts and sizeable special contributions for members of occupational schemes who have sufficient past service to justify such payments.

4. Funding For Tax-free Cash

The current rules permit occupational schemes to fund for tax-free cash only equivalent to 3/80ths of final salary for each year of service. This is not a feature of the new simplified regime although transitional provisions will protect those benefits already accumulated under existing schemes. If taking advantage of this facility it should be remembered that the maximum tax-free cash will be calculated at 5 April 2006 on a leaving service basis.

5. Defer Taking Benefits Until A-day

For many members of occupational schemes the new tax regime will permit a potentially larger tax-free cash sum to be drawn than under their existing rules. Provided the rules of their employers scheme are amended to permit advantage to be taken of the new tax-free cash entitlement, it would be advantageous for such members, due to retire prior to A-day, to defer retirement until A-day to obtain a higher tax-free cash sum. Any such deferment would, of course, be subject to the employers agreement. If the scheme rules are not to be amended or the employer is unprepared to agree to the deferral of the members retirement date, the member could consider opting out of the employers scheme shortly before retirement and effecting a transfer to a personal pension or a section 32 contract. It should, of course, be remembered that where any transfer is made within one year of the members Normal Retirement Date under the scheme it will be subject to the agreement of the scheme trustees as the member will not have a right to a cash equivalent transfer value.

6. Scheme Benefit Design

Scheme trustees, in association with the employer, will need to consider what changes, if any, need to be made to scheme benefit design. For example, occupational schemes with post 89 members subject to the earnings cap may wish to retain that limit (or a comparable salary-related limit) to contain employer pension costs. Decisions will need to be made regarding any realignment of death benefits, the introduction of the new flexibility over payment of retirement benefits, and whether the scheme will introduce the new tax-free cash rules or retain the existing tax-free cash calculation basis. Other issues include whether a scheme should re-admit a member who has opted out to claim enhanced protection.

7. Scheme Audit

With the benefits of all registered schemes after A-day being subject to the same rules, differences in benefits will no longer be an argument for selecting one scheme over another. Instead attention will focus increasingly on charges, investment and service. All schemes will need to be reviewed to see that they meet the members objectives. For example, would a member be better advised to switch his or her benefits to a new registered scheme with a lower charging structure? Would it be advantageous to transfer to a scheme with a wider or more appropriate range of investment options?

Of course great care must be taken when advising any member to transfer from one scheme to another. Aspects that need to be taken into account when making the recommendation will include:-

– whether an employer who contributes into the current scheme will continue to contribute at the same level to a new scheme

– any transfer charges that will be made by the transferring scheme (and/or loss of benefits for transferring before the members retirement date)

– any special features of the existing contract (e.g. guaranteed annuity rates)

8. Information To Scheme Members

Although one new tax regime sounds very simple, there are a good number of complexities that need to be explained to scheme members, particularly if they are likely to apply for transitional protection of their pre A-day benefits. Such information will need to be provided on a generic and a member specific basis.

13.4 The Pensions Act 2004

The Pensions Act 2004 contains 325 sections and 13 Schedules and will come into force gradually. A few minor provisions were introduced immediately but the main provisions are expected to be implemented in three stages.

To be implemented from April 2005:

– the new Pensions Regulator
– the Pension Protection Fund
– the Financial Assistance Scheme
– the changes to pension increases in payment (LPI)
– the stricter debt on the employer calculation in multi-employer schemes
– a new statutory priority order on winding up
– the new requirements for TUPE transfers
– changes relating to the internal dispute resolution procedure
– less prescriptive internal dispute resolution procedures
– new incentives to defer the taking of State benefits

The measures expected to be introduced in September 2005 are those required to comply with EU Pensions Directive and include:

– new scheme funding provisions
– cross-border pension provision

April 2006 will see the introduction of the bulk of the remaining provisions of the Act including:

– the changes to the MNT rules
– the replacement for s.67
– the changes to protected rights benefits (commutation and date benefits can be drawn)
– the introduction of the new early leaver provisions for occupational schemes
– the consultation requirement for employers

The Pensions Protection Fund (PPF) commences on 6 April 2005. The Revenue has confirmed that although the PPF is not a pension scheme it will be given tax treatment equivalent to that of a tax privileged pension scheme with effect from 6 April 2005. This will similarly apply at 6 April 2006 when the new simplified regime takes effect. The Revenue has indicated that tax relief will be allowed for payment of the statutory levies to the PPF, for example, where a sponsoring employer provides a scheme with funding for the levy payments. The Revenue has also stated that as the PPF is not a pension scheme it will not be able to pay tax-free lump sums. It will be interesting to see whether legislation will be passed to enable tax-free cash to be taken and if so how much and on what terms.

13.5 State Pension Changes

1. Council Tax Bills

Each pensioner household with someone over the age of 65 will receive a payment of 200 to help with their council tax bills. This will be paid at the same time as the 2005 Winter Fuel Payment and will mean that pensioners over 65 will receive a total of 400 and pensioners over 80 will receive 500.

2. Deferral Of State Pension

Those deferring their state pension by at least a year from April 2005 will be able to take a taxed lump sum instead of a higher weekly pension. From figures produced by the DWP this indicates that an individual who defers taking their weekly state pension of 82.05 for one year could receive a taxed lump sum of 4,412 instead of an increase in weekly state pension of 8.53. For a five year deferral thus would be a taxed lump sum of 25,244 instead of a weekly increase of 42.67. The lump sums will be taxed at the rate applicable to the individuals other income.


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