Having dealt with the position of unapproved schemes under the current pension tax regime, I would like to move on to consider how they will look under the new simplified regime.
Schemes will be treated as non-registered employer-financed retirement benefit schemes unless they choose to register and meet the required conditions. Under the proposed regime (Chapter 6 Part 4 and Schedule 36 Finance Act 2004):
Employer payments to non-registered schemes will not be taxable or liable to National Insurance as they are made and the employer will not secure tax relief on contributions. Tax relief for the employer and taxation of the former member will result when benefits are paid.
All investment income and capital gains received by non-registered schemes set up by way of a trust will be liable at the rate applicable to trusts and the Schedule F trust rate as opposed to the lower rates which most currently enjoy on investment income. This would mean a tax rate of 40 per cent or 32.5 per cent for dividends.
However, even though the new rate of 40 per cent applicable to trusts and the Schedule F trust rate of 32.5 per cent for dividends have been in force from April 6, 2004, these rates will not apply to Furbs' income until after A-Day on April 6, 2006.
Non-registered schemes which are based on discretionary trusts will be subject to the normal inheritance tax charging rules for discretionary trusts and will therefore have no exemption from the 10-year and periodic exit charges.
Amounts in non-registered schemes will not count towards the lifetime allowance.
Subject to important transitional provisions (see below), benefits paid from a non-registered scheme after A-Day will be liable to tax.
No National Insurance contribution charge will be levied on any benefits paid, provided these are within the limits of benefits that could be paid from a registered scheme. This is also subject to the condition that the employment relationship between the employer and member has ceased.
Under unfunded non-registered schemes, employers will be allowed to continue to provide suitable security and/or underwriting for promised benefits, subject to the member paying a benefit-in-kind charge on the cost to the employer of providing the security.
The Government has recognised the need to provide transitional protection for pre-A-Day unapproved schemes. I will look first at funded schemes.
Where a Furbs was established and received contributions before A-Day, special transitional treatment will apply. To understand this treatment, it is necessary to consider separately schemes where no further contributions are made after A-Day and those where contributions continue after A-Day.
No further contributions made after A-Day (paras 53-55)
The employee was assessed to tax on the employer contributions made and All the income and gains accruing to the scheme have been brought into charge to tax or the scheme was entered into before September 1, 1993 and has not been varied since that date then all lump-sum benefit paid from the Furbs will be tax-free. All the benefits paid on death will also be free of IHT by virtue of section 151 IHTA 1984 and will also avoid the discretionary trust charges (para 56).
Further contributions made after A-Day (paras 53-55)
An appropriate fraction of the lump sum paid out of the Furbs will be tax-free. Broadly speaking, in most cases, an amount equal to the market value of the fund at April 5, 2006, increased by the RPI, will be tax-free. Any excess – even if this is contributed to by increases in the April 5, 2006 fund value by growth in excess of the RPI – will be taxable on the employee under section 394 ITEPA 2003.
The protected portion of the fund, based on the market value at April 5, 2006 and increased by the RPI, will be IHT free but the remainder of the fund will not (para 56).
It should also be noted that any non-dividend income and realised capital gains post-A-Day will be subject to tax at the rate applicable to trusts and any dividend income to the Schedule F trust rate.
No transitional provisions will apply for Furbs where, pre-A-Day, the employee had not been taxed on the contributions as and when they were made.
Now let us look at unfunded schemes – Uurbs. Broadly speaking, any Uurbs in place on the day before A-Day can be consolidated and rolled into a registered scheme within three months of A-Day. Where this is undertaken, the increase in value of the registered scheme due to the inclusion of the Uurbs benefits will not count towards the annual allowance but will be tested ultimately against the lifetime allowance. Of course, to do this under what is, by definition, a scheme with no funds, there will be a requirement for the employer to “capitalise” the promise.
If Uurbs benefits are rolled into a registered scheme at any other time, they will count against the member's annual allowance in the tax year in which the benefits are included in the registered scheme.
Although it is the intention to automatically include any existing approved schemes as registered schemes within the new regime, a scheme can opt out of the new regime at A-Day. Where it does so, it will pay a 40 per cent tax charge on fund assets prior to opting out and funds withdrawn from the scheme after A-Day are liable to tax and National Insurance, with no entitlement to a tax-free cash sum in respect of the member.
Next week, I will focus on funded unapproved schemes. My approach will be to consider what action to take in respect of existing schemes and whether there will be any merit in establishing new non-registered schemes.