Pension simplification on A-Day provided many people with significantly improved opportunities to make pension contributions. The age-related contribution limits were replaced with the more generous annual allowance which applies to all types of registered pension scheme.
However, there is now an overall limit on the level of pension fund that can be accumulated known as the lifetime allowance. Pension funds in excess of the lifetime allowance when benefits are taken will be subject to an additional tax charge, the lifetime allowance charge. There is transitional protection against the lifetime allowance charge for those with pension funds accumulated before A-Day. The deadline for registering is April 5, 2009.
The table above shows the annual and lifetime allowances up to 2010/11. The Chancellor’s recent pre-Budget report included the proposal to freeze the annual and lifetime allowances for five years from 2010/11.
How do you value pre-A-Day pension funds? Money-purchase funds that had not come into payment are generally easy to value although special calculations can apply to older-style plans with guaranteed annuity rates.
It is very important that members of final-salary schemes and those who had just part of their pensions in payment at A-Day know how to value their funds. To obtain the equivalent capital value, a final-salary pension entitlement is multiplied by a factor of 20 but any pension in payment is multiplied by 25. A prospective pension of £80,000 a year would thus be valued at £1.6m. The same pension already in payment would have a value of £2m.
The transitional rules were introduced to protect those with pension arrangements established before A-Day. Protection is offered both for the fund and the tax-free cash element, if there was a tax-free cash entitlement greater than 25 per cent before A-Day. There are two types of protection – primary and enhanced protection.
Primary protection is available to individuals whose funds at April 2006 exceeded the prevailing lifetime allowance of £1.5m. Primary protection will provide the individual with a factor that will be applied to the lifetime allowance when benefits are taken. The factor is calculated as (fund value at A-Day – lifetime allowance)/lifetime allowance.
Enhanced protection is available to anyone. Pension funds do not have to exceed the lifetime allowance of £1.5m at April 6, 2006. If an individual decides to select enhanced protection, they must make no further contributions to registered pension schemes.
For defined-contribution schemes, they must stop contributing to any pension arrangement from A-Day although contributions in respect of death-in-service benefits can continue if these started before A-Day. Any employer contributions must have ceased at the same time. For final-salary schemes, a test is performed when benefits are taken or there is a transfer to another scheme. Benefits will be checked against the appropriate limit. If the benefit paid is within the limit, enhanced protection will still apply and there is no lifetime allowance charge.
If the conditions are met, for money-purchase schemes where growth is determined by the level of contributions and the investment return on the fund, any growth after A-Day will normally be fully protected from the lifetime allowance charge. For final-salary schemes, if the appropriate limit test is passed, the lifetime allowance charge will not apply. It is possible to revoke enhanced protection by becoming an active member of a registered pension scheme or making a further contribution to an existing scheme, therefore losing all transitional protection.
It is also possible to protect any pension credit awarded before A-Day. Pension credit is generally awarded in the form of a share of a former spouse’s pension following divorce. If a share of pension was received before A-Day, it is essential that this is reviewed to determine whether it is necessary to register for transitional protection.
From April 6, 2006, the tax-free cash sum across all pension arrangements (with minor exceptions) is 25 per cent of the fund. However, some members may have had an entitlement to a tax-free cash sum greater than 25 per cent. They can protect their entitlement if: