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Pension Simplification

Detailed below are some of the salient points of the new Pension Simplification rules. To discuss these or any other aspects of the new legislation further, please contact Catherine Billington who will arrange contact with one of our consultants.



Background

In December 2002, a Green Paper was issued by the Government outlining consultation areas in relation to the operation of pension schemes in the UK. From this embryonic stage and industry input, the Finance Act 2004 was born, which outlined how the eight different regimes of pension schemes in the UK were to be replaced by one set of rules to 'simplify' the pensions environment and 'engage the man in the street'. This was coined as 'Pension Simplification'.

Originally, these new rules were to be implemented on 5 April 2005 (A-day), but due mainly to the incapability of both HM Revenue and Customs and large insurers to adopt the new administrative procedures, it was delayed for a year to 6 April 2006.

As a proactive organisation, we were well aware of the implementation of this new legislation, and created a team to work on how this would affect our clients and marketplace from an administration and consultancy perspective. This preparation ensured that the transition would be relatively smooth and efficient.

HM Revenue & Customs now requires us to operate within guidance notes, rather than specific rules. This, in our opinion, can make the new environment of pensions more complex than simple, as it relies on interpretation. However, one thing is clear: this new regime offers further pension planning opportunities both pre- and post-retirement, especially with proactive and bespoke consultancy/administration.

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Standard Lifetime Allowance (SLA)

Individuals are permitted to accrue total pension benefits from all arrangements up to the level of the Standard Lifetime Allowance (SLA) which currently stands at £1.6 million (2007/08). This level is set to increase to £1.8 million by 2010 and broadly in line with RPI thereafter. If an individual's fund exceeds the SLA they become liable to a tax charge of up to 55% of the excess, known as a 'recovery charge', which is taken at source. The SLA will only be tested against when certain instigating events occur, which in most cases will be when an individual draws retirement benefits from their arrangement(s). However, examples of other instances include death or transferring pension assets abroad.

Individuals who have total pension arrangements near or above the SLA at 6 April 2006 can seek transitional protection to safeguard them from the recovery charge. This can be achieved through 'primary' and/or 'enhanced' protection, which must be registered with HM Revenue & Customs by 5 April 2009. This can be a very complicated issue, and seeking early advice regarding this matter could be crucial to individuals not falling foul of the SLA and incurring large tax charges.

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Investments

Independent self-managed arrangements such as SIPP and SSAS continue to be the most flexible pension platforms to orchestrate an investment strategy with the ability to invest through various formats, directly and indirectly, into the main asset classes i.e. equities, fixed-interest, cash and property. Specifically, Pension Simplification has brought further opportunities and flexibility for investments, which include:

  • Pension schemes can transact with scheme members and other connect parties
  • Purchasing unquoted shares (SIPP)
  • Loans for property purchase can be from an individual or company rather than a bank
  • Development of residential property and purchase of residential property through syndicates
  • Loan 50% of fund immediately back to sponsoring/associated company (SSAS only)

However, this has not been a one-way street and there have been some notable downsides to this new regime, examples of which are:

  • Borrowing limits to aid with the purchase of a property are now restricted to 50% of the fund value
  • Shares in sponsoring employers restricted to 5% of fund value
  • Security required in loans back to sponsoring/associated company (SSAS only)

On balance, the new investment framework brought by Pension Simplification undoubtedly allows greater scope for investment planning.

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Contribution Limits

Possibly one of the most fundamental changes since the advent of A-day is the revision to the limits for individual's and employer's contributions into their pension schemes. The current annual gross limit for an individual equates to £225,000 through a mixture of personal and company contributions.

Specifically, tax-relievable personal contributions can be 100% of an individual's gross salary or £225,000, whichever is the lesser. An individual's employer can also make contributions up to this annual limit but with no reference to salary or service. However, the granting of corporate tax relief on an employer contribution is subject to the discretion of the Local Inspector of Taxes (LIT), as it must be deemed to be an allowable business expense tested against the 'wholly and exclusive' provisions.

Exemption from this annual limit is available when an individual is in their final year before they are due to take benefits. In that year, contributions can be received up to the Standard Lifetime Allowance (see above).

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Retirement Age

The earliest an individual is able to retire is currently set at age 50. The will continue until 5 April 2010, when it will be raised to age 55. Individuals born between 7 April 1955 and 5 April 1960 need to pay particular attention to this rule amendment if they have aspirations to retire around their 50th birthday.

There are certain concessions for some groups e.g. sports persons, fire fighters and members of the armed forces, but in the majority of cases the above rules apply.

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Pension Commencement Lump Sum (PCLS)

This is the term that is now used when an individual draws their tax-free lump sum from a pension scheme. The minimum that is now available equates to 25% of the standard lifetime allowance (SLA) of the value of the scheme's fund, and can be taken any time after the minimum pension age, but before age 75. Members of pension schemes who are entitled to more than 25% pre A-Day are entitled to 'transitional protection' to protect their entitlement. However this is a highly complex field where guidance is essential.

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Pension Income

When commencing the drawing of a pension income, individuals under the age of 75 can use either a secured or an unsecured arrangement. The method selected is primarily dependent upon the type of underlying pension scheme and the needs of the member. Examples of a secure pension income include those from a final-salary scheme or an annuity.

Unsecured pension withdrawal usually takes the form of what is referred to as 'income drawdown'. In many cases this is the most beneficial way of drawing benefits and is the route taken by a large proportion of SIPP and SSAS clients. The key to income drawdown is maintaining control and ownership of the accrued pension assets rather than purchasing an annuity, where the capital is lost. This is vital as it allows the flexibility of being able to provide a dependant's pension or lump sum on an individual's death (see below).

The level of pension that can be provided via income drawdown is dependent upon an individual's age and the underlying annuity rate advised by the Government's Actuarial Department (GAD). These rates are the equivalent of what someone could reasonably expect to receive from an annuity on a single life basis. Resultantly, 120% of this GAD rate can be used to calculate an individual's maximum annual benefit/income. The aim is to manage the assets within the pension arrangement such that the return achieved aids towards partially/fully funding an individual's income payments, thus maintaining the majority of the capital.

A pertinent point regarding income drawdown is that there is no requirement whatsoever for an individual to draw a pension once a pension commencement lump sum has been paid. In addition an individual is not obliged to cease working prior to drawing benefits.

One of the most fundamental changes has been the removal of the compulsory requirement to purchase an annuity at age 75. Once an individual reaches age 75, income drawdown ceases. It can be replaced with an annuity purchase, or an Alternatively Secured Pension (ASP). In broad terms, ASPs work on exactly the same basis as income drawdown, the difference being the maximum and minimum that can be drawn by way of income. The parameters are between 55% and 90% of GAD at age 75 and remain constant at this level i.e. it does not increase with age.

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Death Benefits

A fundamental factor of a majority of pension arrangements is the provision provided to beneficiaries upon an individual's death. Beneficiaries are usually financial dependants, such as a spouse, children and civil partners, although there are others who may qualify.

The types of benefits which are available on death are dependent upon the types of scheme the individual had in operation, whether they have withdrawn a pension commencement lump sum (PCLS) and also the age at which they died. These are as follows:


Death before drawing benefits

If an individual dies before drawing pension benefits, the assets of the scheme can be crystallised and can usually be paid as a lump sum to beneficiaries within two years of death, with no further tax consequences. Alternatively, a dependant's pension can be paid, determined by their age.


Death after drawing benefits

Death after taking benefits within an unsecured arrangement i.e. income drawdown, is the same as that above, although if a lump sum is required a 35% charge will be taken at source.


Death after age 75

Both the above scenarios assume death before age 75. If income is derived from an Alternatively Secured Pension (ASP) no lump sum is available, only a dependant's pension. However, on the death of the dependant the capital could be 'inherited' by the second generation to form part of their pension assets and used accordingly. This transfer of funds may be subject to a tax charge of up to 70%. In addition, HM Revenue & Customs will levy a further inheritance tax charge on the remaining 30% (if above the nil rate band) bringing the potential total tax bill to 82%.  This is a key area of planning and requires specialist advice which we offer at Mattioli Woods.

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Unauthorised Payments - Tax Charges

It is now possible for funds to be withdrawn from a pension scheme either by an individual or a company (sponsoring employer), which fall outside the realm of authorised payments set out by HM Revenue & Customs. Such unauthorised payments may not affect the tax exemption status of the scheme and its approval. However, there are severe tax consequences levied on such withdrawals, which need to be considered before proceeding.
Unauthorised payments are defined as a transfer of assets or a monetary amount to a scheme member (or person connect to that member) or a sponsoring employer. Whilst not exclusive these could include:

  • Giving a scheme asset to an individual
  • Selling a scheme asset for less than it is worth
  • A scheme buying an asset for more than its worth
  • Rental arrears (connected leases)
  • Loanback repayment arrears

The broad tax implications of the above are:


Unauthorised payment charge -

up to 40% of the amount withdrawn dependent upon the income tax payable by the recipient

Unauthorised payment surcharge -

a further 15% tax applied if the amount withdrawn is greater than 25% of the total scheme

Therefore the total tax charge could reach 55%.
In some cases the withdrawal may also require a 'scheme sanction charge' to be levied. Therefore, in the majority of cases advice should be sought from an adviser such as Mattioli Woods before proceeding with such a transaction.

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