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   Pension Simplification
  Pension Simplification   "The replacement of eight tax regimes to simplify pensions"

A-Day went a long way to simplify the UK pension regimes by introducing lifetime and annual allowances as controls. Although defined benefit and contributions schemes remain with
many different pension product types, they now all operate with the same annual and lifetime contribution limits.
  Introduction   Lifetime allowance   Term certain annuities
  Law revisions   Annual allowance   Annuity guaranteed period
  Retirement age   Tax free lump sum   Value protected annuity
  AVCs   Trivial pensions   Alternatively secured pensions
  Death benefits   Income drawdown   Carry forward
    Small pots   Cash-in pension fund

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The Chancellor announced in the Budget on 17 March 2004 that the tax simplification proposals from HM Revenue & Customs will be implemented from 6 April 2006. This created a single universal regime to replace the current eight tax regimes and the changes affect savers in occupational and personal pension schemes, employers and financial advisers.

Pension simplification introduces two new controls, the pension lifetime allowance and pension annual allowance replacing all eight current tax regimes with their numerous controls.

The other main changes allow all schemes to offer a tax free cash of up to 25%, to allow employees the opportunity to continue working for their employer while taking benefits from their occupational pension scheme, pensions schemes are to be allowed to invest in all types of investments including residential property and the complex approval process for pension schemes will be replaced with a simplified registration procedure.

In 2014 Budget the Chancellor introduced new allowance limits from 27 March and 6 April 2014 and a radical pension change from April 2015 where people are no longer required to purchase annuities. Instead they can now take their 25% tax free lump sum and the remainder of the fund as a cash sum less tax at their marginal rate.

Law revisions
Previous to A-Day there were eight different tax regimes that govern UK pensions and each of them had their own complex rules that limit the amount an individual and contribute to their pension scheme as well as the benefits at retirement age.

As a consequence there were differences in the contribution amounts required and benefits derived between defined benefit schemes and defined contribution schemes.

An example given by HM Revenue & Customs was that although all pension schemes were subject to the same earnings cap (£105,600 in the 2005-06 tax year) schemes were allowed different contribution levels as follows:

For occupational pension schemes (1989 regime) could contribute up to 15% of earnings up to the earnings cap and receive tax relief while the employer contributions are limited to the earnings cap;
For personal pensions plans (1988 regime) an individual can contribute up to £3,600 per annum of a percentage of capped earnings from 17.5% to 40% depending on age and receive tax relief;
There were different rules applying to pre-1970 schemes, post-1970 schemes, 1987 regime and retirement annuity contracts. For the latter the individual can also use carry back and carry forward for any unused relief.
In addition the regimes had different rules regarding the benefits that can be taken from the schemes. Therefore an occupational pension scheme is limited to 2/3rds of final salary after 20 years service whereas there is no limit imposed on the benefits from a personal pension plan.
There are also different rules that applied to the tax free lump sum from these schemes. An occupational pension scheme is limited to 3/80ths of final pensionable earnings for each year of service whereas a personal pension plan can take 25% of the total fund value.

Lifetime allowance
A standard lifetime allowance is the maximum amount of pension savings that can benefit from tax relief and has been initially set at £1.5 million. This figure will rise over time and the proposed amounts are as follows:

2006/07 - £1.5 million
2007/08 - £1.6 million
2008/09 - £1.65 million
2009/10 - £1.75 million
2010/11 - £1.8 million
2011/12 - £1.5 million
2011/12 - £1.5 million
2012/13 - £1.5 million
2013/14 - £1.5 million
2014/15 - £1.25 million
2015/16 - £1.25 million
2016/17 - £1.0 million
2017/18 - £1.0 million
2018/19 - £1.0 million

The standard lifetime allowance is based on the approximate amount of money that would be needed to purchase a pension equal to the maximum HM Revenue & Customs (HMRC) would permit under the tax regime. Funds in excess of the lifetime allowance are felt to have benefited unduly from pension scheme tax advantages and therefore a tax charge is made.

In terms of occupational scheme benefits the HMRC have determined that the lifetime allowance of £1.5 million is broadly the amount required to provide maximum benefits for a 60 year old with earnings at the earnings cap of £105,600 in 2005/06.

The HMRC are using a valuation factor of 20:1 for converting a defined benefit scheme to a cash equivalent. Therefore the £1.5 million lifetime allowance represents a gross income of £75,000 per annum.

Funds that exceed the lifetime allowance can be taken as a lump sum and in this case the lifetime allowance charge would be at 55%. There is a lifetime allowance charge of 25% on pension funds that exceed the lifetime allowance and are used to provide a pension income. The income would also be subject to income tax at the individuals marginal rate and probably this would be a 40% higher rate tax, therefore the likely overall effect would be a tax rate of 55%.

Annual allowance
The annual allowance was initially set at £215,000 rising to £255,000 and this figure has been reduced to £40,000 for payments to a defined contribution scheme or as accrued benefits within a defined benefit scheme.
2006/07 - £215,000
2007/08 - £225,000
2008/09 - £235,000
2009/10 - £245,000
2010/11 - £255,000
2011/12 - £50,000
2012/13 - £50,000
2013/14 - £50,000
2014/15 - £40,000
2015/16 - £40,000
2016/17 - £40,000
2017/18 - £40,000
2018/19 - £40,000

When you crystallise your benefits, taken your tax free lump sum, your annual allowance remains at £40,000 as long as you do not take any tax able income. Once you take taxable income your annual allowance reduces to £4,000 effective from the 2017/18 tax year.

The limit for contributions such as 17.5% for personal pensions for individuals under age 36, or 15.0% for members of an occupational money purchase scheme have been replaced to allow individuals to make contributions subject to the annual allowance and this gives the individual the opportunity to contribute considerably more to their retirement planning.

However, tax relief on the contributions is to be limited to the higher of 100% of relevant earnings or where tax relief is given at source, limited to £3,600. Where funding exceeds the annual allowance an annual allowance charge of 40% is levied on the excess in contributions. Any investment growth or loss in the value of the fund for all money purchase schemes, whether private pensions or occupational pensions, are not included in the annual allowance.

Where an individual has no earnings it is possible to contribute up to £3,600 per annum (£2,808 net of basic rate tax) to a personal pension or stakeholder pension where tax relief is received at source.

For members of a defined benefit final salary pension scheme the value is to be calculated as the increase in value of the employees' pension benefits accrued during the year using a valuation factor of 10:1, as opposed to the factor 20:1 used at retirement.

Carry forward
For any unused annual relief from the previous three years it is possible to use this in the current year. The maximum single contribution with tax allowance being claimed (subject to taxable earnings) is £140,000 where there have been no previous contributions based on the following tax years.
2012/13 - £50,000
2013/14 - £50,000
2014/15 - £40,000

Small pots
The size of small stranded pension pots that can be taken as a lump sum increased to £10,000 from 27 March 2014 from the previous level of £2,000. Three pots of this size will be able to be taken by an individual, an increase from two.

Retirement age
There is no longer a maximum age when benefits need to be taken, previously it was 75 for pension annuities.

The minimum pension age was 50 years. Pension simplification from 6 April 2006 increased this retirement age to 55 from 6 April 2010 and it is up to the schemes to decide how to implement the change.
This applies to taking the tax free lump sum, purchasing an annuity and income drawdown.

Between 6 April 2006 and 5 April 2010 it was possible for those aged 50 years and over to take pension benefits. This applies to existing pension arrangements that currently have a higher minimum retirement age, such as protected rights benefits where the minimum age was 60.

From 6 April 2010 it will not be possible for individuals under the age of 55 to take pension benefits. The only exceptions are the following:

People who retire due to ill health;
Members of occupational pension schemes that already have contractual rights to retire early;
People with special occupations with lower retirement ages such as sports people.

Any occupational pension scheme member with contractual rights at 9 December 2003 to take benefits from age 50 can retain this right.

For special occupations where individuals have low normal retirement dates (NRD) and are allowed to retire and take benefits before the minimum pension age, they can do so however there will be a 2.5% discount to the lifetime allowance for each year before age 55.

Cash-in pension fund
From April 2015 the Chancellor will allow people retiring to take their 25% tax free lump sum and with the remainder as a lump sum less tax at their marginal rate.

This is intended to give people the greatest flexibility to use the pension fund in the best way possible. The minimum age remains 55 an opens up the possibility of the fund being used for any purpose to generate alternative income, such as purchasing a buy-to-let property.

Trivial pensions
Trivial pension rules aim to increase the number of options available where an individual has a smaller fund by taking this as a lump sum with bigger allowances from 27 March 2014. There are a number of conditions that the individual must comply with as follows:

The member must take the trivial pensions within a 12 month period;
The total amount taken as a cash sum has been increased from £18,000 to £30,000 from 27 March 2014.
Pensions already in payment are valued at £25 capital for every £1 per annum gross pension;
The fund to be used for the trivial pension must be commuted in it's entirety;
Commutation must occur from the member's age of 60;
Pensions in payment may also be commuted but will be taxed in full as earned income.

From the amount commuted 25% can be taken as a tax free lump sum and the balance is taxed as earned income. The following example shows the tax implications for a basic rate tax payer that has a fund of £30,000.

25% tax fee cash
Taxable fund
Basic rate tax (20% 2014/15)  
Net lump sum  
Total pension lump sum     £25,500

Where no trivial fund exists and earnings supported a gross pension contribution of up to £15,000, an individual can plan a single contribution to a pension prior to retirement. In the above example a payment of £12,000 is required, and this benefits from tax relief at the outset so £15,000 is invested in the fund. The individual can immediately encash the fund under the trivial rules realising after tax a sum for £12,750 making a once only net profit of £750.

There is a penalty of up to £3,000 for individuals who negligently or fraudulently obtain an unauthorised payment. This includes trivial commutation payments when the value of benefits from all schemes exceeds the £30,000 limit.

Tax free lump sum
Previous to A-Day the the tax free cash entitlement from a pension differs between defined benefit and defined contribution schemes. Under pension simplification rules all schemes will be able to pay a tax free lump sum of up to 25.0% of the fund value and to a maximum of 25% of the lifetime allowance irrespective of the type of pension. This includes protected rights portion of a pension, AVC, FSAVC's and transfers received from occupational pension schemes.

For defined benefit schemes such as final salary pensions the scheme must calculate the value of the pension to determine the maximum tax free cash. The calculation used by the HMRC is a 20:1 value for converting a defined benefit scheme to cash. Therefore assuming a pension accrued of £15,000 per annum, this would represent a cash value of £300,000 which would produce a tax free cash sum of £75,000.

Prior to A-Day where a scheme member has rights within an occupational pension scheme greater than 25.0% tax free cash, these rights are automatically retained within the pension scheme. They will also be uplifted in line with the standard lifetime allowance. Benefits accrued after 6 April 2006 must apply the 25.0% maximum tax free cash and this applies to all occupational pension schemes on transfer to another scheme irrespective of any retained rights. If the tax free lump sum in total exceeds 25.0% or more than £412,500 (25% of the £1.65 million lifetime allowance for 2008/09) a tax charge would be made.

The balance of the pension fund must still be used to purchase pension annuities at retirement. The individual has the option to search for the highest annuity rates using an open market option, however, before making a decision at retirement, learn more about annuities, compare annuity rates and secure a personalised annuity quote offering guaranteed rates.

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