Changes that have taken effect from 6th April 2006
From 6th April 2006 all pension plans will have one set of tax rules, with an individual lifetime limit for everyone. The lifetime allowance One of the main features of the simplified regime is a single lifetime allowance for every individual on the amount of tax-privileged pension they are able to have. The Government will set this at £1.5 million initially and this will increase as follows: £1.6m in 2007/08, £1.65m in 2008/09, £1.75m in 2009/10 and £1.8m in 2010/11. Gordon Brown announced in his Budget 2004 speech that the lifetime allowance is to be reviewed every five years. |
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The lifetime allowance charge
The Government will permit an individual with a fund in excess of the lifetime allowance to take the excess funds as a lump sum (less 55% tax). If the excess is taken as a pension, 25% tax will be deducted by the scheme and the income will be taxed under PAYE (which also equates to an effective charge of 55% for higher-rate taxpayers).
The annual allowance
There will be an annual limit of inflows to an individual's pension funds. Any inflows above the annual allowance will be subject to a 40% tax charge. The annual allowance will be set at £215,000 in 2006/07. This will increase by £10,000 each year so that in 2010/11 it will be £255,000. The allowance will be applied to contributions to Personal Pension Plans and increases in accrued benefits in Occupational Pension Schemes, and it is expected that it will also be reviewed every five years. The annual allowance will not apply in the tax year where benefits are taken in full, either on retirement or death. This will aid some employees who receive an enhancement of pension rights in cases of redundancy, ill health or early retirement that may otherwise have been penalised.
Pension age
The minimum age for taking benefits will increase from age 50 to age 55 by 2010; pension schemes will decide how to make this change. Some protection will be provided to members of occupational schemes with existing contractual rights to take benefits after age 50 in cases such as redundancy. For those who currently have an agreed lower retirement date, such as professional sportspeople, benefits can be taken before age 55 but a reduced lifetime allowance will be applied (2.5% reduction for each year before age 55). Until 2010, the 2.5% reduction will apply for each year before 50. This reduction will not apply to those in the current armed forces, police and fire services pension schemes. However new schemes for these professions (which will adopt the age 55 rule) are expected to be in place before 2010. All benefits will have to be vested by age 75 either by an annuity or by Alternatively Secured Income (ASI).
Form of retirement benefit
Up to 25% of a pension fund (up to the lifetime allowance) can be taken as tax-free cash. This would allow schemes that currently do not provide cash, for example free standing AVC schemes, to do so. Whether tax-free cash is to be made available from contracted-out benefits is still to be determined. This issue is not part of the tax simplification issue; the Department for Work and Pensions (DWP) will be providing more information on this in due course.
The remaining fund must provide an income in one of the following ways:
- Secured benefits - a guaranteed income (annuity purchase or scheme pension).
- Alternatively Secured Pension, available from age 75, this option was introduced to meet the needs of religious groups that are against the pooling of mortality risk.
- Unsecured Pension - available up to age 75, a non-guaranteed income (new form of drawdown) or a short term annuity for 5 years until the age of 75.
Death benefits
Lump sum death benefits of up to the lifetime allowance will be paid out tax free. Where the lifetime allowance is exceeded a recovery charge of 55% will be levied on the excess fund where this is taken as a lump sum. Where the excess benefits are paid as a pension there is no recovery charge.
When death occurs during drawdown the whole of the remaining fund can be paid out less 35% tax. The death benefits from an annuity that gives value protection (before age 75) will be calculated as the purchase price less instalments less 35% tax.
Investment
Holdings of shares in the sponsoring employer will be restricted to 5% of the fund value. Loans of up to 50% of the fund value can be made but only to employers. Investments made before A-day will not be affected by these changes. Scheme borrowing will be restricted to 50% of the scheme's assets subject to DWP requirements, which may be more restrictive. There will no longer be an Inland Revenue requirement for a pensioneer trustee.
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