Ritson Smith hot topic: pension changes, and understanding the implications of “A” day

 
The following article has been prepared by David Dowell, senior tax manager with Aberdeen-based accountancy practice Ritson Smith.

 
The Government has changed tax rules for pension plans; from 6 April 2006 (“A” day) a new, simpler set of tax rules applies to all pensions.  These new rules replace all existing pension tax rules which, over the years, have become increasingly complex and diverse.

The changes are quite radical but should be welcomed by everybody as they are designed to simplify things by applying a single and unified regime to all forms of pension provisions.

Annual and Lifetime Allowance

Pension schemes will now have to be registered with, rather than approved by, HMRC.  If a pension scheme is not registered by “A” day, it will be subject to a tax charge of 40% on its assets.

Current rules restricting the amount of money that can be paid into a pension plan, and thus the amount of income people can receive, will also be changed.

From “A” day a new Annual Allowance and Lifetime Allowance will be introduced.

The new regulations allow tax relief on contributions made in each tax year of up to 100% of UK earnings.  No carry back” or “carry forward” will be allowed in respect of contributions.  However, the Annual Allowance will restrict the total amount of contributions that can be made on which tax relief is available to £215,000 for 2006/07 rising to £255,000 for 2010/11.  This amount will be reviewed every five years thereafter.

Where the total pension input in a tax year is in excess of this allowance, the amount over the limit will be taxed at 40% (this will be known as the Annual Allowance Charge).

The Lifetime Allowance will limit the total value of a pension fund that can benefit from tax relief.  From “A” day this lifetime limit will be £1.5m for 2006/07 rising to £1.8m for 2010/11.  Again this amount will be reviewed every five years thereafter.  Any excess over these limits will be subject to further tax charge. The Lifetime Allowance Charge will be 25% on funds in excess of the allowance if the excess is taken as pension income or 55% if taken as cash.

Options at retirement

Flexible retirement will also be available allowing members of occupational schemes to continue working whilst also drawing retirement benefits.  As part of this reform the normal minimum retirement age will be raised from 50 to 55 years from 6 April 2010. In addition to being able to take a tax-free sum of up to 25% of the value of the fund, pension benefits may be taken initially in any of the following four ways:

• Secured scheme pension – the pension is provided from a registered scheme or from an insurance company selected by the scheme administrator
• Lifetime annuity – the member can choose whether or not to take the annuity
• Unsecured income – this option is available up to age 75 and allows income withdrawals from the fund
• Alternatively secured pension – restricted form of income withdrawal only available from age 75.

Death benefits

Death benefits will also be affected by the new rules.  If the member dies before having taken the benefits and before age 75 death benefits can be paid as a lump sum (with any excess over the Lifetime Allowance being taxed at 55%) or as a pension to dependents.  If the member dies after having taken benefits, different rules apply depending on the kind of pension scheme selected.

The main change to death benefits, however, will apply to cases when members do not have any dependants.  In this situation, the residual fund may be transferred to another person nominated by the member.  

This is a very innovative reform as, for the first time, an inter-generational transfer of pension funds will be possible.  Alternatively, the residual fund may be paid to a charity nominated by the member.

Corporation tax relief

Current arrangements permitting an employer to claim a deduction in computing profits chargeable to corporation tax for employer contributions paid to pension schemes will be continued under the new regime in relation to payments to registered pension schemes.  As before, contributions must be wholly and exclusively for the purpose of the employer’s trade.

Capital contributions will not be disallowed but the legislation continues the current practice of spreading large contributions over two to four years (i.e. when an employer makes a one-off contribution greater than £500,000 the tax relief will be spread over a maximum of four years).

These are only some of the main aspects of the new pensions regulations which came into effect from 6 April 2006.  Even though the new rules aim to simplify the world of pensions, it can be difficult to understand exactly what the changes consist of, and if or how they will affect your pension scheme.

Ritson Smith will be happy to help you grasp the meaning of the new rules.

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