new pension limits – pre A-Day action
by Roderick Ramage, solicitor, www.law-office. co.uk
first published (by distribution to professional contacts) 6 January 2004
This article is not advice to any person and may not be taken as a definitive statement of the law in general or in any particular case. The author does not accept any responsibility for anything that any person does or does not do as a result of reading it.
update May 2004
The Finance Bill 2004 published on 8 April 2004 proposes some changes to the new tax regime, principally: A-Day to be 6 April 2006, initial lifetime limit to be £1.5m rising to £1.8m in 2010, annual allowance initially £215k rising to £255k in 2010, funds in excess of lifetime limit at retirement to be taxed at 25% or 55% if taken as a lump sum
The Government’s December 2002 consultation paper “Simplifying the taxation of pensions: increasing choice and flexibility for all” was followed in December 2003 by “Simplifying the taxation of pensions: the Government’s proposals” setting out the Government’s responses and inviting further consultation. On the assumption that the latest proposals or something very like them will become law, the main characteristics of the new system, so far as there might be scope for action before “A-Day”, are as follows. “A-Day” is the day on which new system comes into force and is intended to be 6 April 2005.
There will be two tax limits, which will apply to both money purchase (defined contribution or DC) and final salary (defined benefit or DB) schemes, an annual allowance and a lifetime total. The limits will be indexed by the RPI rounded up to the nearest £1k for the annual allowance and £10k for the lifetime allowance. Anyone will be able to have as many pension schemes as he or she wishes, whether occupational or personal and whether DB or DC, and the limits will apply to the aggregate of all his or her schemes. In all cases a maximum of 25% of the fund value may be taken as a tax free lump sum. No change is proposed to the requirement for pension to start before age 75. 25% of the fund value can be taken as a tax free lump sum.
The annual allowance is £200,000. In a DC scheme this is the actual amount of the contributions paid to it, whether by the member or the employer, and in a DC scheme it is the annual amount of increase in the value of the member’s fund calculated by a factor of £10 value for each £1 of pension accrued.
The lifetime total will be £1.4m. In a DC scheme this is the actual value of the individual’s pension fund and in a DB scheme it is the value of his or her fund calculated using a 20:1 factor. The 20:1 factor assumes that pensions increase in line with RPI and that dependants’ pensions equal to the member’s pension will be payable on his or her death.
It is the lifetime allowance which has caused the most controversy, partly because of the level of the limit and the number of people who may be affected by it and partly because of the tax cost if it is exceeded. The lifetime allowance will be tested when the pension comes into payment rather than annually. The tax charge will be in two parts. The first is a recovery charge of 25% (reduced from 33%) of the value of the fund in excess of the lifetime allowance and the second, if the excess after the recovery charge is taken as a lump sum, is tax on it at the higher rate of 40%, making a total tax charge of 55%.
The proposed transitional arrangements will go some way to mitigating the effect of the limit and point to action which can be taken now. Any mitigating action must be taken before A-Day.
One proposal is an exemption for pension scheme if before A-Day the member ceases to pay contributions and suspends pensionable service. The effect of this is that the scheme is frozen but, increases in the value of the pension fund and benefit rights accrued before A-Day will not be subject to the recovery charge when the pension comes into payment after A-Day, no matter how large his or her pension fund then is. The same will apply if a member aged 50 or more, and therefore eligible to retire early, starts pension immediately before A-Day, either by the purchase of an annuity or by income draw-down.
Another proposal is that pension funds in excess of £1.4m may be protected from the tax charge. A member, who has a fund valued in excess of £1.4m on A-Day, may register that value as a percentage of the £1.4m. The example given in the 2003 paper is that a fund value of £2.1m registered on A-Day has a percentage of 150%. The effect of this is that, on the date when that member starts his or her pension and the lifetime value is to be assessed, the amount on which the tax charge will be assessed will be 150% of the lifetime limit then in force. In other words the excess over the lifetime limit on A-Day, if registered, will be indexed until retirement and only the increase in the fund value over that will suffer the tax charge.
Pension scheme members, whose fund values are already over or are likely to exceed £1.4, might be tempted, as a first response to the new tax system, to cease paying pension contributions in order to avoid the risk of a recovery charge and higher rate tax. The transitional arrangements however might point instead to increasing contributions or accrual rates with a view to either freezing the scheme or registering as high an amount as is advised to be possible as his or her fund value on A-Day, and then paying no more contributions or accruing no more service after that date.
These are financial rather than a legal issues and pension scheme members, who are or might be affected by the lifetime limit, should take financial advice sooner rather than later on the decision whether to refraining from making further contributions or increase them (or increase the rate of accrual) before A-Day. There may be less immediate urgency on the decision whether or not to continue pensionable service after A-Day.
30 December 2003
Principally “Simplifying the taxation of pensions: the Government’s proposals” available from the Treasury or the Inland Revenue web sites at www. (either) hm-treasury.gov.uk (or) inlandrevenue.gov.uk.
copyright Roderick Ramage
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