On 6 April 2006, known as A-day, HM Revenue
& Customs introduced new tax rules for the treatment of pension
contributions and retirement benefits.
The following is a summary of those rules.
Lifetime Allowance
There is a limit on the value of retirement benefits that you
can draw from approved pension schemes before tax penalties
apply. That limit is called the Lifetime Allowance.
The Lifetime Allowance is £1.8m in the 2011/12 tax
year. The following table shows the Lifetime Allowance for
past and future tax years.
| The Lifetime Allowance - 2006/07 to 2012/13 |
| Tax Year |
Lifetime Allowance |
| 2006/07 |
£1.50m |
| 2007/08 |
£1.60m |
| 2008/09 |
£1.65m |
| 2009/10 |
£1.75m |
| 2010/11 & 2011/12 |
£1.80m |
| 2012/13 |
£1.50m |
At the time of payment, a recovery
charge will be applied to the value of retirement benefits in
excess of the Lifetime Allowance. The amount will depend on
how the excess is paid.
If it is paid in the form of a pension, the excess will be
subject to a 25% tax charge and the income will be subject to
Income Tax. For example, if you had a pension fund of £1.9
million in 2006, £400,000 would be subject to the tax charge
of 25% (tax due £100,000) leaving £1.8 million to
provide an income.
If the excess is paid as a lump sum, it will be subject to a
one-off 55% recovery charge. For example, if you had a
pension fund of £1.9 million in 2006, £400,000 would be
subject to the tax charge of 55% (tax due £220,000), leaving
a lump sum of £180,000.
Your pension scheme's rules may dictate how the excess is paid -
either as pension or as a lump sum.
Protecting against the Lifetime Allowance
Until 6 April 2009 it was possible to protect yourself
against the tax change above if you are have, or are likely to
have, retirement benefits valued above the Lifetime
Allowance. There were two ways of doing this.
Primary protection
The value of your retirement benefits at 6 April 2006 will be
expressed as a percentage of the £1.5m Lifetime Allowance and
that percentage will continue to be exempt from the recovery
charge. So, if you had retirement benefits valued at £2.25m
on 6 April 2006, you will always be able to have 150% of the limit,
whatever level it is, and only incur a charge on the excess.
Enhanced protection
You can cease active membership of your pension schemes on or
before 5 April 2006 and be exempt from the tax charge, as
long as you have already built up retirement benefits valued over
£1.5m at 6 April 2006.
If you are a member of a defined contribution
scheme, including (money purchase, personal and stakeholder
arrangements, you cannot pay further contributions on or after 6
April 2006.
If you are a member of a defined benefit
scheme (including final salary and career average
schemes) you can continue to accrue benefits, but any increase
will be tested when retirement benefits come into payment or you
transfer.
Valuing retirement benefits
For the purposes of valuing benefits to measure against the
Lifetime Allowance, all defined contribution benefits will be
taken at their asset value, while pensions building up in defined
benefit schemes will be valued at £20 for each £1 of
pension, irrespective of the individual's age. For all pensions
already in payment, the value will be £25 for each £1
of pension.
Time limit
There was a time limit for applying for Primary or Enhanced
protection. You had until 6 April 2009 to apply to HM Revenue
& Customs. It is now too late to apply for
protection.
Fixed Protection - Reduction of Lifetime Allowance From 6 April
2012
From 6 April 2012, the Lifetime Allowance is reducing from
£1.8m to £1.5m. If you expect your total pension
benefits to be worth more than £1.5m, you will be able to
apply for Fixed Protection. Fixed Protection will mean your
pension benefits are protected from any tax charge, up to the value
of £1.8m. If the Lifetime Allowance subsequently
increases to more than £1.8m, fixed protection will stop.
Click here to to visit HMRC's website and
download a Fixed Protection application form and guidance
notes. The deadline for applying for
Fixed Protection is 5 April 2012.
Annual Allowance
The Annual Allowance replaces the previous maximum annual
contribution limits to approved pension plans.
For defined benefit schemes,
the total amount of pension accrued in a year is limited to the
Annual Allowance.
For defined contribution
schemes, the amount of contribution in a year is limited to the
Annual Allowance.
The Annual Allowance is £50,000 in the 2011/12 tax
year. The following table shows the Annual Allowance for past
and future tax years.
| The Annual Allowance: 2006/07 to 2011/12 |
| Tax Year |
Annual Allowance |
| 2006/07 |
£215,000 |
| 2007/08 |
£225,000 |
| 2008/09 |
£235,000 |
| 2009/10 |
£245,000 |
| 2010/11 |
£255,000 |
| 2011/12 |
£50,000 |
Prior to 6 April 2011 there was no
Annual Allowance test in the year of vesting, i.e. contributions to
a defined contribution scheme or increases in the value of a
pension in a defined benefit scheme that take place in the year
benefits are vested were ignored for the purposes of the annual
allowance. From 6 April 2011 there will be no longer be a
blanket exemption from the Annual Allowance test in the year
benefits are vested. There will only be exemptions in the cases of
serious ill health retirement and on the death of a pension scheme
member.
New Annual Allowance Rules From 6 April 2011
We have produced three factsheets to help you understand this
change and it's implications. Click here to visit our publications page and
view the factsheets.
Whilst we endeavour to do our best to help all our customers, we
are a small organisation and do not have the capacity to undertake
the checking of individual calculations. Annual Allowance
calculations are a complex area of law on which individual advice
should be sought.
HMRC has also published a guide and several examples on the
new rules here:
http://www.hmrc.gov.uk/pensionschemes/annual-allowance/index.htm
Tax Free Lump Sum
The amount of tax free lump sum available from a pension scheme
is limited to 25% of the fund of the retirement benefits (subject
to a limit of 25% of the Lifetime Allowance).
There is transitional protection for those who would have had
the right to a higher figure based on the rules that applied before
6 April 2006.
Maximum lump sums taken from Retirement
Annuity Contracts (RACs) on or after 6 April 2006 are 25%
of the fund, despite previous allowances to take more.
Contributions
There is no limit on the amount of contributions that can be
paid. However, there is a limit on the amount which enjoys tax relief. The annual limit is
£3,600 or 100% of earnings (capped at the Annual Allowance),
whichever is greater. There is no limit at all in the year in which
benefits are taken in full.
National Insurance rebates (on contracting-out) do not count
towards the annual limit.
Early Retirement
Since 6 April 2010, the earliest age at which retirement is
allowed is 55. Click here to read more about
minimum retirement ages.
Ill-health retirement will be possible from any age, scheme
rules permitting.
If your life expectancy is less than 12 months, you can take
your full pension fund as cash under serious ill health
rules. If the lump sum is less than the Lifetime Allowance
(£1.8m in 2011/12), the cash sum is tax free.
Small Pension Funds ('Triviality')
If you have retirement benefits that are valued at less than 1%
of the Lifetime Allowance (i.e. less than £18,000 in the
2011/12 tax year), they may be paid as a one-off lump sum.
Click here to
read more about triviality.
Overseas membership of a UK registered pension arrangement
The changes brought about by A-day now mean that an individual can contribute
to a UK pension arrangement even though they or their employer is
resident abroad. Nor is there any restriction on the amount of
contributions that they or their employer my make. However, UK tax
relief on contributions may not be available or it may be
restricted in certain circumstances. Annual and lifetime allowances
will apply to overseas resident members of a UK registered pension
arrangement.
An individual may be eligible for UK tax relief on their
contributions to a registered pension scheme if they are viewed as
being a relevant UK individual during a tax year. The conditions
are as follows:
- They have relevant UK earnings that are subject to UK income
tax for that year,
- They are tax resident in the UK at some time during that
year,
- They were tax resident in the UK both at some time during the
five tax years immediately before that year and when they became a
member of the pension scheme, or
- They, or their spouse, have for that year general earnings from
overseas Crown employment subject to UK tax.
There is an annual limit for relieved contributions which has
been set at the greater of:
- The individual's relevant UK earnings which are chargeable to
UK income tax for the tax year, and
- The basic amount of £3,600 (or such greater amount as the
Treasury may by order specify) if relief at source is
provided.
Therefore, if you are classed as a relevant UK individual but
have no relevant UK earnings then, UK tax relief is only available
on contributions up to £3,600 in a tax year. Tax relief will
be applied on a pro rata basis depending on how many of the above
conditions apply in each of the five tax years after ceasing to be
a UK resident provided that their registered pension scheme
operates relief at source. This will then be subject to a test
against the Annual Allowance and a charge will apply if the annual
allowance is exceeded.
Payments arising from a registered UK pension scheme to overseas
residents are liable to UK income tax unless they are exempt by
virtue of a double taxation agreement. Overseas residents are also
subject to the Annual Allowance and Lifetime Allowance and
therefore, are liable to charges should the occasion arise.
However, these charges will normally only apply if the overseas
resident were active members of a scheme whilst they were classed
as being a relevant UK individual. Therefore, a member of a
registered pension scheme will normally not suffer any charges if
they have never been a UK resident and have never received UK tax
relief on pension contributions to the scheme.
Miscellaneous
Where benefits are split (after A-day)
as a result of divorce, the party who receives benefits (the
Pension Credit member) will have these benefits count against their
lifetime allowance. The lifetime allowance of the party giving up
the benefits, (the Pension Debit member) may have their lifetime
allowance amount recalculated or enhanced/ primary protection
revoked.
Small
self-administered schemes will no longer have a requirement to
appoint a pensioneer trustee.
In schemes where, prior to A-day, the rate of pension increases
was limited to the RPI and, as a result,
surpluses had built up, it may be possible for the excess to be
released. This is more likely if the pension is paid as an annuity
in the individual's own name; but in the case of a final salary and
career average scheme, for example, no surplus may have built
up because it was distributed as it arose. There may be a tax
charge on any funds released, due to the size of the benefit or the
age of the individual.
Q & A's
If the value of your pension benefits exceeded the Lifetime
Allowance, you could have protected the value of your pre 6
April 2006 benefits from the Recovery Charge by one of two means,
primary or enhanced protection.
Primary protection will value an individual's pension rights on
6 April 2006 and the value will then be used to produce a
percentage uplift to the lifetime allowance. For example, if
registered benefits on 6 April 2006 were £2.25 million this
would equate to 150% of the lifetime allowance. Benefits would then
be protected from the recovery charge until the value exceeded 150%
of the Lifetime Allowance at the point they were drawn.
Enhanced protection will require an individual to cease being an
active member and opt out of future registered pension provision
before 6 April 2006 . No further contributions, or accrual of
benefits is allowed, but benefits regardless of their value can be
taken without the application of any recovery charge
For final salary schemes, benefits can still increase in line
with pensionable earnings but there will be a ceiling on which
earnings can be based - for those subject to the earnings cap,
pensionable pay will be restricted to 1/14th of the Lifetime
Allowance. For others, if in excess of 1/14th of the Lifetime
Allowance, pay must be averaged over a minimum period of 3
years.
The deadline for applying for protection was 6 April 2009.
There was no need to register if the value of your pension
rights was unlikely to exceed the Lifetime Allowance
Some individuals, although they have pension rights which are
under the Lifetime Allowance, will be entitled to a higher tax
free cash sum than that allowed under the new regime. In this
scenario there is no need to protect the cash sum built up to 6
April 2006 . This will be protected and indexed forward in line
with the Retail Prices Index. However, any cash sum built up after
6 April 2006 will be limited to 25% of the post 6 April 2006
benefit value. Furthermore, if an individual subsequently transfers
their pension rights to another arrangement, the protection
extended to their pre 6 April 2006 cash sum will be lost.
No. The Earnings Cap will be irrelevant if a member opts for
Primary Protection.
If a member was previously subject to the Earnings Cap,
increases in benefit will be restricted to 1/14th of the Lifetime
Allowance.
It is expected that members will be required to fill in
declarations, regardless of how large or small their pension is,
confirming whether there is sufficient Lifetime Allowance available
to cover the benefits that are to be paid.
If a member does not confirm any information about any other
plans, schemes can assume that the member has exceeded their
Lifetime Allowance. Consequently, a recovery charge would be
applied to the whole of the benefit.
The onus will be on the member but in practice the Scheme will
be expected to deduct this tax at source and pay it to HM Revenue
& Customs.
Where the member resides abroad, responsibility will rest with
the scheme administrator.
A recovery charge will be applied to the excess over the
lifetime allowance. The amount will depend on which option you
elect to receive the benefit that is in excess. If pension is
elected, it will be subject to a 25% tax plus the normal tax
payable on receipt of their pension. If cash is elected, the excess
will be subject to the recovery charge plus a tax charge of 40% on
the balance (equating to a one off 55% recovery charge).
For example, assuming funds are in excess of the Lifetime
Allowance by £1,000 and cash is elected on the excess:
- £1,000 x recovery charge of 25% = £250
- £1,000 less £250 = £750
- £750 x 40% = £300
- Cash payable = £750 - £300 = £450
The total effect of the recovery and tax charge equates to 55%
on the excess.
Yes, the value of pensions already in payment will count towards
an individual's Lifetime Allowance. If you have never taken pension
benefits in the past, the whole of your Lifetime Allowance can be
used when you elect to draw your pension benefits.
Where pension benefits have previously been taken, the remainder
of your Lifetime Allowance can be used for further pension
benefits. In the calculation to establish the balance of the
Lifetime Allowance still available, the value of benefits
previously taken will be adjusted as follows:
Benefits previously taken x Standard Lifetime Allowance at the
time current benefits are taken.
Standard Lifetime Allowance at the time of the previous election
of benefits.
HM Revenue & Customs has advised that administrators should
notify pensioners annually of the value of their pension in payment
and suggested that it could be included in their P60. The onus
however will remain with the member to advise other pension parties
of the value of their benefits in order that they can be tested
against the Lifetime Allowance.
Rights should be registered with HM Revenue & Customs.
Unfortunately it is now too late an registrations had to be
submitted by 6 April 2009.
