HM Revenue Rules

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 £1.5m in the 2012/13 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.

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 reduced from £1.8m to £1.5m.  If you expected your total pension benefits to be worth more than £1.5m, you were able to apply for Fixed Protection.  Fixed Protection means 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.

The deadline for applying for Fixed Protection was 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 2012/13 tax year.  The following table shows the Annual Allowance for past and future tax years.

The Annual Allowance: 2006/07 to 2012/13
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 and 2012/13	£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 (£1.5m in 2012/13), the cash sum is tax free.

Small Pension Funds ('Triviality')

If you have retirement benefits that are valued at less than £18,000 in the 2012/13 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