Retirement Benefit Rules
The current pension regime arrived on 6 April 2012 and is deemed to be the greatest reform of the pension tax regime since the implementation of the earnings cap in the Finance Act 1989.
Main points of the Pensions 2012 bill:
- Replace the current, complex state pension system with a new single tier pension which is currently estimated to be set at around £140 per week, so that those of working age can save for their retirement with confidence.
- Increase in the state pension age to 67 between 2026 and 2028.
- Commitment ensuring the state pension age is increased in future to take into account increases in longevity.
The journey of the changes to the retirement benefits rules are detailed below. An awareness of these historic changes is important due to the number of updates since 2004.
Finance Act 2004
The regime governing the growth and pay out of retirement benefits was simplified. The start date of the revised regime was 6 April 2006, revolutionising the rules surrounding retirement benefits, with a view to making the retirement benefit rules easier to understand
Finance Act 2007
Legislation was updated which primarily focused on revising the rules for Alternatively Secure Pensions (currently known as Income Drawdown) and withdrawal of tax relief for individual pension term assurance contracts.
Finance Act 2009
A special annual allowance was introduced in this act which limited higher rate tax relief for those with gross earnings over £150,000; this limit was subsequently reduced in December 2009 to £130,000.
Finance Act 2010
Following the post-election budget the special annual allowance of £130,000 was scrapped and a revised reduced annual allowance was introduced to everyone saving for retirement. The annual allowance was reduced to £50,000 as from 6 April 2011.
Finance Act 2011
In addition to the annual allowance reducing to £50,000 the following legislation was also introduced
- Capped drawdown rules amended
- Treatment of retirement benefits after age 75
- Changes to state pension age
- Requirement for employers to auto enrol employees in an eligible pension scheme and make contributions
- Lifetime allowance revised
The majority of the current rules took effect from 6 April 2006, and the latest revision to the retirement benefit rules happened on 6 April 2012. To ensure scheme members were not disadvantaged by these changes transitional rules were put in place to protect funds that were over the threshold limits.
THE LIFETIME ALLOWANCE
This is a limit on the amount of retirement benefits you can draw from an approved pension scheme before tax penalties apply. This limit is called the Lifetime Allowance.
The Lifetime Allowance is £1.5m in the 2012/13 tax year.
If you exceed the life time allowance you will be subject to a tax charge by HMRC. The amount will depend on how the excess is paid. Your pension scheme's rules may dictate how the excess is paid - either as pension or as a lump sum.
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.
If the excess is paid as a lump sum, it will be subject to a one-off 55% recovery charge
These charges may be avoided if you claimed for protection and are within the terms and conditions set.
THE ANNUAL ALLOWANCE
In order to obtain tax relief on your pension contributions you cannot contribute more than the greater of £3,600 and 100% of UK earnings in any tax year. Any contribution above the annual allowance is subject to an annual allowance charge
The Annual Allowance is £50,000 in the 2012/13 tax year
The sharp decrease in the allowance introduced the ability to carry forward unused relief to help investors saving for retirement; however it is important to note this is not a permanent measure. The following link to HMRC’s website gives greater clarity around the subject www.hmrc.gov.uk/.../annual-allowance/carry-forward.htm
Prior to 6 April 2011 there was no Annual Allowance test in the year you chose to take your retirement benefits therefore you could invest more into your pension and exceed the limit set. This option was withdrawn from 6 April 2011 and the only exemption to this rule is in the cases of serious ill health retirement and on the death of a pension scheme member.
TAX FREE CASH (TFC) / PENSION CASH/PENSION COMMENCEMENT LUMP SUM (PCLS)
When you decide to take retirement benefits the maximum amount of tax free cash you can take from your retirement fund is 25%., subject to the lifetime allowance.
If you applied for protection and are within the terms and conditions you may be entitled to more.
RETIREMENT AGE/PENSION AGE
The minimum age you can retire is 55; the maximum retirement age has been removed.
The maximum lump sum death benefit must not exceed the current lifetime allowance which is £150,000. Any excess is subject to a 55% tax charge on the beneficiaries. The scheme administrator will deduct this charge before it is paid to the recipients.
If you die whilst in drawdown the tax charges have changed as follows:
Death occurred before 6 April 2011 the rate of the tax charge is 35 per cent.
Death occurs on or after 6 April 2011 the rate of the tax charge is 55 per cent.
Unsecured pensions and alternatively secured pensions have been replaced by a new set of income drawdown rules
To protect those investing for their retirement against the reduction in the lifetime allowance during 2012/13, fixed protection was introduced. This gave investors the option to retain the previous allowance of £1.8 million. The option to claim this protection ended on 5 April 2012.
WHAT IS THE LIFE TIME ALLOWANCE (LTA) AND HOW DOES IT AFFECT ME?
Lifetime allowance (LTA)
The lifetime allowance is the total capital value of all your pension arrangements, but not your state pension, which you can build up without paying extra tax.
If the value of your benefits when you draw them (not including any state retirement pension, state pension credit or any spouse’s, civil partner’s or dependant’s pension you may be entitled to) is more than the lifetime allowance you will have to pay tax on the excess.
The lifetime allowance for 2011/2012 was £1.8million and reduced to £1.5 million in 2012/13.
The lifetime allowance covers any pension benefits you may have in all tax-registered pension arrangements.
There are protections called primary or enhanced protection for benefits earned up to 5 April 2006 in respect of those high earners affected by the introduction of the lifetime allowance from 6 April 2006. If you already have primary or enhanced protection you will be unaffected by the reduction in the lifetime allowance from 2012/13.
Because the lifetime allowance reduced to £1.5 million in 2012/13 there is a new form of protection called fixed protection.
Full guidance on how the lifetime allowance works can be found in chapter 11 of the Registered Pension Schemes Manual (RPSM). This chapter contains guidance on how the lifetime allowance works from:
- 6 April 2006 to 5 April 2012
- 6 April 2012 onwards
WHAT IS THE ANNUAL ALLOWANCE (AA) AND HOW DOES IT AFFECT ME?
The annual allowance for 2012/2013 is £50,000.
The allowance covers any pension benefits you may have in all tax-registered pension arrangements where you have been an active member of a pension scheme during the tax year i.e. you have paid contributions during the tax year (or your employer has paid contributions on your behalf).
You are subject to an annual allowance tax charge if the value of your pension savings for a tax year increases by more than £50,000.
A three year carry forward rule allows you to carry forward unused annual allowance from the last three tax years. This means that even if the value of your pension savings increase by more than £50,000 in a year you may not be liable to the annual allowance tax charge. To carry forward unused annual allowance from an earlier year you must have been a member of a tax registered pension scheme in that year.
If, however, you are affected you will be liable to a tax charge (at your marginal rate) on the amount by which the value of your pension savings for the tax year, less any unused allowance from the previous three years, exceeds £50,000.
Your pension provider will inform you if your retirement/pension savings in a pension input period are more than the annual allowance of £ 50,000.
If you exceed the annual allowance in any year you are responsible for reporting this to HMRC on your self-assessment tax return. Your pension provider will be able to tell you how much the value of your benefits have increased during an input period, plus the amount of any Additional Voluntary Contributions (AVCs) you may have paid during the input period.
Full guidance on how the annual allowance works can be found in chapter 6 of the Registered Pension Schemes Manual (RPSM), as follows:
- RPSM06105000 – how the annual allowance works from 6 April 2011
- RPSM06100001 – annual allowance for the period 6 April 2006 to 5 April 2011
AT WHAT AGE CAN I TAKE MY RETIREMENT BENEFITS?
From April 2010, the minimum age at which you are able to take your company or personal pension increased from 50 to 55.
You may still be able to take your pension before age 55 in certain circumstances. For example if you are unable to work due to ill-health.
The Finance Act 2011 removed the requirement for benefits to be taken after age 75 therefore it is possible not to elect to take your benefits, however any lump sum death benefits on untouched funds will be subject to a 55% tax charge
The over 75’s now have access to the following options at retirement:
- Tax Free Cash/ Pension Commencement Lump Sum
- Serious ill health lump sum (subject to a 55% tax charge
- Trivial commutation lump sum
- Trivial commutation lump sum death benefit
- Value protected lump sum death benefits
If you decide to take your retirement benefits a lifetime allowance test will apply
The current age for eligibility for the state pension (assuming contributions have been made) is 65 for men, and for women is gradually increasing from 60 to 65 between 2010 and 2020. For both men and women the age will be gradually increasing to 68. The state pension cannot be taken before these ages.
Subject to scheme rules it may be possible to draw retirement benefits before the minimum retirement age on the grounds of ill health. Medical reports will be requested by the pension provider in order to evidence that an individual is unable to perform their occupation due to either a physical or mental impairment
On serious ill health you may be able to take the whole fund as a lump sum. This will be subject to scheme rules and evidence from a registered practitioner.
WHAT IS A BENEFIT CRYSTALLISATION EVENT (BCE)?
A benefit crystallisation event is when you choose to take either part of your retirement fund using drawdown or the full value of your retirement fund to provide an annuity.
An event also occurs if you choose to transfer your funds to a qualifying overseas pension scheme, upon death and if you reach the age of 75 with untouched retirement funds still invested.
The value of your retirement fund is tested against the lifetime allowance (currently £1.5 million for the 2012/13 tax year).
John crystallises benefits with a capital value of £150,000. The standard lifetime allowance is £1.5 million, so the percentage used up is 10%. If John had not crystallised any other benefits previously, he will have 90% of his lifetime allowance still available for the next benefit crystallisation event.
The same process occurs when John crystallises benefits at a future date.
This time John crystallises’ a further £150,000, the standard lifetime allowance remains static at £1.5 million. So John has used up a further 10% of the standard lifetime allowance. In total John has used up 20% of his lifetime allowance.
The percentage of the standard lifetime allowance used up at a particular benefit crystallisation event in a particular tax year remains constant year by year even if the standard lifetime allowance is changed in subsequent tax years.
TAX FREE CASH/PENSION CASH
TAX FREE CASH LUMP SUM (TFC) / PENSION COMMENCEMENT LUMP SUM (PCLS)
Subject to the lifetime allowance you are generally allowed to take 25% of your pension fund as tax free cash when you choose to retire. There is transitional protection in place if someone’s cash entitlement exceeded 25% of benefit value at 5 April 2006 or if you claimed primary/enhanced protection because your tax free cash entitlement exceeded £370,000 at 5 April 2006.
New rules removed the maximum age you can take tax free cash meaning if you are aged 75 or over you are now eligible for this option.
Yes you can take up to 25% of the fund as tax free cash. Income Drawdown, as with other options for taking a pension, you have a one-off chance to take a tax free lump sum of up to 25% of the funds you wish to crystallise.
You are able to take 25% of the fund as tax free cash as long as the credit paid from your ex-spouses pension arrangement was not in payment at the time the pension sharing order was issued.
There is no limit placed on the level of benefits an individual can be provided with under a registered pension scheme. However, every individual has a set level of benefits that they can draw from all registered pension schemes in their lifetime, without triggering certain tax charges. This is referred to as the lifetime allowance.
The lifetime allowance is expressed as a capital value and is set at a particular standard level for each tax year. The level for the 2012/13 tax year is £1.5 million
For the amount that you exceed the lifetime allowance when your pension comes into payment you will be liable for a lifetime allowance charge.
The current rate of tax is as follows:
- 55% if the excess is released as a lump sum
- 25% if the excess is used to provide retirement income
If you are a 40% tax payer there is unlikely to be any difference in the tax charges stated above.
You will be asked whether you wish to pay this as a lump sum or have a reduced pension. You will also be required to include details of exceeding the LTA on your personal self-assessment tax return. More details can found via the following link www.hmrc.gov.uk/pensionschemes/lifetime-allowance/guide.htm
CAN I TAKE MY WHOLE RETIREMENT FUND AS A LUMP SUM?
If a retirement fund is small enough and meets regulation then yes you may be able to take the whole fund as a lump sum.
From 6 April 2012
From 6 April 2012, the link to the lifetime allowance was removed. The threshold is announced each year by the government and is £18,000 for 2012/13.
The option to cash-in a small pension can be exercised from age 60. There is no upper limit (although there was an upper age limit of 75 before 6 April 2011).
In addition to the above the following conditions need to be met:
- All benefits from the retirement fund are released
- All retirement funds need to be settled within a period of 12 months.
- The total value of all your retirement funds must not exceed £18,000 (2012-13). If your funds are likely to tip slightly over the threshold please contact your pension provider to discuss nomination dates. Your provider may be able to pin point a settlement date 3 months before your retirement date.
NEW RULE FOR SMALL PENSION POTS OF £2000 OR LESS
You may be able to exchange your pension benefits for cash if you have a non-occupational or non-public sector pension such as a personal pension, SIPP, section 32 buyout, stakeholder plan or a retirement annuity contract.
This rule allows non-occupational pensions to be cashed in under triviality rules, even if the main rules above have not been met. The rules are:
- You must have reached the age of 60;
- The payment does not exceed £2,000;
- It eliminates all your rights under the arrangement; and
- You have not received more than one payment under one of these schemes. This excludes any separate 'stranded payments' under an occupational or public sector scheme.
WHAT WILL HAPPEN TO MY CONTRACTED-OUT/ PROTECTED RIGHTS PENSION BENEFITS?
If you opted out of the State Second Pension, the Government paid a rebate of your National Insurance Contributions into a pension. The rebate consists of a refund of contributions already paid during each year, plus tax relief.
If you did decide to contract out you will lose some or all of your entitlement to the State Second Pension. In general you only lose this for the time you are contracted out. It is important to note that the decision to contract out will not affect your entitlement to the basic State Pension.
In line with the 2007 Pensions Act the ability to contract out of the State Second Pension via a defined contribution product was removed with effect from 6 April 2012.
- If you contracted out via an occupational money purchase scheme you will now pay the standard rate of National Insurance Contributions instead of the reduced contracted-out rate
- Your money purchase contracted out pension fund will now be treated the same way as your non protected right’s fund when you apply to purchase an annuity, transfer and in the event of death.
- Previously Protected Rights had to be used to buy an annuity with a 50% Spouse's Pension (if married) but, from 2012, there will not be a restriction on the type of annuity purchased.
Contracting out through an occupational salary-related (defined-benefit) scheme will still be allowed. However, contracting out for these schemes will be reviewed in the future.