| Guide to Pensions Simplification and SIPP
Investment |
A-Day is the name given to the scheduled date for the implementation of the
pensions Simplification rules. This date is the 6th April 2006.
The rules are intended to standardise and simplify the numerous different
pension's regimes and rules which have built up over the last 20 years. At
present there are a widely differing range of rules and pension benefits which
may apply to an individuals pension and tax-free cash allowance at retirement.
There are also some onerous rules which currently apply to an individual who
wishes to access pension benefits but not necessarily stop work. The new rules
are designed to ease this problem and place all pension funds and arrangements
on the same platform.
Not only have the rules for pensions been completely rewritten but the
terminology used has completely altered as well, which poses its own problem of
understanding for pensions professionals and individual investors alike.
To further complicate matters the 'old rules' will still apply to any pensions
which have been given a form of transitional protection for benefits which are
currently 'better than new rules' benefits. For a period of time the old rules
will still have to be understood and used along with the new rules.
This has happened before, the best example being the change from so called pre
1987 rules to post 1989 rules for occupational pensions. The
effects of this change are still relevant 17 years later.
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| The new rules summarised. |
Individuals may contribute, and receive tax relief, on the higher of £3,600 a
year or 100% of their UK earnings up to the Annual Allowance. One word of
caution is that any individual lifting their salary to what is deemed abnormal
levels for one year to pay in a very large pension contribution will
have to seek approval from the local inspector of taxes. This may then vary
from region to region, but I understand that the inspectors will be given
guidelines.
There is no limit designated on Employers' contributions. However for
total contributions which exceed the annual allowance, an annual allowance tax
charge of 40% of the excess contributions will be levied against the employee.
The annual allowance begins at £215,000 in 2006/7.
The maximum tax-free cash sum allowable from all pension plan types will be
fixed at 25% of all funds. (Subject to transitional arrangements for pre A-day
benefits which are protected).
The earliest retirement age will move up from age 50 to age 55 by 2010.
Exceptions are for those with Personal Pension Plan's effected up to 6 April
2006 (A-day) in special occupations and members of occupational schemes who at
A-day had joined a scheme which was approved by 10 December 2003 which had a
retirement age less than 50. (For example; sports people such as footballers)
A 2.5% annual reduction to the Standard Lifetime Allowance (SLA) will apply,
for every year less than at age 55 that pension is taken for individuals in
special occupations with low Normal Retirement Date at A-day, with a reduction
to Standard Lifetime Allowance (Protected Lifetime Allowance if protection is
opted for)
This is applicable at age 50 prior to 2010
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| Triviality Rules |
This is a facility to take the full fund value as cash, with 25% as tax-free
cash with the balance which can be taxed as income and taxed at an individual's
tax-band. It is subject to the following;
-
It will be allowed between the ages of 60 and 75
-
All benefits must be commuted in a single 12 month period
-
Funds can be commuted if the total pension benefits do not exceed 1% of the
Standard Lifetime Allowance (£15,000 in 2006/2007)
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| Divorce |
-
Post A-day Pension Sharing Orders count towards the receiving spouse's Standard
Lifetime Allowance, (£1.5M indexed to 2010), but not the
Annual Allowance. This will be important when considering large divorce
settlements particularly from final salary pension schemes. Dynamised
calculations will also be important to have done to ensure settlements do not
go over the Standard Lifetime Allowance.
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| Death Benefits before Taking Pension Benefit |
-
Before a member reaches age 75, death benefits can be a lump sum (as return of
fund for money purchase schemes), dependants pension or contribution or a
combination of the two
-
If a lump sum is paid, this count's towards deceased's Standard Lifetime Allowance
so there could be a retrospective tax consideration outside of Inheritance Tax.
It may be wise to consider the use of a trust for this benefit.
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| Death Benefits after Taking Pension Benefits |
Schedule of options available
Members under age 75 - secured income
-
An annuity payable for remainder of a dependants life, or
-
Pension protection - lump sum payment based on difference between the annuity
purchase price when secured income was selected and income payments made to
date of death, or
-
If annuity purchased with guarantee period (maximum 10 years), balance of any
guaranteed period.
Members under age 75 - unsecured Pension
-
A lump sum less a composite 35% tax charge.
-
A dependant may continue to draw down an income from their fund until they
attain age 75
-
A dependant may draw down an income from an alternatively secured fund if over
75
-
An annuity can be purchased for a dependant (secured)
-
A short-term annuity, with maximum term of five years, must cease at
dependant's 75th birthday (unsecured).
Members over age 75
Alternatively Secured Pension (only available to members from age 75)
The remaining fund must be used to provide a dependant with:
-
A Scheme based pension, or a lifetime annuity
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The facility for Income drawdown, so that the member can still draw income from
the fund.
If no dependant is eligible, then the remaining fund may be paid as lump sum to
transfer to:
-
Another member's pension of same scheme (note that this means that pension
funds can be passed on to older children or any other member, if no spouse is
eligible)
-
A charity of their choice
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| Scheme borrowing and investments: |
-
The maximum amount of borrowing = 50% of net scheme assets.
-
A wider range of investment excluding residential property, but still including
Commercial Property is available.
-
It is our understanding that there is not a connected party rule so that this will allow
transactions between an individual and their pension scheme, so that Commercial
Property already owned by an individual may be purchased by your pension fund
and vice versa.
-
A loan to a sponsoring employer will be authorised if the loan does not exceed
50% of the net asset value of the scheme, the term of the loan must not be less
than 5 years and it is secured by a first charge on a non depreciating asset of equivalent
value and that attracts an interest rate at least 1% over the base lending
rates of specific UK banks.
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| Maximum Allowable Limits to Pension Schemes |
Standard Lifetime allowance (SLA)
| 2006/2007 |
£1,500,000 |
| 2007/2008 |
£1,600,000 |
| 2008/2009 |
£1,650,000 |
| 2009/2010 |
£1,750,000 |
| 2010/2011 |
£1,800,000 |
Thereafter revalued and then confirmed every five years via Treasury Order
Valuation of existing pension benefits and the associated/tax charges
| Defined benefits rights =
|
£20 capital for every £1 pension |
| Pensions in payment =
|
£25 capital for every £1 pension |
Tax charges at retirement on funds in excess of the Standard Lifetime Allowance
(Unless protected - see primary/enhanced protection):
55% if the excess is paid as a lump sum, or;
25% if funds are paid as income
(Please note that income tax will be payable at the current rate of 40% under
PAYE).
A sample calculation is below.
Sample calculation
£1000 is paid to pension net of high rate tax and so is a net £600 contribution
although at source it receives 22% tax relief. If we assume that it is then
deemed in excess of the Standard Lifetime Allowance, and for the calculation we
assume the following;
5 years growth at 7% per annum gives a fund of £1,402, at retirement and is
then taken as cash,- the fund is taxed at 55%, and so is reduced to £631.
This clearly leaves the fund at the same investment position as when the net
amount was invested. Although this is very simplistic it gives the idea of the
point of the new rules which is to prevent any profit from excess pension funds
over the new limits.
Contributions Allowance Limits
Annual Allowance
|
£ |
| 2006/2007 |
215,000 |
| 2007/2008 |
225,000 |
| 2008/2009 |
235,000 |
| 2009/2010 |
245,000 |
| 2010/2011 |
255,000 |
Thereafter to be confirmed every five years via Treasury Order.
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| Valuation of pension benefits and exclusions |
Defined benefits are generally final salary pension Schemes and Defined
Contribution pension scheme's are Moneypurchase plans such as Executive Pension
Plans. These have been regulated under Occupational Pension rules until A-Day.
They will still remain, but only if the pension scheme retains the 'old' rules
and for pensions seeking protection under the new rules.
| Personal Allowance =
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|
| |
Total contributions to Defined Contributions (DC) arrangements + the annual
increase to Final salary Defined Benefit (DB) rights |
Annual increase to DB rights = £10 capital for every £1 pension
Any contribution made in excess of the allowance will be liable to a tax charge
of 40% on the member
However this can be ignored in the actual tax year that all benefits are vested
This calculation excludes Protected Rights, Divorce Pension Credits, life
assurance premiums, fund growth, and approved transfers in from registered
pension schemes.
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| New ways to take benefits (now called crystallisation) |
Please note, the option to take a pension annuity, as now, remains.
Unsecured Pensions
-
Available between the ages of 50 and 75 and this will rise to age 55 in 2010.
-
No minimum withdrawal, so a £0 minimum will apply per annum.
-
Short-term annuity purchase is allowed for five years, ending no later than
member's 75th birthday.
-
Then maximum income is 120% of prevailing GAD rate revised every five
years.
Alternatively Secured Pension
-
Available from age 75
-
No minimum withdrawal, so £1 minimum will apply per annum.
-
Maximum income is 70% of relevant annuity for 75 year old, reviewed annually
-
On death there is the potential to pass on a lump sum into another members
fund of same scheme (if there is no spouse or financial dependant)
-
The income can have a 10 year guaranteed period.
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| Protection for pre A-Day benefits: |
Primary Protection The pension scheme must be registered within three
years of A-Day, which is 6th April 2006.
Total benefits must be £1.5 million or over at A-Day to qualify to register
A Lifetime Allowance Enhancement Factor (LAEF) is calculated with the
following formula:
| £ Fund Value at registration -- less the £1.5m Lifetime Allowance |
|
| |
= LAEF |
| Standard Lifetime Allowance of £1.5m |
The amount protected is (SLA) Standard Lifetime Allowance + (SLA x LAEF) is the
Personal Lifetime Allowance (PLA)
There is then a tax charge on funds in excess of protected benefits.
Enhanced Protection
This allows benefits in excess of the new limits to be protected
This must be registered within three years of A-Day
There is no minimum fund value to register
Pensionable service must cease at A-Day -for example no further accrual or
contributions
All salary increases and fund growth increases can be protected.
The individual can revert back to Primary Protection (if sought and over £1.5m
on the 6th April 2006) at any time enabling payment of further contributions.
There is no Lifetime Allowance charge.
Tax-Free cash in excess of 25% can be fully protected
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| April 2006 |
| Protection? The big question!! |
This is a very difficult question because the Enhanced Protection clearly
offers complete protection of benefits under the 'old' rules. However there are
many other issues which are contained in the new rules, and it may be
beneficial to make further contributions to a pension scheme.
For those opting for Primary Protection the decisions are further clouded with
issues such as good fund growth over the years making the fund 'too large' and
there are difficult calculations which apply to the Lifetime Allowance
Enhancement Factor (LAEF) which could mean that despite further
contributions after A-Day and with Primary Protection no further tax-free cash
may be payable.
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| Click image to enlarge 
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Important Notice
As with all of these matters we recommend that an investor takes professional
advice. This summary is a guide and is our view of current legislation. You
should not take any action based on your reading of this without seeking
professional advice. Legislation may change in the future, and the views on
this briefing may become incorrect on occasions until updated.
Peter Neal Pensions do not accept any responsibility for any loss by an
investor which arise from an individual or company taking actions following
reading this briefing.
Please note that the text is copyright Peter Neal Pensions.
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