Retirement: The new rules effective from April 2006
Before 6 April 2006 there were different rules governing the tax treatment of contributions, the limits on those contributions and how much pension could be taken at retirement, all of which depend on the type of pension scheme. This can give rise to difficulties, particularly if a taxpayer is in several different types of scheme.
In December 2002 the Government produced a consultation document simplifying the taxation of pensions. Based on that consultation the Finance Bill 2004 has introduced legislation to cover all pension schemes. The new rules came into effect on 6 April 2006.
In essence the new rules will be the same for all pensions schemes. You will be able to contribute to as many schemes as you wish at any time and all schemes will have the same investment criteria, limits and tax rules. There will be transitional provisions to ensure that individuals who have better benefits under the current rules compared to the new rules will not lose out.
Under the new rules pension schemes will no longer be approved by HM Revenue & Customs to qualify for the tax benefits (such as tax relief on contributions and tax free growth). Instead there will be a much simpler registration process. All schemes which are currently approved by the Inland Revenue will automatically be registered from April 2006.
Summary of the new rules
- All tax-privileged schemes are subject to a single set of rules. This includes occupational schemes, retirement annuity contracts, and personal pensions.
- There is a single lifetime allowance for the level of tax-privileged pension saving (including the capital value of a defined benefit scheme).
- The lifetime allowance is fixed for the first five years as:
2006/07 £1,500,000 2007/08 £1,600,000 2008/09 £1,650,000 2009/10 £1,750,000 2010/11 £1,800,000 - Transitional protection for funds that exceed, or are likely to exceed, these levels. However, action must be taken soon to obtain this protection.
- There is an annual allowance for contributions to defined contribution schemes and increases in the capital value of defined benefit schemes, which is worked out by multiplying the increase in benefits by a factor of 10.
2006/07 £215,000 2007/08 £225,000 2008/09 £235,000 2009/10 £245,000 2010/11 £255,000 - There is no carry back or carry forward.
- Personal contributions are limited to the lower of the annual allowance or 100% of earnings. Payments over this level will have a tax charge of 40%. Employer contributions will be allowable if they are deemed by the local inspector of taxes to be a 'wholly and exclusive' business expense.
- The lifetime allowance is the key allowance. The annual allowance is only a guard against overfunding. In a year in which pension benefit is taken in full (and the lifetime allowance is tested) a person whose fund is below the lifetime allowance may pay any amount within the lifetime allowance.
- 25% of the capital value of a pension, up to the lifetime allowance, may be taken as a tax free lump sum.
- Whether through excess contributions or through investment growth, funds may exceed the lifetime allowance. Excess funds may have enjoyed tax and NIC relief on the way in and will have enjoyed tax free investment growth. A recovery charge is made to recover the excess tax privilege. The charge is 25% of the excess.
- The whole of the excess funds may be taken as a lump sum, after 55% tax.
- By 2010 the minimum pension age will be increased to 55.
- As a general rule, pension benefits must be taken between age 55 and age 75.
- A member of any pension scheme may draw benefits whilst remaining in employment.
- Providers of retirement annuity contracts will not initially be required to operate tax relief at source, but they may choose to do so.
- Non-privileged schemes can continue; they are simply non-privileged. This includes FURBS (Funded Unapproved Retirement Benefit Schemes).
- The need to purchase an annuity can be avoided.
- The lump sum may be taken without the necessity to draw an income from the residual fund.
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