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The big announcement in this year’s Budget was the Government’s proposed reforms to the taxation of pensions. As well as the changes that apply in 2014/15 to capped drawdown, flexible drawdown, trivial commutation and small pots, more fundamental changes are scheduled for next Spring. The most important change is that from 6 April 2015 it will be possible to draw down all of the cash in a money purchase pension plan without needing to satisfy any conditions with regard to having a minimum level of other pension income.
However, whether and, if so, how to take advantage of this new flexibility needs a good deal of thought as to all the implications of the new pension rules and, of course, the appropriate tax legislation. To make sure that all aspects are considered and to make sure that all views will be taken into account, the Government has embarked on a process of consultation with interested parties. That consultation process ended in June and as a result the Government has published the Taxation of Pensions Bill. This puts quite a bit of flesh on the bone of the 2015 changes.
In particular, we now know that the following rules will apply:-
- Flexi-access drawdown Flexible drawdown will disappear and capped drawdown will only remain if it was set up before 6 April 2015. The new drawdown regime for money purchase schemes will allow a person to draw what they want, when they want, from their drawdown fund, taxed as income. As now, when they designate part of their pension plan to be used in drawdown, they will also be able to draw a 25% tax-free lump sum.
- Uncrystallised funds pension lump sum This cumbersome phrase hides a simplified way of drawing a one-off lump sum from a money purchase pension. Instead of designating part of the fund to drawdown, making a 100% withdrawal and taking the related tax-free lump sum, a person can just take an uncrystallised funds pension lump sum (see example below), leaving the rest of their pension arrangement untouched.
- Annual allowance reduction To prevent the new rules being used as a tax-efficient way of paying an employee aged 55 or over, the Bill imposes a new “money purchase annual allowance” of £10,000 for contributions to money purchase schemes if a person uses either of the facilities described above to draw income.
- More flexible annuities The current restrictions that generally prevent annuity income from being reduced once in payment will disappear, as will the 10 year ceiling on the maximum period for which payments may be guaranteed.
So how will the Uncrystallised Funds Pension Lump Sum work?
Other areas are still being addressed – such as the level of taxation of lump sum death benefits and some detail may change – but the proposed structure of the new regime is now clear.
These tax changes will give rise to considerable opportunity for not only people who are considering making further contributions to pension schemes but also to those who are contemplating a withdrawal of benefits in the not too distant future.
We look at a couple of opportunities in relation to new pension contributions in the article that follows this one below.
Capped drawdown will continue for those who are already in it at 6 April 2015. Provided income withdrawals continue within permitted parameters, the tax position will not change – which means the member can still have a £40,000 annual allowance for contributions to money purchase schemes. However, if they exceed the income limit from their capped drawdown arrangement, they will automatically be switched into flexi–access drawdown with a consequent reduction in the allowance for money purchase schemes to £10,000. For such people, if the pension provider permits, it may be worth them transferring other pension benefits to the capped drawdown plan before next April. By augmenting the fund in this way, they will be able to draw more income within limits and will retain a £40,000 annual allowance.
Maximise Pension Contributions to Access Increased Flexibility
The ability (from 6 April 2015) to draw down all of a money purchase pension plan from age 55 is likely to encourage people – particularly higher rate taxpayers – to commit more to pensions.
However, there are limits. In general the maximum contribution will continue to be restricted by two factors:-
- the annual allowance of £40,000 and
- the lifetime allowance of £1.25 million which applies to the value of all registered pension plans.
Assuming that an individual is well within their lifetime allowance, the individual may wish to maximise their contributions. With this in mind there are two special rules that apply:-
- (i) The individual can only pay contributions within their annual allowance of £40,000. However, provided the individual has been a member of a plan for the previous 3 years and the full contribution not made in those years, a contribution can be paid in the current year for those years. This is known as “carry forward” and when calculating carry forward it is possible to use the annual allowance that applied in that particular year eg. £50,000 for each of the years 2013/14, 2012/13 and 2011/12. Also don’t forget that:-
- the individual must extinguish the current year’s allowance by making a contribution of £40,000 before accessing carry forward from a previous tax year, and
- for personal contributions, the individual must have relevant earnings at least equal to the grossed-up contribution that is being paid.
- (ii) Where an individual wants to pay more into a pension plan than is allowed by their available annual allowance (and carried forward allowance – if available) another form of planning may work. The annual allowance applies per pension input period – the accounting periods that apply to pensions. The member could therefore consider starting two schemes and change the pension input period (PIP) end date for one so that one ends on 5 April 2015 (ie. in 2014/15) and one ends after 5 April 2015 – say 1 May 2015 (ie. in 2015/16). Contributions of up to £80,000 can then be made between 1 May 2014 and 5 April 2015.
- Such a strategy may be particularly useful for individuals who have no ability to carry forward unused relief because they didn’t have a pension plan in force in earlier years.
- (iii) Some clients may now welcome the prospect of a higher contribution to a pension scheme but not have the funds or sufficient relevant earnings to make it themselves. In such cases it may be that an employer company contribution will work. Where the employee is a director, this should be fairly easy to organise. For people who are mainstream employees, a salary sacrifice arrangement may be attractive whereby the employee gives up a salary that the employer contributes to the pension scheme. In both cases there will be the advantage of a NIC saving for the employer (and employee) that the employer may be prepared to add to the contribution. Whilst such contributions do count toward the employee’s annual allowance they do not need to be tested against relevant earnings. The employer will receive a deduction against profits for the accounting year in which the contribution is actually made.
Pensions will be more attractive to clients under the proposed new flexible pension rules.
Call us for more information on both the current and post 5 April 2015 rules in relation to contributions and benefit withdrawal.
Past performance is not a reliable guide to the future. The value of investments and the income from them can go down as well as up. The value of tax reliefs depend upon individual circumstances and tax rules may change. The FSA does not regulate tax advice. This newsletter is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at January 2011 and the contents of the 2010 Comprehensive Spending Review. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction.
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