THIS WEEK I continue my previous article on the new UK pensions regulations that will come into force on April 6, 2006 (referred to as A-Day). Last time I looked at the general aims of the regime, the lifetime and annual allowances and the minimum retirement age. Part 2 looks at the more technical aspects of the system.
Retirement benefits (tax-free cash)
The cash lump sums payable on retirement will remain tax-free. Individuals will be able to take up to 25 per cent of the value of their fund at the date of vesting. The balance will be used to pay a pension subject to PAYE.
Pensions must be secured by purchasing an annuity, or paid from the pension scheme where appropriate security of income exists (e.g. large self-administered or insured schemes). An unsecured pension may be paid up to age 75 when an annuity must be purchased, or alternative secured income may be provided without the requirement to purchase an annuity – but no lump sum death benefit would then be payable.
There will be no limit on benefits payable on the death of a member before vesting, either on the lump sum or dependants’ pensions. Where a member dies after vesting benefits, unexpired pension guarantee payments can be made and dependants’ pensions paid, secured as appropriate. If the deceased member’s pension was unsecured, a lump sum may be paid subject to a 35 per cent tax charge. All lump sum death benefits will remain free from income tax and inheritance tax.
From April 6, 2006 pension rights may be transferred between registered pension schemes without restriction.
There will be a common investment regime for all pension schemes. All schemes will be able to invest in the same areas with few restrictions. Loans to members will not be allowed, but loans to employers will be permitted, up to five per cent of the value of the fund (50 per centwhere all members are trustees).
The rules governing what you can invest your pension contributions in will be relaxed, the biggest change being that investment will be allowed in all forms of property, including residential and holiday property. Letting to, and joint ownership with, members will also be allowed. Borrowings will be allowed up to 50 per cent of the value of the fund.
Registration of pension rights accrued before April 6, 2006 will be available for members of pension schemes, who have funds greater than the lifetime allowance, to avoid any tax charge on the excess. Registration must be made with the Inland Revenue by April 5, 2006. Two methods of protecting such rights will be available:
Primary protection will be available where the value of all pension rights accrued before A-day exceeds the lifetime allowance of £1,500,000. Primary protection can only be used where the value of the pension rights exceeds the lifetime allowance at April 6, 2006.When benefits are vested, the excess over the multiple of the lifetime allowance will be subject to a tax charge.
Enhanced protection will be available to protect the capital value of all of a member’s pension rights accrued before April 2006, whatever their total value at that date or on vesting. While enhanced protection ensures all pension rights accrued before A-Day will be exempt from any tax recovery charge, this option is subject to members ceasing all pension contributions and active membership of all schemes from that date.Enhanced protection will protect the full value of tax-free cash lump sums, particularly if they are currently more than 25 per cent of the value of the fund.
Increases in value of a member’s fund – whether it is already greater than £1,500,000 at April 5, 2006 or a pension scheme is established and its value approaches the appropriate lifetime allowance – will necessitate constant monitoring to avoid potential tax charges on excess funding when benefits eventually vest.
Firstly though, members will need to check the value of their retirement benefits from all sources before April 6, 2006 as this will be essential in reaching a decision on whether to register for primary or enhanced protection.
If members are unsure which protection option should be registered, they should not pay further contributions to their pension schemes after April 5, 2006 until they decide which protection option to register – enhanced protection will be unavailable if contributions are made thereafter.
Members of all pension schemes should compare the amounts of tax-free cash lump sums payable on retirement and death under the current and new regimes. The retirement lump sum may be greater under the current regime than under the new one, whereas the lump sum death benefit may be greater under the new regime than currently. The opportunity to maximise one or the other benefit will need considering, possibly in conjunction with a transfer of retirement benefits by April 5, 2006.Seek professional advice.
To enable members to reach informed decisions going forward into the new regime, it would be most advisable for trustees and administrators of pension schemes to have all pension scheme assets, particularly property and land, revalued before April 6, 2006.If any type of pension scheme owns property or land with planning permission or potential for development, it may be best to sell the asset before A-Day. A sale after April 5, 2006 might increase the value of a member’s fund above the lifetime allowance and precipitate a tax recovery charge.
This article is a summary of a long piece of complex legislation. If you have any concerns about how this may affect your pension, seek advice from a qualified independent financial adviser or pensions specialist. It is also important to consider how your pension will be taxed in your country of residence if you are no longer tax resident in the UK.
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