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Budget 2011 – the impact on Pensions

Introduction

The Governments pension shake up will come into force from April the 6th and if you still have any misunderstandings or qualms about what you can and cant do then Liberty are here to help. In this newsletter Liberty will try to explain these changes, making sure that you are ready for the up and coming tax year.

The main changes will affect contributing and drawing down with a pension scheme, which are key issues when it comes to retirement planning. With the change in contribution limits you will need to be sure that your clients will not be suffering any extra tax liabilities and with regards to drawdown changes, you want to be able to offer all the retirement options when they decide to take an income from their pot.

The general idea of the legislation changes are to simplify pensions and also to make the capital invested in pensions more accessible. Whether this works or not, only time will tell.

Pension Input periods

As one of the main changes from the 6th April onwards will be regarding the pension contribution annual allowance, we feel that it is necessary to recap on pension input periods (PIPs). PIPs are the rogue element of an uneasy marriage with Annual Allowances. Unfortunately PIPs do not coincide with tax years and the tax year that a PIP will fall into will be the tax year that the PIP finishes in. Therefore the amount of contributions that you can make into a pension scheme will be judged on how much you have contributed in your current PIP, not the current tax year.
Contributions

In October the Treasury confirmed that they will be dramatically reducing the annual allowance for pension contributions from £255,000 to £50,000. They also confirmed that the lifetime allowance will be cut from £1.8m to £1.5m, however these change will not be coming into affect until 2012. Along with these changes the treasury has decided to scrap plans to bring in special annual allowances, which would have restricted higher rate tax relief on pension contributions for those with gross income of £150,000 or more, and relevant income of £130,000 or more. However you still cannot get tax relief on contributions that exceed 100% of earnings.

However the government has made the point that people who make one-off larger contributions will not be at too much of a disadvantage as they will be able to use unused allowances from previous years, over a 3 year period. Therefore in the treasury’s terms “protecting individuals on low and moderate incomes as far as possible”. This will be known as the three year carry forward rule.

The three year carry forward rule

The carry forward rule in essence allows you to back track to the last 3 tax years in order to use up any unused allowances. However if you are carrying forward unused allowances form the tax years 2008/09, 2009/10 and 2010/11, which you can rightly do, you must remember that the annual allowance that HMRC will be using will be £50,000. Therefore if you have contributed less than £50,000 in those tax years you will be able to carry forward those amounts to increase your annual allowance for the tax year 2011/12. You will however have to use up your annual allowance in a stringent order, using your allowance for the current tax year first, followed by the previous 3 years starting with the earliest

Eg 1.

So how much can this client contribute with a pension input period ending in the tax year 2011/12?

Eg 2.

What happens if a client contributes more than £50,000 in one of the carry forward tax years?

This example is very similar to the first example however the client contributed £70,000 in 2009/10 instead of £20,000. This does not only affect the 2009/10 tax year but also affects the annual allowance for the 2008/09 tax year as they contributed more than £50,000. As they contributed more than the annual allowance the client would of had to use up their remaining annual allowance in the 2008/09 tax year. In theory the client would have only been able to carry forward £15,000 from 08/09 however the actual annual allowance for that tax year was £235,000. £50,000 is used as a theoretical annual allowance in respect of the carry forward rule. So in conclusion this client will have an annual allowance of £90,000, £50,000 from 11/12 and £40,000 from 10/11.

Drawdown

In the Governments most recent ploy to make pensions more appealing, accessible and easy to understand they have removed the ‘age 75 rule’ where clients must take out an annuity or ASP when they reached age 75. They have also given clients the option of a new type of drawdown known as flexible drawdown, as long as they can meet certain minimum income requirements. Finally they are decreasing or increasing, depending on your age and type of pension you were taking/likely to take, the tax on lump sum death benefits to 55%.

In the past and up until the 6th April 2011 when you reached age 55 you could take a 25% tax free lump sum and also start income drawdown known as USP (Unsecured Pension). When you reached age 75 you would have to either buy an annuity with your remaining pension fund or take ASP (Alternatively Secured Pension). The Government Actuary’s Department (GAD) provided limits of how much income you could take from both USP and ASP. In USP you could take 120% of the GAD rate and in ASP you could take 90% of GAD. If you were to die before reaching age 75 your remaining pot would be taxed at 35% with the tax charge after 75 reaching 82%.

So what happens under this new legislation?

When you reach 55 you will still be able to take your 25% tax free lump sum and take an income, however USP will be replaced by Drawdown Pension (DP). Then on your 75th Birthday you will just simply carry on with DP if you have already started taking an income, and if you are yet to start there are now no obligations to do so. Therefore ASP will also be replaced by DP where you will be able to take a maximum 100% of the new GAD rates. They will be publishing updated GAD tables to cope with the fact that they will have to take into account mortality rates etc. In light of these new changes to USP and ASP, GAD maximum reviews will take place every 3 years instead of 5 up until age 75 and annually thereafter.

Drawdown Pension (DP)

There will be two types of DP, capped drawdown and flexible drawdown. Capped drawdown will be almost identical to USP however you will only be able to take 100% of the new GAD rates. Once you start capped drawdown you can continue to take it until you die under the new legislation, whereas before you would have been forced into buying an annuity.

Flexible drawdown allows individuals, who can meet certain income requirements, to accelerated and unlimited withdrawals of their pension fund. This requirement is known as the minimum income requirement (MIR) and will be set at £20,000 (to be reviewed at least every 5 years). The MIR only includes scheme pensions, state pensions, annuities and occupational pension schemes that are guaranteed for life.

Therefore this client would be able to take advantage of flexible drawdown, if they wished to do so, as their secured yearly income will be over £20,000. Being in flexible drawdown allows the client to withdraw as much of the remaining pension pot as they wish, however they will be subject to income tax at their marginal rate. eg

Lump Sum Death Benefits

If you are under 75 then any uncrystallised funds remain tax free

Every other scenario will incur 55% tax

You can pay tax free lump sum benefits to a member nominated charity, however only in the absence of any living dependants

Matthew Rankine

For further information, please contact:
Liberty SIPP
Telephone: 01706 826 511
Fax: 01706 681 463
Address: Liberty SIPP Limited, Suite 3, Havana House, Stubbins, Bury, BL0 0NE, UK
 

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