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Anyone with property is likely to risk falling into the inheritance tax net. Even the simplest tax affairs benefit from professional advice and the more complex the more there is to be gained.

Finesco Prsentation on New Pension Rules - A New Generation Begins

The Finance Act 2011 received Royal Assent on 19th July 2011 and regulations have recently been published that provide more detail of the changes introduced from 6th April 2011 and those which will come into effect from 6th April 2012. The following summarises those changes.

Key Points for Accountants & Solicitors to Consider

• Removal of requirement to start taking pension benefits by age 75
• USP and ASP broadly replaced by capped drawdown pension
• New flexible drawdown option to take entire fund as income subject to certain criteria
• Annual allowance reduced to £50,000 from 6th April 2011
• Facility for scheme to pay annual allowance charge if member’s charge exceeds £2000
• Lifetime allowance reducing to £1.5m from 6th April 2012

Changes to the benefit rules for registered pension schemes with effect from 6th April 2011:

• It is not mandatory to start taking pension benefits from age 75
• Drawdown Pension replaced Unsecured Pension (USP) and Alternatively Secured Pension (ASP).

There are two forms of drawdown pension: capped and flexible.

Capped drawdown:

• Maximum income withdrawal limit is 100% of the value of an equivalent annuity
• Minimum income is nil
• Maximum withdrawal limits are reviewed every 3 years to age 75, and annually from age 75

Flexible drawdown offers the facility for individuals to take unlimited amounts from their drawdown pension fund, subject to certain criteria.

• Pension Commencement Lump Sum (PCLS) is available after age 75, as are other lump sums such as those payable on trivial commutation and serious ill health
• A tax charge of 55% normally applies where a lump sum death benefit is paid whilst in receipt of drawdown pension, or after age 75, irrespective of whether any benefits have been taken, except when paid to charity
• Lump sums paid on death do not form part of the individual’s estate for Inheritance Tax (IHT) purposes.
Two elements remain linked to age 75:

• Tax relief on contributions will cease at age 75
• The lifetime allowance test will apply at age 75.

From 6th April 2011 USP and ASP, including dependant’s USP and ASP, became known as drawdown pension. All those in USP immediately before 6th April 2011 were switched to drawdown pension, initially on the capped drawdown basis, whilst those in ASP normally switch on the next pension year anniversary.

There are two forms of drawdown pension, both of which are usually available from the Normal Minimum Pension Age (NMPA) of 55:

• Capped drawdown - the maximum income is 100% of a comparable annuity based on annuity rates issued by the Government Actuary’s Department (GAD). There will be no minimum income requirement.

The GAD rates used to calculate the maximum income have also changed, and the general trend is that the new rates will produce a lower level of income. This, coupled with the reduction in the overall maximum limit from 120% to 100%, and low Gilt yields (to which the GAD rates are linked), means that an individual’s maximum income may fall more than anticipated at their next review.

Reviews of the maximum capped income will be carried out every 3 years prior to age 75 and annually thereafter, with reviews being based on actual age up to age 85. For those already in USP or ASP immediately before 6th April 2011, there are transitional arrangements in place, so that the first review for those cases will take place on the earliest of:

• The 5th anniversary of the most recent review
• The first anniversary of the most recent review after a 75th birthday
• The first anniversary of the most recent review after a transfer to another registered pension scheme.

Flexible drawdown - this can be any amount of income between nil and 100% of the drawdown pension fund, subject to the individual being in receipt of at least £20,000 per annum of secure pension income from other sources.

This is known as the Minimum Income Requirement (MIR) and applies per member. The MIR may include state pensions, but excludes any income being taken from a drawdown pension fund. The purpose of the MIR is to prevent individuals relying on financial assistance from the State in the future. The level of the MIR will be reviewed every five years.

If the individual wishes to take flexible drawdown, he or she must declare that they meet the conditions for each pension arrangement from which flexible drawdown is to be taken. The individual must be able to confirm that they have actually received secure pension income of £20,000 per annum or more in the tax year in which they make the declaration. In addition, the individual must not be an active member of a defined benefit or cash benefit scheme, and, for money purchase schemes, no contributions can have been paid, in the current tax year.
For any future years, the individual can make further pension contributions but will not have any annual allowance and therefore will not be entitled to tax relief on any contributions paid.

It is not possible to take protected rights in the form of flexible drawdown. In view of this, a number of Finesco’s pension providers will be offering flexible drawdown from 6th April 2012, when protected rights will be abolished, so that full drawdown options are available to all pension funds from that date.

All withdrawals from drawdown pension funds will be taxed as pension income at the individual’s marginal rate of income tax.

On death in drawdown pension, any lump sum death benefit is subject to a tax charge of 55%. Any uncrystallised funds (“unused funds”) paid after age 75 will also be subject to the 55% tax charge. The only exception to this charge is if there are no dependants and a lump sum death benefit is paid to a charity, in which case it is tax free.

Reduction in the Annual Allowance

With effect from 6th April 2011:

• The annual allowance was reduced to £50,000,
• It is possible to carry forward any unused annual allowance from up to 3 previous tax years,
• Any carry forward is based on a deemed annual allowance of £50,000,
• Contributions in excess of the annual allowance are subject to an annual allowance, charge which effectively negates any tax relief granted,
• The annual allowance test applies in the year of taking benefits except on death or on serious/severe ill health,
• The factor used for valuing defined benefits (DB) has increased from 10 to 16,
• Any CPI or RPI increases to deferred pensions in DB schemes do not count towards the annual allowance charge.

With effect from 6th April 2011, the annual allowance is £50,000 regardless of the level of an individual’s income. This will apply to all contributions paid to money purchase and/or DB scheme benefits accrued for that individual.

Where an individual has been a member of a registered pension scheme in the previous 3 tax years, even if no contributions have been paid during those years, there will be the facility for any unused allowance up to £50,000 for each year, to be carried forward. The current year’s annual allowance is used first and then carry forward of any unused annual allowance may be utilised. Any unused relief must be applied against the earliest years first.

If carry forward is used, any annual allowance for those tax years is added to that for the current tax year which has the effect of increasing the annual allowance for the current tax year. If contributions exceed the available annual allowance, an annual allowance charge will apply. This will be linked to an individual’s marginal tax rate so that the net effect will be to disallow all tax relief on the excess contributions. (Prior to 6 April 2011), the annual allowance charge was 40% of the amount in excess of the annual allowance, irrespective of the individual’s marginal rate of tax.
Whilst it is possible to carry forward unused annual allowance, it should be remembered that tax relief on member contributions is still restricted to 100% of relevant UK earnings or £3600 if more (or there are no relevant UK earnings). It does not allow tax relief to be claimed on a previous year’s earnings.

For defined benefit schemes, benefits will be valued using a factor of 16, with provisions for indexation and other adjustments due to transfers in or out, benefit crystallisation events or pension reductions.

Any changes in the level of the annual allowance will be announced by Treasury Order.

Where an individual’s annual allowance charge exceeds £2000, it may be possible for the member to elect to have part, or all, of the charge paid by the scheme administrator of their pension scheme. This facility must be made available by the scheme where the charge is more than £2000 and the total amount of the individual’s pension savings exceeds the annual allowance for the tax year to which the charge relates, although the scheme administrator may also offer this facility where these conditions are not met.

In return for the scheme paying the annual allowance charge, the individual’s pension benefits are reduced on a “just and reasonable” basis, which, in the case of a money purchase scheme, would mean that the individual’s fund would be reduced by the amount of the charge.

The member must still report the annual allowance charge on their self-assessment tax return even if the scheme pays the whole charge. More information on this option is available at
Reduction in the Lifetime Allowance and Fixed Protection

Fixed Protection with effect from 6th April 2012:

• The lifetime allowance (LTA) will reduce from £1.8million to £1.5million
• Those with pension savings likely to be valued at more than £1.5million and who believe they may be affected by the reduction in the LTA, may apply to HMRC for fixed protection
• Applications for fixed protection must be made by 5th April 2012 and no pension benefits may accrue on or after 6th April 2012
• Those with enhanced protection who wish to apply for fixed protection will have to revoke enhanced protection first
• The limit for trivial commutation lump sums and winding up lump sums remains at £18000

The detail

Individuals with pension benefits likely to be valued at more than 1.5million by 5th April 2012 may use this window of opportunity to maximise their contributions, possibly by utilising carry forward of unused annual allowance, and then apply for fixed protection so that their lifetime allowance is maintained at £1.8million.

It is not possible to have both enhanced and fixed protection, therefore individuals who choose to give up enhanced protection to benefit from fixed protection, must ensure that HMRC receive their separate notice revoking enhanced protection no later than 5 April 2012.

Individuals need to complete applications for fixed protection to be received by HMRC on or before 5 April 2012. The form cannot be filed online. The application for fixed protection must be made to TBN/9/2011 HMRC on the prescribed form (APSS227) which can be found at p://
Going forward all UK employers must have a workplace pension scheme in place by a designated date, which will depend on the number of employees in the company. This will mean that employers will automatically enroll eligible workers in their pension scheme. If an individual is claiming fixed protection or is still relying on enhanced protection, he or she must opt out of the pension scheme within one month, otherwise the protection will be lost.

One of the pension legislation changes, effective from 6 April 2011, is the reduction in the Annual Allowance (AA) from £255,000 to £50,000 for pension input periods (PIPs) ending in the 2011/12 tax year and beyond. While this is a sizeable reduction in the AA, opportunities to maximise tax relievable pension funding will be available under the new carry forward rules that have been introduced.

The headlines

• The new AA of £50,000 will apply from 6 April 2011 for PIPs ending in the 2011/12 tax year and thereafter.
• Tax relievable contributions of more than £50,000 may be paid, without incurring an AA charge, by carrying forward any unused allowance from the three preceding tax years.
• Carry forward will only be available in respect of the three previous tax years if the individual was a member of a registered pension scheme in those years.
• For the purposes of determining the unused allowance from the three tax years preceding 6 April 2011 it is deemed that the AA in each previous year was £50,000.
• The AA for the current tax year must be used before carry forward becomes available.
• The exemption from the AA test in the tax year in which all benefits taken from an arrangement is removed from 6 April 2011. The only circumstances in which the AA test will not apply is in the tax year of death or severe/serious ill health.
• The factor used to value defined benefits is increased from 10 to 16 from 6 April 2011.

From 6 April 2011 all contributions made and/or the increase in the value of the benefit in a defined benefit scheme exceeding £50,000 during PIPs that end in the relevant tax year will normally be subject to an AA charge. To assess the amount paid against the AA for the tax year, it is necessary to establish the pension input amount (PIA) in the PIPs ending in that tax year. For money purchase schemes the PIA will be the total of all contributions to each scheme during the PIP. The PIA for a defined benefit scheme is worked out by taking the increase in the value of accrued benefits over the PIP and multiplying this by a factor of 16:1.

It may be possible however to make a contribution in excess of the AA without incurring a charge where there is unused AA from the three previous tax years which can be carried forward. The starting point for determining if there is any unused AA available from the three previous tax years is to establish if the individual was a member of a registered pension scheme in those years.  The individual just has to have been a member and does not need to have actually made any contributions during those years nor does the scheme of which he or she was a member need to be the scheme to which any carried forward contribution is to be paid.

Initially the first three tax years for which carry forward will be available will be 2008/09, 2009/10 and 2010/11. For the purposes of determining what unused AA is available the AA for each of those years is deemed to be £50,000. It is then necessary to work out the PIAs for the PIPs ending in each of the tax years. Where the total PIA for the PIPs is less than £50,000 the difference between the two is the unused AA for that tax year. If the PIA exceeds £50,000 there will be no unused AA from that tax year, furthermore the excess would reduce or eliminate any unused AA from preceding years.

Once it is established that there is unused AA from earlier years available and having used the current years AA, the unused AA can be carried forward from previous years using the earliest available year first.

Carry forward can be used automatically with no requirement to make a claim to HMRC to bring forward any unused AA. In addition it will not need to be included on a tax return where carrying forward the unused AA means that an AA charge is not due.

Member and employer contributions, or a combination of the two, can be used when looking at a carry forward exercise. In order to receive tax relief any member contributions need to be within 100% of the individual’s relevant UK earnings, while employer contributions will receive corporation tax relief if the “wholly and exclusively” rule is satisfied.

What opportunities does this offer?

So what types of individuals may be in a position to benefit from using carry forward? Those that might be in a position to take advantage include:

• High income individuals whose contributions have been limited previously under the anti-forestalling provisions;
• Defined benefit scheme members who receive a large salary increase resulting in a significant increase in accrued pension benefits in a given year;
• Those approaching retirement looking to boost their retirement fund;
• An employee who has received a sizeable bonus or self-employed person that has enjoyed a successful year and enjoyed an increase in profits;
• Someone who has received a sizeable redundancy payment;
• A director of a company looking to reduce the company’s corporation tax bill.

Planning example

Sue currently has relevant UK earnings of £180,000 and earned a similar amount in the previous tax year so was subject to the anti-forestalling provisions. She has paid a contribution of £50,000, to use the current years allowance and would like to pay a further contribution to make use of the previous year’s unused allowances. Sue has been contributing to a personal pension for a number of years and her contribution history over the last three tax years is as follows.
Tax year Pension contribution Deemed AA Unused allowance Carry forward amount available
2008/09 £20,000 £50,000 £30,000 £30,000
2009/10 £20,000 £50,000 £30,000 £30,000
2010/11 £20,000 £50,000 £30,000 £30,000

Impact on Relevant Benefit Accrual

Annual Allowance of £50,000 applies to Final Salary schemes. However in order to arrive at the Annual Allowance test the relevant benefits accruing on behalf of the member of the Scheme need to be capitalised.

This is because in a Money Purchase Scheme, accrual is simply pound for pound of contributions (not growth), whereas in a Defined Benefit Scheme, Relevant Benefit Accrual is the increase in the benefit in Pension Input Period ending in that tax year.

Benefit increases arise from accrual of additional years’ service and salary increases with the benefit being multiplied by 16:1 to calculate capital sum.

Where benefit includes lump sum rights, these are valued 1:1

Increase in Benefit is however discounted by CPI inflation

Possible that the CPI period used may not overlap with the PIP at all

Where inflation is high and salary frozen, it is possible that the calculation will give a negative figure; sadly this cannot be used to enhance annual allowance of £50,000.


The protection is limited; a retained LTA of £1.8 million but only if the individual accepts that they can have no further benefit accrual. This means stopping all contributions to a money purchase pension plan after 5 April 2012. Final salary accrual may continue but is limited to CPI increases (or other increase covered in the scheme rules by 9 December 2010) on the pension accrued at the start of the year.

In practice this means most active members of final salary schemes would have benefit accrual by the end of the 2012/13 tax year and would lose fixed protection. People should tell HMRC if they lose fixed protection, even when it arises as a result of final salary benefit accrual. Few laypeople would have the expertise or awareness to deal with this themselves, so they generally rely on their scheme administrator or adviser to help them.

Whether or not to apply for fixed protection leads to several questions and planning issues. It may vary from a relatively simple decision to being highly complex, requiring in-depth analysis.

Finesco have summarised the key issues below.

• When does the person expect to have finished all benefit crystallisations? (Remember that with drawdown, there is a crystallisation event at outset followed by a second crystallisation at the earliest of buying an annuity or reaching age 75.)

• Will the LTA increase in future, when and by how much?

• At what point during the benefit crystallisation or decumulation period might the LTA be exceeded?

• What will the rate of LTA excess tax charge be?

• Should an individual with projected benefits above £1.5 million stop money purchase pension contributions and/or opt-out of final salary schemes, so they can have fixed protection?

• If they do, will the benefits they (and their dependants) give up amount to more or less than the LTA excess tax saved?

• A taxable benefit from a registered pension scheme is normally better than no benefit. But in some circumstances an individual might have to pay more tax on other benefits already accrued to get that benefit. Accrued Benefits already falling between £1.5 and £1.8 million would be an example.

• What about loss of employer contributions and/or final salary guarantees?

• If someone stops being an active member of a registered pension scheme, will their employer offer some other benefit in lieu?

• If accrual continues, will it also exceed the annual allowance meaning even less tax relief on pension savings that might also exceed the LTA?

• On the other hand, if accrual ceases in favour of fixed protection, the client may miss out on future tax relief up to the level of the annual allowance.

• If there is both the means and the desire to make further retirement provision, what alternative savings vehicle might be more suitable than a pension scheme – even a pension scheme that ultimately may attract a relief recovery charge?

• If an adviser still feels that opting out/ceasing contributions could be suitable for a client, how do they satisfy their Conduct of Business rules? Normally the starting position is that opting out of an employer-sponsored pension scheme should be considered unsuitable. Can opt-out advice be structured so that it is suitable in the context of a potential future tax charge? Or will we see an increase in insistent customers?

• And can all this be resolved before 5 April 2012 to meet the fixed protection application deadline?

I think it is fair to say that for many, these issues and imponderables will lead to the advice being to stay put. Exceptions may include:

• Those with imminent retirement dates and full benefit crystallisations, perhaps no more than 5 years away, where there is less uncertainty about the projected level of future benefits, LTA and tax charges

• Where the difference between an LTA of £1.8 million and £1.5 million equates to a negative outcome, without the aid of fixed protection

• Those who receive generous compensation from their employer, in the shape of other benefits as a result of giving up future pension saving.

For further information please contact:
John L Douglas
Senior Consultant
Finesco Financial Services Ltd
6 Woodside Crescent
G3 7UL
Telephone: 0141 332 3113

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