Pensions and the Budget 2010
September 13th, 2010
Restrictions on tax relief
The annual allowance is an annual limit on the amount of ‘pension benefit’ that can be built up in a tax advantaged environment. The annual allowance is currently set at £255,000 and if the total of employer and employee contributions to money purchase schemes (together with the increase in the capital value of any benefits held under a final salary scheme) exceeds this annual limit, the individual is subject to a flat rate tax charge on the excess (40% in 2010/11).
In his emergency budget statement on 22 June 2010, however, the Chancellor announced that the main feature of the post April 2011 pension funding regime will a significantly reduced annual allowance of between £30,000 and £45,000 a year.
For the remainder of the 2010/11 tax-year, therefore, (and as long as you are not a ‘high earner’ caught by the ‘special’ annual allowance restrictions) if you have Relevant UK earnings of more than the proposed reduced annual allowance it would probably be a good idea to maximise making tax-relievable personal contributions whilst you still can.
‘Relevant UK earnings’ includes earnings from employment and self-employment – but not unearned income from savings and investments or pension income.
To illustrate the potential advantage of maximising personal contributions now, someone with Relevant UK earnings of £80,000 in 2010/11 could obtain tax-relief on a gross personal contribution of £80,000, but if in 2011/12 the annual allowance is reduced to, say, £40,000, the maximum tax relievable contribution would be halved.
With the impending increase to national insurance contributions due to come into force from 6 April 2011 as-well, the appeal of salary and bonus sacrifice arrangements will also increase.
Abolition of the requirement to purchase an annuity and the introduction of capped and flexible drawdown
The current requirement for people with money purchase schemes, who do not want to utilise income drawdown, to purchase an annuity no later than age 75 will be abolished from 6 April 2011. An annuity is still the most common retirement option in the UK and even though it won’t provide flexibility of income it will provide a guaranteed income for life in exchange for a lump sum.
Income drawdown, on the other hand, enables you to take a flexible income within certain limits direct from your pension fund, which remains invested, without having to buy an annuity. The key risk of income drawdown, however, is that your fund could be significantly (if not completely) eroded if the underlying investment returns are poor potentially leaving you with little or no income for the remainder of your retirement – There is no guarantee an income will be paid for life.
So what are the proposed changes?
From 6 April 2011, there will be no maximum age by which an annuity must ever be purchased, but to help those approaching their 75th birthday, the age at which an annuity must be bought has been temporarily increased from 75 to 77 with effect from 22 June 2010.
In practice, the announcement on 22 June to increase the upper age limit to 77 is really just a device to buy the Government time to introduce the relevant legislation and, in effect, simply acts an interim measure to ensure that any individual’s who will attain age 75 on or after 22 June 2010 (but before 6 April 2011) will be able to benefit from the formal abolition next year.
The more restrictive income limits and death benefit rules that currently apply to people utilising income drawdown beyond age 75 will also be abolished and two new types of drawdown (capped and flexible) will be available both before and after age 75.
Under the capped option, it has been proposed that the ability to draw an income of between 0% and 120% of the otherwise available single life annuity (based on rates issued by the Government Actuaries Department) that is currently only available to those under age 75, will also be made available to individual’s utilising drawdown beyond age 75, with no upper age limit. It has been stated, however, that the current upper income limit of 120% will be reviewed to see if this remains appropriate.
Under the flexible option, individuals will be able to withdraw unlimited amounts of income from their drawdown arrangement, both before and after age 75, provided that they have secured a minimum income to prevent them from exhausting their savings and falling back on the state.
The method of assessing this ‘’Minimum Income Requirement’’ has yet to be decided although it has been proposed that this should be based solely on the individual’s other pension income already in payment (including any state pensions) and the requirement to demonstrate a minimum income will apply at the point that an individual first wants to exceed the annual capped drawdown limit.
With regard to attaining age 75, the Government has also confirmed that, from April 2011, whilst benefits will continue to be tested against the lifetime allowance at age 75 and tax relief on member contributions will only continue to be available where these are paid prior to attaining age 75, it intends to remove the age 75 limit on tax-free cash payments and the ability to commute small pension funds as a lump sum under the ‘trivial commutation’ rules.
What action, if any, do I need to take?
If you are under age 75 and will not attain age 75 prior to 6 April 2011, you do not need to take any action.
Similarly, if you over 75 and already in drawdown, you do not need to do anything either as the new ‘capped’ and ‘flexible’ drawdown options should apply to your current arrangement from 6 April 2011.
If, however, you are currently under age 75 but will attain age 75 prior to 6 April 2011 and either (a) you are already in drawdown or (b) you would like to enter income drawdown with funds that have not yet been vested, it is important to remember that, for the remainder of the 2010/11 tax year, drawdown providers do not have to allow the more flexible income limits and death benefit options that are currently available prior to age 75, to extend beyond age 75.
So, if you are approaching age 75, and your provider will not offer this flexibility between you attaining age 75 and 6 April 2011 , you may therefore want to consider the viability of transferring to another provider prior to your 75th birthday .
Furthermore, if you have pension rights that have not yet been vested, it is important to remember that you will need to vest those benefits prior to attaining age 75 in order to be able to draw 25% as a tax-free lump sum. If you reach 75 before 6 April 2011 and you do not take your benefits by your 75th birthday, any entitlement to a tax free lump sum will be lost.
For further advice on the technicalities of the changes and whether or not you should take any action, please speak to your financial adviser.
Please note that the proposed changes described above may still be subject to change and are currently subject to a period of consultation. This article is therefore based on our current understanding of the proposals.