Changes to pensions legislation from 6 April 2011

6 April 2011 brings with it significant changes to the way in which pensions work. Robert Graves, Head of Pensions Technical Services, Rowanmoor Pensions and Chairman of the Association of Member-Directed Pension Schemes, outlines these changes.

Reduction in the annual allowance from £255,000 to £50,000

The annual allowance is the maximum tax relievable contribution that can be made by you, or on your behalf, into all registered pension schemes in a tax year. As income tax relief is given on pension contributions, the Government, concerned about how much income tax relief is being paid out, has decided to limit the size of tax relievable contributions by reducing the annual allowance to £50,000.

In the tax year prior to this the annual allowance was £255,000.

If you do exceed the annual allowance the excess will be treated as if you received it as earned income. Your personal tax assessment will therefore take account of this excess amount and income tax will be applied to it.

Introduction of carry-forward

A new facility, called carry-forward, has been introduced with effect from 6 April 2011.

As the annual allowance is being reduced from £255,000 to £50,000 it has been recognised that this substantial and rapid reduction could unduly penalise some people. As a way of easing this situation, if contributions to your scheme exceed the new £50,000 annual allowance you can ‘look back’ at the previous three tax years.

If total contributions in any of the three preceding qualifying tax years have not exceeded £50,000, any balance may be carried forward and used to make tax relievable contributions in excess of £50,000 in the 2011/12 tax year or later tax years. If a contribution of over £50,000 was paid in any of the three qualifying tax-years prior to 6 April 2011, the amount of relief which can be carried forward will be limited, as a notional £50,000 annual allowance is to apply to these years, despite the actual annual allowance being higher.

This means that there is still an opportunity to make personal contributions in excess of the new £50,000 annual allowance, but not exceeding your earnings, and still receive tax relief at your marginal rate of income tax. You will also not be taxed if these contributions are made by your employer and they will also be eligible for corporation tax relief. One provision is that to use carry-forward you must have been a member of a registered pension scheme in the year(s) concerned.

Reduction in the lifetime allowance from £1.8m to £1.5m with effect from 6 April 2012

The lifetime allowance is the maximum pension fund that an individual can accumulate from all of their pension schemes without being subject to a tax charge, known as a lifetime allowance charge. If the value of all pension benefits exceeds the lifetime allowance then you will be taxed on the excess amount.

Following the introduction of the lifetime allowance in 2006 there was an opportunity for individuals who already had funds in excess of or close to the lifetime allowance to apply for ‘primary’ or ‘enhanced’ protection which enabled them to avoid tax on any pension funds which built up in excess of the lifetime allowance. Anyone with such protection is not affected by the changes to the lifetime allowance but you can no longer apply for this type of protection.

With the lifetime allowance being reduced there will be an opportunity for those who do not have primary or enhanced protection to apply for a new type of lifetime allowance protection called fixed protection. Fixed protection preserves the lifetime allowance at the 2011/2012 tax year level of £1.8m.

Whether to apply for fixed protection will be an important consideration for those who already have pension funds worth more than £1.5m, or which could be worth more than £1.5m by the time retirement benefits are taken. A condition of fixed protection is that no further contributions can be made after 5 April 2012.

Changes to income drawdown

Prior to 6 April 2011, unsecured pension was the facility that allowed pension income to be drawn from the pension fund before age 77 (extended from age 75 by Budget 2010 changes) without the need to purchase a lifetime annuity.

The unsecured pension option has changed to a similar but new facility known as capped drawdown. The maximum amount that can be drawn down as income from a pension fund using the capped drawdown facility will be 100% of an equivalent amount that could be provided by purchasing a lifetime annuity. This is a reduction from the 120% maximum which was available under the unsecured pension facility.

Up to age 75, the review period for maximum income under capped drawdown is every three years, rather than every five years, which was the case under unsecured pension. From age 75 capped drawdown limits must be reviewed every year.

At a capped drawdown review the maximum amount of income, which can be taken from a pension fund is recalculated.

Individuals, who were drawing income via unsecured pension prior to 6 April 2011, will switch to capped drawdown with effect from this date. However, the reduced maximum income limits will not apply until the date of the next review. Calculations at this first capped drawdown review have to take account of the reduction in the maximum amount from 120% to 100% of an equivalent annuity, it will be calculated using the current fund value and interest rates at the time of the review. These may have changed significantly since the last review. We recommend that anyone affected seeks advice from their financial adviser on how these changes may affect them and how to plan for them.

Alternatively secured pension has been abolished

Pensions legislation prior to 6 April 2011, required individuals to have used all of their pension fund either to purchase a lifetime annuity or scheme pension by the age of 77 (extended from age 75 by Budget 2010 changes), or if not, required them to draw an income from their pension fund via the alternatively secured pension facility.

New draft legislation has abolished the requirement to purchase an annuity, or scheme pension, at any set age with effect from 6 April 2011 and consequently the alternatively secured pension facility has been abolished.

Instead, the capped drawdown facility can be used from age 55 throughout life.

Anyone already receiving alternatively secured pension, which requires you to draw an income of between 55% and 90% of an equivalent annuity, now comes under the new capped drawdown rules, which allow income of between 0% and 100% of the equivalent annuity to be drawn.

Introduction of flexible drawdown

Income drawdown via flexible drawdown has been introduced from 6 April 2011 and allows income greater than the maximum income allowed under capped drawdown to be drawn from your pension fund.

Provided you have at least £20,000 a year secure pension income, known as the minimum income requirement, you will no longer be subject to the maximum income limit under capped drawdown and will be able to draw down any amount from your fund. Amounts drawn down under flexible drawdown are classified as pension income and will be taxed as income.

In order to take flexible drawdown, all tax relievable pension contributions, or benefit accrual under any pension arrangements must have stopped permanently before the tax year in which you first take flexible drawdown and cannot recommence under any new pension arrangements in the future.

Secure pension income means a pension income for life such as state pension, scheme pension or lifetime annuity.

If you have a scheme pension, the flexible drawdown facility is not available in respect of the funds associated with your scheme pension.

Taxation of lump sum death benefits from pension funds has changed

Lump sum death benefits are taxed differently for deaths occurring after 5 April 2011.

On the death of a member the whole of that person’s pension fund can be used to provide a pension income to dependants. As an alternative the trustees of the pension scheme may pay the fund as a lump sum to beneficiaries and the taxation of these lump sum payments is changing.

Under the new rules there are three different scenarios:

1. If you die before age 75 and before drawing benefits the pension fund can be paid to beneficiaries as a lump sum free of tax.
2. If you die after age 75 but before drawing benefits the pension fund can be paid as a lump sum to beneficiaries less a tax charge of 55%.
3. If you die at any age and were taking benefits via capped drawdown or flexible drawdown, the pension fund can be paid as a lump sum to beneficiaries less a tax charge of 55%, or if there are no surviving dependants, or nominated beneficiaries, to charities, free of tax.

All of these changes are contained within draft legislation, which is part of the Finance Bill 2011. The Finance Bill is expected to receive Royal Assent and become law in June or July 2011 but with provisions made for legislation to be back dated to 6 April 2011 where relevant.

If you would like to know more about how these changes affect SSAS, SIPP or Family Pension Trusts (Family SIPPs) please contact us, or read the information in our Library. If you think you are affected, we recommend that you seek advice from your financial adviser. Journalist enquiries are handled by our media contacts.

6 April 2011

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