Pensions update

Reduced relief

• The standard £40,000 (AA) is reduced by £1 for every additional £2 of an individual’s ‘adjusted income’ over £150,000 (provided the individual’s ‘threshold income’ also exceeds £110,000). 
• Adjusted income is the total gross taxable income from all sources plus employer pension contributions, and before any deductions
• Threshold income is the total gross taxable income from all sources, plus any amounts that the individual foregoes under a post-8 July 2015 salary exchange arrangement, less any pension contributions made by the individual.
• The minimum AA will be £10,000 a year for individuals with an annual income of £210,000 or more. Where the total of personal and employer contributions for a pension input period (now all aligned with tax years) is in excess of the AA, this triggers a tax charge at the individual’s marginal rate – effectively withdrawing the tax relief on the excess contribution. It is possible to elect for AA charges to be paid from the individual’s pension fund under “Scheme Pays” rules.
• As pension contributions paid by individuals (not via salary exchange) are taken into account when calculating threshold income, making such contributions can avoid an AA charge which might otherwise arise.
• Anti-avoidance rules prevent the manipulation of income, for example, where the individual has income below the £150,000 limit one year and significantly above the limit in the next. Where it is ‘reasonable to assume’ that arrangements are designed to avoid a restriction of the AA, the restriction is calculated as if the arrangements had not taken place.

Unused AA

The restriction will only affect the AA for a single year. So if an individual, whose allowance for 2018/20 is restricted but has unused allowances brought  forward from earlier years (eg. 2016/17 , 2017/18 and 2018/19) this can still eliminate or reduce an AA charge that might otherwise arise in 2019/20. 

Equally, if an individual has adjusted income above £150,000 but pension contributions are less than the restricted allowance (or nil), only the unused restricted annual allowance can be carried forward to 2019/20 and later years.

Planning

While individuals may wish to arrange with employers to limit pension contributions to ensure that no AA charge arises, it should be remembered that the charge simply claws back income tax relief given on contributions. Where tax relief is not obtained, in theory, there is a risk of double taxation as contributions are made from post-tax income and eventual withdrawals could be taxed under Lifetime Allowance charges. However, where the individual’s total pension fund is significantly below the lifetime allowance, depending on the individual’s long term investment plans, there may still be some benefit in placing funds within a pension where they can (hopefully) achieve long-term growth in a tax-free environment until benefits are eventually taken or funds passed on to the next generation. In all cases, independent financial advice is always recommended to ensure that you invest your money in the right financial product or pension.  The Lifetime Allowance has increased  £1,055,000 for 2019/20.

It has long been the case that if an individual died under age 75 before taking any pension benefits the fund remained outside the individual’s estate for inheritance tax (IHT) purposes and no exit charge arose on funds paid to their nominated beneficiaries. However, under the old rules, for those who died after age 75, or after they had begun to take benefits, a flat 55% exit charge existed on funds paid out to the beneficiaries as a lump sum (or 25% on income funds used to provide income). 

Since 6 April 2015, the exemption is extended so that, not only does the exemption apply where an individual dies before age 75 but, for those aged above, the flat IHT charge on death is also removed  where funds are left to beneficiaries as a flexi-access fund. However, where the individual  dies at age 75 or over, beneficiaries who take funds from the inherited pot will pay income tax on those funds at their marginal rates of income tax. 

This new flexibility applies to members of defined contribution  schemes (personal pensions / money purchase) but not for members of defined benefit schemes (final salary) although it may be possible to transfer entitlements to a personal pension to benefit from the new rules (see below). 

The beneficiary can also nominate a successor so that should any funds remain in the drawdown fund at their own death they can be passed on to their children or chosen individuals. Again, if the beneficiary dies before age 75, the successors inheriting the drawdown fund can access it both income and inheritance tax free. If inherited after age 75, as above, the funds are taxed as income when withdrawn. 

The potential IHT advantages of being able to pass on your pension should be considered by anyone who will be able to fund their retirement by other means. Many individuals may need to revisit their current plans and update their Wills and letters of wishes to their pension fund trustees  to ensure their intended beneficiaries get the full benefit of any pension funds remaining at their death. 

Transfers from defined benefit schemes

Most final salary pension schemes have existed for many years and while they can be extremely advantageous for members, often providing a high level pension income, they rarely have much flexibility and benefits for surviving spouses and dependents can be minimal or even absent. 

Low market interest and gilt rates that have helped to create the sort of pension funding deficits referred to as ‘pension black holes’ in the press have also increased the capital transfer value for individuals seeking to move to a personal pension. Put simply, it now takes significantly more capital to generate the level of pension income that a final salary scheme offers.  However, if you don’t need that pension income because you have other funds to live on in retirement or where life expectancy is shorter and/or greater dependents benefits are required, staying in your current final salary scheme could leave you paying high rates of tax on income that is not needed and with little or no entitlement to pass on when you die. If the scheme provider will allow it (government pension schemes tend not to), you could transfer to a personal pension and gain access to a sizeable pension fund that can be drawdown flexibly in lump sums and pass on unused funds to the next generations. 

Mandatory advice

It is a legal requirement that individuals must take professional advice from a qualified independent financial adviser before any transfers out of final salary schemes can be made. It is also vital to take tax advice to plan for a tax-efficient retirement and to ensure that you can pass on funds to your family, if you choose, without penal tax charges. 

Auto-Enrolment 

The gradual introduction of compulsory enrolment of employees into pension schemes is now complete. All employers now have an obligation to automatically enrol eligible staff (ie, most) into qualifying schemes within three months of them being employed. There are minimum contribution rates and these differ depending on the pensionable earnings definition used but in general from 2019 employer minimum contributions are now 3% where an employee contributes 5%.  Employer obligations are to select a qualifying workplace pension scheme, assess workers and enrol the eligible ones into the scheme and communicate to staff in the prescribed manner.  They will also need to pay contributions, manage any opt-outs, complete declarations of com