Simplifying the taxation of pensions: the Government’s …webarchive.nationalarchives.gov.uk/20091222074811/http:...ABOUT THIS CONSULTATION HM Treasury Inland Revenue Public Enquiry

December 2003

Simplifying thetaxation of pensions:

the Government’s proposals

10th December 2003

Simplifying thetaxation of pensions:

the Government’s proposals

Inland Revenue contacts

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Fax: 020 7438 6527

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ISBN: 0-947819-73-8

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Page

About this consultation 1

Introduction 3

List o f chapters

Chapter 1 The simplified pensions regime 5

Chapter 2 Pension age 13

Chapter 3 Scheme benefits 15

Chapter 4 Pension schemes: investments and administration 19

Chapter 5 Transitional issues 21

List o f annexes

Annex A Technical details 23

Annex B Administrative issues 49

Annex C Pre A-Day pension rights and transition 55

Annex D Questions for feedback 67

Annex E Glossary of technical terms 69

List o f tab les

A1 Membership categories 23

A2 Annual value of pension savings in DB schemes example 26

A3 Operation of the lifetime allowance example 27

A4 How does grossing up work? 28

A5 Taking benefits above the lifetime allowance 29

A6 Operation of the lifetime allowance further examples 31

A7 Unsecured income example 33

A8 Use of limited period or term-certain annuities example 33

A9 Trivial commutation example 38

A10 Unauthorised payment example 41

A11 Authorised payment examples 41

B1 Information required when registering a new scheme 49

B2 Unauthorised payment charge example 51

B3 Reportable events 53

C1 Protection of pension rights from the recovery charge examples 56

C2 Tax free lump sum examples 58

C3 Lump sum protection example 63

C4 Fully worked examples of transitional protection for registered rights 64

CO N T E N T S

AB O U T T H I S C O N S U LTAT I O N

Simplifying the taxation of pensions: the Government’s proposals

Simplifying the taxation of pensions: increasing choice and flexibility for all, published inDecember 2002, sought views on high-level proposals for a radical simplification of the taxrules governing pensions. In publishing these proposals the Government signalled itscommitment to remove the obstacles to saving imposed by the existing complex pensionregime. The Government also signalled its desire, in working up the high-level proposals, towork in partnership with those who will use the new rules.

The Government has considered the responses to the consultation. These are reflected in thisdocument Simplifying the taxation of pensions: the Government’s proposals. In this documentthe Government sets out the simplified regime and wishes to consult on the detailedproposals.

The proposals described in the body of this document and the annexes represent animportant part of the Government’s pensions strategy. They need to be considered in the lightof the broader issues and proposals in recent reviews of pensions and financial services:

• Institutional investment in the UK: a review – Paul Myners (March 2001);

• Medium and Long-term Retail Savings in the UK: A Review – Ron Sandler (July2002);

• A Simpler Way to Better Pensions: An Independent Report – Alan Pickering (July2002);

• Simplicity, security and choice: working and saving for retirement – theDepartment for Work and Pensions, HM Treasury and Inland Revenue(December 2002); and

• Action on occupational pensions – the Department for Work and Pensions(June 2003).

Copies of these can be found through the websites of HM Treasury and the Department forWork and Pensions.

www.hm-treasury.gov.uk

www.dwp.gov.uk

A partial regulatory impact assessment has been published separately. Questions forfeedback are at Annex D. Also, because of the technical nature of this paper, a glossary isprovided.

Please reply by 5 March 2004. Please note that your reply will not be treated as confidentialunless you ask for it to be so treated.

To enquire about this document or to obtain further copies, please contact either the InlandRevenue Pensions Simplification Team or HM Treasury Public Enquiry Unit. If requesting acopy by e-mail, please include “subscribe simplification” in the subject field.

1

AB O U T T H I S C O N S U LTAT I O N

HM Treasury Inland RevenuePublic Enquiry Unit Pensions Simplification TeamHM Treasury Room 132A1 Horse Guards Road New WingLondon Somerset HouseSW1A 2HQ Strand

LondonWC2R 1LB

Tel: 020 7270 4558 Tel: 020 7438 8374Fax: 020 7270 4574 Fax: 020 7438 6527E-mail: [email protected] E-mail: [email protected] can also find HM Treasury on the You can also find the Inland Revenue on internet: the internet:www.hm-treasury.gov.uk www.inlandrevenue.gov.uk

You may respond either by post to the Inland Revenue address above or by e-mail [email protected]. Please put the phrase “response pensions” in the subject lineof your e-mail. If you respond by e-mail with an automatic confidentiality disclaimer, for theavoidance of doubt, please say in your e-mail whether you are content for your comments tobe published.

If you have any complaints about the consultation process, please contact:

Steve WebsterRegulatory Impact UnitNew WingSomerset HouseStrandLondonWC2R 1LB

Tel: 020 7438 6535Fax: 020 7438 9191

You may wish to refer to the Government’s Code of Practice on written consultations. You canfind it through the Cabinet Office website at:

www.cabinet-office.gov.uk/servicefirst/index/consultation.htm

2 Simplifying the taxation of pensions: the Government’s proposals

IN T R O D U C T I O N


The Government set out its proposals for radical pensions simplification last December inSimplifying the taxation of pensions: increasing choice and flexibility for all.

This second consultation document sets out how the simplified regime would work ifintroduced, and proposes a number of modifications following the consultation, including:

• reducing the rate of the recovery charge from 331⁄3 per cent to 25 per cent,where people exceed the lifetime allowance;

• a single, fair and reasonable factor for valuing defined benefits against thelifetime allowance – 20:1 at all ages;

• the ability to take funds above the lifetime allowance as lump sums, once therecovery charge has been applied;

• more generous transitional arrangements designed to ensure that there is noretrospection – either real or perceived – on contributions and service madeor accrued before the simplified regime is introduced; and

• confirmation that unapproved, unfunded arrangements will be allowed, soemployers will have a choice whether to offer unlimited pensions within orwithout the tax-privileged regime.

The purpose of the Government’s proposals for pensions simplification is to cut red tape forbusiness, to provide more flexibility and choice for those saving for a pension, and to giveemployers and individuals the flexibility to design schemes that suit their needs. They werenever intended to raise revenue; with the Government’s proposed modifications they wouldcarry a modest cost to the Exchequer.

The Government has always wanted to proceed by consensus.

However, the consultation so far has revealed contrasting views. Many people have expressedsupport for the proposed simplified regime and the significant benefits that arise, includingfrom being able to convert the existing annual cap into a lifetime allowance.

Others have argued that there is no reason to change the existing regimes, arguing insteadthat the Government should continue to allow the future build up of uncapped tax-privilegedpension rights of those who are exempted from the post-1989 regimes because they joinedtheir existing scheme before that date. They argue that for this group there is no need to applyany cap on the amount of future saving on which tax relief can be received.

The consultation so far has also revealed contrasting interpretations of the impact of the newproposals.

The Government believes, as set out in the first consultation document last December, thataround 5,000 people – either currently in, or previously in, a pre-1989 uncapped pensionscheme – will have aggregated pension funds worth £1.4 million or more when theseproposals come into force – for these people the Government has ensured that all of theiraccrued rights are fully protected; and that there may be a further 1,000 people a year, withpension funds currently worth below £1.4 million, who over the next ten years will retire andbe affected by the lifetime allowance on account of membership of a pre-1989 regime – forthese people the Government has ensured that they can opt out of the simplified regime andprotect their accrued rights.

3

IN T R O D U C T I O N

For all other pension savers currently subject to the post-1989 regimes, the Governmentbelieves that £1.4 million is the lifetime equivalent of the existing annualised earnings cap,equivalent to the maximum pension available under the post-1989 occupational regime, andis therefore – balancing the need to incentivise saving, to ensure fairness, and of publicexpenditure priorities – the right level for converting the annual limit to a lifetime allowance.

In response to concerns expressed during the consultation so far, the Government will ask theNational Audit Office to consider, in the light of the proposals set out in this document:

• whether it is factually accurate that the £1.4 million lifetime allowance is,using a factor of 20:1 to calculate the capital value of a defined benefitpension, equivalent to the maximum pension available under the currentoccupational pensions regime which includes the earnings cap;

• whether it is reasonable for the Government to estimate that around 5,000people will have pension funds in excess of £1.4 million at 5 April 2005; and

• whether it is reasonable for the Government to estimate that around 1,000people a year may be affected by the lifetime allowance who would not havebeen affected by the earnings cap.

The National Audit Office will report in advance of Budget 2004, in order to allow anannouncement to be made in the Budget on whether or not the Government will introducethe simplified regime. If it is decided to proceed, the measures will be in the 2004 Finance Billand will be introduced in April 2005. Otherwise the current eight different regimes will remainin place.


1 TH E S I M P L I F I E D P E N S I O N S R E G I M E


1.1 Simplifying the taxation of pensions: increasing choice and flexibility for all set out theGovernment’s aim to introduce a simple and transparent tax regime for pensions. Removingthe existing plethora of controls would make pensions easier to understand and cheaper tooperate, which should benefit everyone. The key benefits of the simplified pensions regime,if it is introduced, would be that:

• almost 15 million people will be able to save for their future pension withoutinterference from artificial tax rules;

• people will benefit from the lower charges associated with reducedadministration costs;

• financial advice will be straightforward and based on need, not efforts toexploit arbitrary tax differences between the various pension regimes;

• it will no longer be necessary to leave employment in order to access anemployer’s occupational pension. This means that advisers will not need toencourage people to transfer from an occupational scheme to a personalpension to obtain a pension while still working;

• it will no longer be necessary to choose between membership of a personalpension and an occupational pension. Anyone will be able to join any typeand any number of pension schemes at any time;

• all occupational schemes will be able to pay a lump sum of up to 25 per cent of the value of the benefits;

• the maximum permissible tax free lump sum for all those earning more than£100,000 a year in the 1987 and 1989 occupational regimes rises from £150,000to £350,000;

• people will not need to consider whether to transfer to obtain tax advantagesspecific to a personal pension;

• all those in the 1989 regime earning more than £100,000 will have moreflexibility to make tax relieved contributions and will no longer be restricted topensioning only part of their salary;

• those on more modest earnings who leave their pension saving late will notfind that they are restricted in the amount of extra contributions they canmake each year; and

• the labour market distortion that makes people reluctant to move jobsbecause doing so might mean a change to a less generous pensions tax regimewill be removed.

1.2 Unlike the current complex and inflexible system, which sets an absolute limit onpensions and/or contributions, the simplified regime would have one key feature:

• a single lifetime allowance for the level of tax-privileged pension saving (£1.4million, indexed annually).

5

The newsimpleregime

TH E S I M P L I F I E D P E N S I O N S R E G I M E11.3 This would be accompanied by a light-touch rule to stop exceptionally high increasesin tax-privileged pensions, consisting of:

• an annual allowance for contributions to Defined Contribution (DC) schemesand increases in the capital value of benefits accrued in Defined Benefit (DB)schemes (£200,000, indexed annually).

1.4 The lifetime and annual allowances would apply to everyone saving for a pensionthrough a registered pension scheme, regardless of the type of scheme to which they belong.

1.5 There would no longer be any limit on the amount people can save in a pension.However, the allowances would limit the amount of tax-privileged pension saving. Those whocan afford to save more would be free to do so, but the allowances would seek to recover theexcess tax relief. Tax relief would be available on 100 per cent of earnings. For those earningless than £3,600, gross contributions of up to £3,600 a year could still be made to schemesoperating relief at source, which would reclaim tax at the basic rate regardless of whether ornot the member paid any tax.

1.6 The new rules would also allow up to 25 per cent of the capital value of the pensionbelow the lifetime allowance to be taken as a tax free lump sum.

1.7 The Government consulted widely on the proposals last December in the documentSimplifying the taxation of pensions: increasing choice and flexibility for all. The documentelicited many responses, copies of which have been placed in the House of Commons Library.A summary of the responses can be found on the Inland Revenue website atwww.inlandrevenue.gov.uk/pensionschemes.

1.8 The simplified regime replaces long-standing absolute controls on tax-privilegedpensions saving. For example, in the pre 1987 occupational regime there was a limit on theamount of pension – two thirds of final salary after ten years’ service.

1.9 Around three out of every four occupational pension scheme members are currentlysubject to rules introduced in 1989. Under these rules, the maximum pension that can beaccumulated in a DB scheme is two thirds of final salary subject to an earnings cap, currently£99,000. The lifetime allowance that the Government is now proposing broadly replicates themaximum pension, £66,000, that an individual earning at or above the current earnings capof £99,000 could accrue over a working lifetime under the 1989 rules.

1.10 The Government reiterates its estimate set out last December in Simplifying thetaxation of pensions: increasing choice and flexibility for all that, when these proposals comeinto force, around 5,000 people will have aggregated pension funds worth £1.4 million ormore. And over time a small number of people who have been in schemes since before the1989 regime was introduced may also be affected – perhaps about 1,000 a year over the next10 years. Further details on this are set out at in the partial regulatory impact assessmentpublished alongside this document.

1.11 The Government has noted speculation that the number of people disadvantaged bythe lifetime allowance is much higher than these figures and has received responses to theconsultation making this point. However, such views have been based on assumptions. Theseinclude:

• ignoring the fact that three quarters of all occupational pension schememembers are currently in the 1989 regime which caps pensions at £66,000;

• assuming that the 1989 cap is indexed by earnings;


Responses tothe

consultation

TH E S I M P L I F I E D P E N S I O N S R E G I M E 1• assuming that all earnings are pensioned;

• assuming that all pre-1987 members of occupational pension schemes staywith their existing employer until the scheme’s normal retirement age;

• valuing DB benefits using highly conservative factors; and

• assuming optimistically generous real earnings growth.

1.12 The Government believes that there has been no credible evidence presented tosuggest that the figures set out in paragraph 1.10 above are understated.

1.13 As now, employers will continue to make pension decisions on the basis of thecompany’s recruitment, retention and reward strategy. It will still be possible to save forretirement outside the new regime where neither the lifetime allowance nor the recoverycharge will apply – see paragraphs 1.39-1.45 below.

1.14 The simplified regime will apply to both DC and DB schemes, which means thatdefined benefits will have to be valued for the purposes of testing against the lifetimeallowance.

1.15 A number of factors influence the capital value of a DB pension and differentapproaches could be used to produce tables of factors for valuing benefits. But this would re-introduce major complexity. Instead, the Association of Consulting Actuaries suggested asingle factor of 20:1 for valuing DB benefits against the lifetime allowance.

1.16 The Government is keen to create a simple, stable and fair system that will be easy formembers to understand and simple for schemes to administer. The Government proposesthat where a DB pension is brought into payment this should be valued on the basis of astandard valuation factor of 20:1. This factor assumes that the pension increases inpayment in line with the retail prices index (RPI), and dependants’ pensions equal to themember’s pension would be payable on the death of the member. Schemes wishing to offermore generous levels of indexation or dependants’ benefits must agree a different factorwith the Inland Revenue.

1.17 Using a factor 20:1 at all ages, the Government believes that £1.4 million is broadlyequivalent to the maximum pension allowable under the 1989 regime for those earning at orabove £99,000 per year, and represents a generous level of savings on which to provide taxrelief. This will be the level of the lifetime allowance from the introduction of the new regimein April 2005, if it is decided to proceed.

1.18 Pension funds will not be tested against the lifetime allowance until they are broughtinto payment. It would be extremely onerous administratively to end the tax relief once totalfunds across multiple schemes reached the level of the lifetime allowance. People cantherefore continue to make contributions and receive relief even though their funds may, atthe time, exceed the lifetime allowance.

1.19 The Government believes that the new regime will be much simpler and more flexiblethan the regimes it will replace. However, there needs to be some mechanism for recoveringexcess tax relief. As the consultation proposed therefore, there will be a recovery charge onpension funds in excess of the lifetime allowance at the time that the pension vests.

1.20 The recovery charge on funds and the value of promised benefits in excess of thelifetime allowance needs to be set at a level which, broadly, will neutralise the tax relief givenon all contributions and investment growth. The original proposal, as set out in Simplifyingthe taxation of pensions: increasing choice and flexibility for all, was that the recovery chargeshould be set at one third.

7Simplifying the taxation of pensions: the Government’s proposals

The lifetimeallowance

Funds in excessof the lifetime

allowance – therecovery charge

TH E S I M P L I F I E D P E N S I O N S R E G I M E11.21 This proposal argued that the recovery charge should aim to neutralise the tax reliefgiven initially on contributions and then on the growth of funds during investment, ratherthan to be a personalised figure to make an exact recovery of the tax relief on savings abovethe lifetime allowance. Excess funds will have received 40 per cent tax relief on contributionsand on fund growth, as well as exemption from National Insurance for employercontributions. So where money has been in a pension fund for many years, a relatively highrecovery charge is implied because of tax relief on many years’ fund growth; but, wheremoney has been in a pension fund for only a short time, the effective level of tax reliefobtained would have been lower. Similarly, some respondents pointed out that thecalculation of the recovery charge assumed that all paid National Insurance contributions,but that this would not be the case for the self-employed. Some respondents thereforeconsidered that the recovery charge was set too high.

1.22 The Government has therefore looked again at the rate of the recovery charge inlight of the overall package, and now proposes that the recovery charge should be set at 25per cent of funds above the lifetime allowance. Whilst better reflecting the situation of theself-employed, the Government believes this is still at a sufficient level broadly to recover theexcess tax relief paid in most cases.

1.23 Some respondents queried the requirement to take funds that had been subject to therecovery charge as a mixture of pension and lump sum. They suggested that, as the purposeof the recovery charge was to put people back into the position that they would have been inif they had taken taxed salary instead of a pension contribution, they could see nojustification for restricting what sort of benefits might be taken.

1.24 The Government accepts the strength of this argument. Therefore, post A-Day, amember with a fund in excess of the lifetime allowance may choose, at the time of vestingthe benefits, to take funds in excess of the lifetime allowance as a lump sum. The rate of taxwill be 55 per cent, which equates to the normal level of the recovery charge (25 per cent)plus tax at the higher rate of income tax (40 per cent) on the remainder.

1.25 The annual allowance was proposed as a means of protecting against large paymentsinto a tax-privileged scheme, which might then be removed from the scheme without theimposition of tax. The consultation document set out what would count towards the annualallowance.

1.26 The Government estimates that an annual allowance of £200,000, as proposed in theconsultation document, will affect fewer than 1,000 people each year.

1.27 In exceptional circumstances where the allowance might otherwise be exceeded, forexample, a combination of long service, generous benefit accrual and a large pay rise, theseeffects could be mitigated by adjusting pension scheme benefits or remuneration andretirement packages.

1.28 A number of respondents commented that it is not necessary to have both annualand lifetime allowances and suggested other ways of preventing abuse. These suggestionshave been considered carefully but, on balance, are thought unlikely to prove effective.

1.29 A particular concern about the annual allowance was that, although generous at£200,000, it might still catch enhancement of pension rights in cases of redundancy or ill-health retirement. It was suggested that in a year where the pension had been vested in full,and tested against the lifetime allowance, the annual allowance should not apply.


Annualallowance

TH E S I M P L I F I E D P E N S I O N S R E G I M E 11.30 The Government continues to believe that it is necessary to limit tax relief through alight-touch annual allowance as well as a lifetime allowance. The Government thereforeproposes that there will be an annual allowance of £200,000, but, in order to lessen its effectwhen someone is close to retirement, to exempt contributions and benefit growth from theannual allowance in any year in which the benefit is taken in full.

1.31 Again there needs to be a simple means of valuing the annual increase in benefits inDB schemes. The actual cost of making annual provision for people at all different ages, wherethe funds have different periods over which to accumulate and grow, varies widely. A factor of£10 of value for every £1 of DB pension would reflect this.

1.32 The Government therefore proposes that, taking into account the range of factorsthat could be applied across a range of ages, a single factor of 10:1 will be used for thispurpose.

1.33 The current earnings cap is indexed in line with RPI. The consultation documentproposed that the lifetime and annual allowances would be similarly indexed.

1.34 The Government believes that continuing the existing approach introduced in 1989,which increases the earnings cap by RPI, is the correct one. Accordingly the lifetime andannual allowances will be uprated annually by RPI. The lifetime allowance will be roundedup to the nearest £10,000 and the annual allowance up to the nearest £1,000.

1.35 The consultation document suggested that rights over £1.4 million at A-Day would beprotected. Many who responded to the consultation document suggested that those who“opted out” of future contributions or pensionable service should be exempt from the lifetimeallowance.

1.36 The Government has considered these responses and has decided to offer schemesthe option of allowing members to opt out of making further contributions or accruingfurther service in return for increased protection of the pension from the recovery charge.

1.37 Inevitably this will be more complicated than the process envisaged in theconsultation document; however, the Government feels that what is now suggested meetsmany of the points raised in consultation. Chapter 5 and Annex C give full details of the newproposals.

1.38 The new regime will be sufficiently flexible to allow for unlimited pensions withinregistered schemes, with the only limit being on how much tax relief is given. Fundedunapproved retirement benefit schemes (FURBS) and unfunded unapproved retirementbenefit schemes (UURBS), as separate top-up vehicles to provide benefits to high-earningemployees, are therefore no longer essential, unless the aim is to provide benefits that wouldnot be allowed under a registered scheme.

1.39 The Government can see no clear justification for continuing to provide privileged taxtreatment for unapproved schemes within the new regime. They may continue, but in futurewill not receive tax-favoured status. Amounts in FURBS at A-Day will have some protection,details of which are given in Annex A.


Indexation

Transitionalprotection

Unapprovedschemes

(FURBS andUURBS)

TH E S I M P L I F I E D P E N S I O N S R E G I M E11.40 Given that any future retirement provision made through the equivalent of FURBSand UURBS (non-registered pension schemes) will not attract any specific tax privilege underthe new rules, the Government agrees with respondents that amounts saved in any suchscheme should not be tested against the annual and lifetime allowances and the recoverycharge should not apply to them.

1.41 For unfunded schemes the value of the promise to pay a pension on retirement:

• will not be taken into account when considering the annual allowance; and

• will not be tested against the lifetime allowance.

1.42 When benefits are paid out, whether by lump sum or pension, they will be fullysubject to tax at the member’s marginal rate. The Government recognises that someemployers currently seek to back an unfunded promise with an asset. This will be allowed tocontinue under the new regime. In addition, from the day the new rules enter into force,employers may insure the promise against the risk of default on account of the sponsoringemployer becoming insolvent, provided that the premiums are charged as a benefit in kindon the employee promised the pension.

1.43 From the day the new rules come into force, non-registered schemes will be treatedlike any other scheme to provide benefits to employees. This will mean that:

• employer contributions to non-registered schemes will not be taxable on theemployee or liable to NICs as they are made, nor will the employer get anydeduction for his contributions until benefits start to be paid to the employee;

• all investment income and capital gains received and liable to UK tax by non-registered schemes set up by way of a trust will be liable at the rate applicableto trusts, as opposed to the lower rates some currently enjoy on investmentincome;

and subject to transitional protection:

• benefits paid out after A-Day will be liable to income tax within the generaltaxation provisions;

• benefits paid out of non-registered arrangements will not be subject toemployers’ or employees’ NICs if the benefits are consistent with the generalbenefit rules described in paragraph 3.2; and

• non-registered schemes will from A-Day lose their current inheritance tax(IHT) favoured status and benefits from these will be taxed like those from anyother scheme to provide employee benefits.

1.44 These proposals will provide sufficient flexibility to save more than the lifetimeallowance without incurring a recovery charge.


TH E S I M P L I F I E D P E N S I O N S R E G I M E 11.45 The Government believes a package comprising the following is the right way toproceed:

• a lifetime allowance for tax-privileged pension savings of £1.4 million indexedin line with RPI;

• a single valuation factor for valuing DB schemes against the lifetime allowanceat £20 for every £1 of pension;

• a recovery charge at a lower rate of 25 per cent on funds in excess of thelifetime allowance;

• allowing funds in excess of the lifetime allowance to be taken as a lump sum,subject to a higher recovery charge of 55 per cent;

• a light-touch annual allowance for contributions and benefit accretions of£200,000 indexed by RPI;

• increased transitional protection for those who decide to stop accruingfurther contributions and pensionable service;

• exempting contributions and benefit growth in the final year from the annualallowance provided that the benefit is vested in full; and

• exempting funds held in schemes outside the simplified regime from therecovery charge, although there will be no separate tax advantages for suchschemes

An announcement will be made in the 2004 Budget on whether or not the Government willintroduce the simplified regime.


Summary


2 PE N S I O N A G E


2.1 A simpler regime with fewer controls will provide greater flexibility for employees andemployers to agree the pension arrangements that are best suited to their respective needs.An important area where greater flexibility is desirable is around pension age.

2.2 People who are fit and able as they approach the end of their careers may want towithdraw gradually from the labour market: combining work and retirement in ways that suittheir circumstances. The tax rules will no longer dictate that it must be one or the other: workor retirement.

2.3 The reality is that people are now working longer and to reflect this the previousconsultation document proposed that the minimum age for taking benefits should rise from50 to 55 by 2010. This would apply to all pension schemes that qualify for tax relief.

2.4 The consultation document asked for views on whether pension schemes should beleft to decide how to move to a minimum age of 55 by 2010 or whether Government shouldprescribe a phased introduction between A-Day and 2010. It also asked for views on the needfor special transitional rules for people who have already built up rights to a pension beforethe age of 55 in existing schemes.

2.5 There was recognition of the need for the Government to encourage people to worklonger to reflect increasing life expectancy. Some respondents agreed that schemes should beallowed to phase in the change up to 2010 in a way that best suits their needs. Others thoughtthe Government should specify how it should be phased in.

2.6 The Government continues to believe it is right to make the change, and by 2010.Government policy is to encourage greater participation in the labour market by olderworkers.

2.7 The Government proposes that schemes should be free to decide how and when tomove to a minimum pension age of 55 by 2010.

2.8 Respondents were concerned that there should be protection for active and deferredmembers of occupational schemes with an existing contractual right to draw a pension afterage 50, typically in the event of redundancy. To meet the concerns of those with existingcontractual rights at A-Day, the Government proposes that any member of an occupationalscheme, active or deferred, with a contractual right to draw a pension after age 50, may havethat right honoured, so long as: that right was extant before the date of issue of thisdocument; the pension is fully vested when the right is honoured; and the employmentterminates before the pension is vested.

2.9 The consultation document proposed that the new minimum pension age of 55would apply to all schemes, including those in the current system with low normal retirementages such as those for sports people.

2.10 The working lives in some professions can be very short. But many people in theseprofessions go on to a second career once their first career finishes. People in occupationswith low normal retirement ages, some as early as age 35, know that they will be in thisposition and can arrange to spread their assets between pensions and other savings.

2.11 The Government does not believe that there is a place for early minimum pensionages in the new simplified regime. But some protection for those people with currentexpectations of early retirement is appropriate.

13

Phasingthe change

in

Protectionfor existing

rights

Schemeswith low normal

retirementages

PE N S I O N A G E22.12 The Government proposes to allow people in pension schemes at A-Day with a lownormal retirement age to keep their existing rights to take benefits early, but subject to twoconditions:

• the pension will be tested against a reduced lifetime allowance; and

• the full pension must be vested.

2.13 A reduction of 2.5 per cent will be applied to the lifetime allowance for each yearbefore 55 that the pension is taken. For example a pension taken at age 35 would reduce thelifetime allowance of that individual by 20 x 2.5 per cent, i.e. 50 per cent. The pension fundwould therefore be valued against 50 per cent of the prevailing lifetime allowance (£700,000using 2005 figures). 50 per cent of the lifetime allowance would remain unused and could becarried forward for use in determining the amount of any further tax-privileged savings thatcould be built up.

2.14 The consultation document recognised the special position of members of the armedforces, police and fire services and it is not proposed to apply reductions in the lifetimeallowance to them.

2.15 The consultation document also referred to further work being done on the positionof members of the pension schemes for the armed forces, police and fire services. TheGovernment announced proposals for the new armed forces pension scheme in September2003 and work is in progress on new arrangements for the police and fire services. Newschemes for all three groups are expected to be in place well before 2010. To be tax compliant,the new schemes will not allow benefits to be paid before age 55. From A-Day, any newentrants to the old schemes for these and other public services will not have an entitlementto pension benefits before age 55 except on grounds of ill health.

2.16 Incapacity early retirement is a long-standing feature of the current pensions system.People can take benefits at an early age on account of a medical condition such that thesufferer is incapable of returning to his or her occupation. The Government proposes thatincapacity early retirement should continue to feature in the simplified regime.

2.17 The Government proposes that:

• the minimum age for taking benefits will rise from 50 to 55 by 2010;

• schemes will be free to decide how and when to move to a minimum pensionage of 55 by 2010;

• deferred and active members at A-Day with a contractual right to draw apension after 50 will have that right protected, so long as that right was extantbefore the date of issue of this document;

• those people in pension schemes at A-Day with a low normal retirement agewill be able to keep their existing rights to taking benefits early, subject tocertain conditions; and

• incapacity early retirement will continue.


Publicservices

Incapacityearly

retirement

Summary

3 SC H E M E B E N E F I T S


3.1 The consultation document described a single consistent set of tax rules about howbenefits could be drawn. These would apply to all benefits and replace the multiplicity ofrules that exist in the current system, for which there is no clear rationale.

3.2 The new rules would allow up to 25 per cent of the capital value of the pension, belowthe lifetime allowance, to be paid as a tax free lump sum. In addition pension benefits must:

• start before age 75;

• not start before age 55 (age 50 until 2010), with an exception for ill-healthretirement;

• last for the remainder of the person’s life;

• be paid in instalments at least annually;

• not be assignable to anyone, other than where permitted by Inland Revenuerequirements;

• not be guaranteed for a minimum period greater than 10 years;

• up to age 75, not offer a capital guarantee of more than value protection;

• lie between certain minimum and maximum income limits; and

• be taxed as income, generally under PAYE. Annex A gives further detailregarding benefits payable from Retirement Annuity Contracts (RACs).

3.3 The Government confirms that the new regime will contain this set of generalbenefit rules. The rules outline the characteristics of pension benefits but, unlike theexisting rules, the means of delivery of the income is no longer specified. Annex A sets outin detail how the rules will operate.

3.4 The previous chapter discussed the Government’s proposal to move the minimumage for taking benefits to 55. The Government intends to retain the existing rules, whichrequire all pension savings to be used to provide an income either to the member or, ondeath, to his or her survivors, by age 75. This reflects the fact that pension savings areintended to be used as income in retirement.

3.5 Conventional pensions and annuities are likely to remain the most popular andsuitable means of securing benefits. However, some religious groups have principledobjections to the pooling of mortality risk and need to be accommodated by the new rules.The Government, therefore, proposes to allow pension income to be delivered after age 75through Alternatively Secured Income (ASI).

3.6 The pension scheme must at all times remain responsible for delivering ASI. All incomepayments to the member must be paid via the scheme whether or not the administration andinvestment of the funds underlying the ASI have been placed with a financial institution. ASIwill need to satisfy the general benefit rules but there will be additional controls in place toensure that funds are used for their proper purpose. The maximum income that can be taken inany year will be 70 per cent of that which could be generated by applying to the fund an annuityrate for a person of the member’s age and sex up to age 75. From 75, the annuity rate for a 75year old will be used. The minimum income to be taken from the product in any year will be £1or any greater DWP minimum income requirement. If at any point the scheme is to be woundup, the ASI funds standing to the member’s credit must be used to purchase an annuity for themember.

15

General benefitrules

Age 75

SC H E M E B E N E F I T S33.7 The maximum income will have to be reviewed annually. On the member’s death anyremaining funds underlying the ASI must be used first to provide dependants’ pensions. Ifthere are no dependants, any remaining pension fund must revert to the scheme, where itmay be re-allocated to provide pension benefits for other scheme members or possibly bepaid to a registered charity. Otherwise, funds will revert to the employer.

3.8 ASI is likely to be an inferior choice for pension savers without dependents and whodo not have a principled objection to the pooling of mortality risk. The product may beconverted to a guaranteed pension for life or an annuity at any time at the member’sdiscretion.

3.9 Post A-Day the Government proposes that death benefits from funds which have notcome into payment (“unvested”) can be paid either as pensions to dependants or, before themember reaches 75, as a lump sum:

• under a pension promise provided by an employer;

• from a life assurance policy; or

• from pension funds earmarked for the member.

3.10 Any lump sum paid will not be taxed as pension income, but will need to be testedagainst the lifetime allowance and a recovery charge of 55 per cent paid on the excess, whereappropriate. This change is a direct result of the decision to allow all funds over the lifetimeallowance to be taken as a taxed lump sum. However, there will be no test against the lifetimeallowance where the death benefits are paid as dependants’ pensions.

3.11 Once the pension fund has vested and benefits are in payment there will be limits onhow much can be returned on the death of a member. Two proposals in the consultationdocument attracted particular comment:

• the prohibition of return of capital if the member dies on or after age 75 wasseen by some as unfair, arbitrary and creating a cliff edge; and

• the limit on the amount of undrawn funds that can be returned as capital ifthe member dies before age 75 could generate a windfall to the pensionprovider on the death of any member without dependants.

3.12 The Government does not accept the arguments for returning capital after the age of75. Pension saving is to provide an income in retirement for the member which, on death,may continue to be paid to any dependants. It is not a route for conserving and passing oncapital, regardless of whether or not this is properly taxed.

3.13 The Government wishes to ensure that pensions remain a vehicle for providingincome in retirement, especially in later years. To preserve the integrity of this purpose, theGovernment confirms that a registered pension scheme will not be permitted to providebenefits that involve direct or indirect capital payments triggered by the death of a pensionscheme member aged 75 or over.

3.14 However, the Government also recognises that those taking their benefits usingincome drawdown, a feature of the current system, bear mortality and investment risk. It alsorecognises that proposals to limit capital repayments to the initial fund value less instalments(see 3.15 below) could lead to a windfall for the product provider. The Government thereforeproposes that where a member dies before age 75, having taken benefits but without havingsecured income, any undrawn funds in that pension fund may be repaid as a capital sumsubject, as now, to tax at 35 per cent.


Death benefits –before the

pension fundvests

Death benefits –after vesting

SC H E M E B E N E F I T S 33.15 Secured pensions may offer value protection. Value protection is the repayment onthe death of the member before age 75 of an amount representing the initial capital value ofthe pension less any pension instalments paid before the date of death. All value protectionpayments will be taxed at 35 per cent.

3.16 Pension schemes may offer a guarantee that the pension will continue for a periodnot exceeding 10 years from the date of vesting.

3.17 Value protection and a guaranteed period of pension payments are mutuallyexclusive options.

3.18 The consultation paper proposed that any pension rights from spouse A which wereacquired on divorce by spouse B would be ignored for the purposes of testing spouse B’spension against the lifetime allowance but would continue to count against spouse A’slifetime allowance.

3.19 The great majority of those responding on this point considered the proposals unfair.The alternative approach put forward was not to count the amount of the pension shared byspouse A on divorce against his or her lifetime allowance, and to maintain equilibrium bycounting the amount shared against the acquiring spouse B’s lifetime allowance.

3.20 This would allow a divorcing couple to build their pension funds up to the value of thelifetime allowance. The respondents stated this would make pension sharing simpler andfairer.

3.21 The Government agrees that there is an overwhelming case for pension sharingarrangements to reflect the position after the share has occurred. Where sharing orders areeffective post A-Day, those pension credits granted under a pension sharing order will countagainst the recipient’s lifetime allowance but pension debits will not be counted towards thedonor’s lifetime allowance. Neither pension debits nor credits will count towards the annualallowance.

3.22 Transitional rules will apply for pension sharing orders in existence at A-Day. TheGovernment proposes that, for pension sharing orders in existence at A-Day, in calculatingthe value of a member’s pre A-Day pension rights, the value of any pension allocated tospouse B on divorce will be ignored for the purposes of both spouses’ lifetime allowances.

3.23 The Government proposes:

• a single set of tax rules about how benefits can be drawn;

• pension funds must be secured before age 75 using one of:

• a pension – guaranteed by an insurance company (i.e. an annuity);

• a pension – promised by an employer; or

• ASI – where security is gained by reducing the maximum income thatcan be taken.

• if death occurs before the pension vests it can be paid to dependants as a lumpsum, subject to the recovery charge if in excess of the lifetime allowance, or aspension income subject to income tax;

• no capital may be returned if death occurs on or after age 75;


Value protectionand guarantees

Pension sharingon divorce

Summary

SC H E M E B E N E F I T S3• if death occurs after the pension vests but before age 75, a capital payment

may be made and this payment will be subject to a tax charge of 35 per cent;and

• where a pension is shared by a divorcing couple, each share will count towardsthe lifetime allowance of its recipient. This will apply only to pension sharingon divorce orders made after A-Day.


4 PE N S I O N S C H E M E S : I N V E S T M E N T S A N DA D M I N I S T R AT I O N


4.1 The original consultation document proposed a single set of investment rules for allpension schemes. These new rules would apply to all investments, with transitional rules toprotect schemes from having to make urgent disposals of assets incompatible with the newrules.

4.2 The new regime will, subject to DWP requirements, allow pension schemes to investin all types of investments, including residential property. There will be limits on holdings ofshares in the sponsoring employer’s company (of 5 per cent of the fund value) and on loansto employers. The proposed rules on self investment are covered in Annex A.

4.3 This will provide many schemes with the freedom to invest in a wider range of assetsthan they currently enjoy. It will be left to the trustees and scheme administrators to decidewhether the investment is suitable for the scheme in question.

4.4 Any investment entered into before A-Day will be subject to the rules in force when itwas entered into. It will not be affected by the new rules. Where, after A-Day, there is a changein the terms of a loan made by the scheme before A-Day, the whole loan will be subject to thenew rules.

4.5 Details of rules regarding investments in a sponsoring employer and the use ofinvestments and to extract funds from schemes are set out in Annex A.

4.6 There will be proportionate sanctions to ensure scheme compliance with the regime,and to deal with schemes that wind up. Details are set out in Annexes A and B.

4.7 Greater freedom to invest will mean that schemes can hold assets capable of beingenjoyed by members, for example, residential property.

4.8 The Government proposes that any non-commercial use of an asset by a member oran associate of a member will create a tax charge on the member – a pension benefit in kindcharge. Annex A sets out in detail how the charge will be calculated and collected.

4.9 It has been widely accepted that the new simplified regime should ease theadministrative burden of pension providers. One leading industry spokesperson said that thesimplified system should reduce personnel training needs and suggested that for the adviceindustry, savings of around £10 million per year could be achieved. There will of course betransitional costs for the industry in moving over to the new regime. However, in the long runbenefits from simpler and cheaper administration are likely to bring savings of around £80million a year, as estimated in the first consultation. This is good news for both providers andscheme members, who will benefit indirectly from the lower costs of selling andadministering pensions.

19

Investments

Benefit in kindcharges

Administration

PE N S I O N S C H E M E S : I N V E S T M E N T S A N D A D M I N I S T R AT I O N44.10 Annex B explains in more detail how the administration of the new system will work.A registration system will replace the current approval process. There are also plans to reducethe amount and frequency of information collected from schemes by streamlining thedemand for information associated with:

• Inland Revenue registration;

• registration with the Occupational Pensions Regulatory Authority and itssuccessor; and

• contracting out.

4.11 Annex B also provides more detail on the new compliance regime.

4.12 The Government proposes that:

• subject to DWP requirements, pension schemes will be allowed to invest in alltypes of asset with minimal interference from tax rules;

• proportionate sanctions will be introduced to ensure schemes comply withthe regime, and to deal with schemes which wind up;

• a pension benefit in kind charge will be levied where assets of the schemehave been used by the member or employer, or their associates, on a non-commercial basis; and

• a registration system will replace the current approval process.


Summary

5 TR A N S I T I O N A L I S S U E S


5.1 People will be able to protect their pre A-Day rights. Broadly, they will be able toprotect their pre A-Day pension fund from the recovery charge and their right to a tax freelump sum in excess of the new limits – the lower of 25 per cent of fund value or £350,000.

5.2 Where an individual has pension rights valued in excess of £1.4 million at A-Day, heor she can register that value. Values that are registered will be expressed as a percentage ofthe statutory lifetime allowance (£1.4 million at A-Day). For example, for someone who has afund of £2.1 million at A-Day the percentage will be 150 per cent. By expressing the A-Dayvalue in percentage terms, the value will be automatically indexed in parallel with theindexation of the lifetime allowance. When the pension vests the individual can take benefits,in this example up to 150 per cent of the value of the statutory lifetime allowance in that year,without incurring any tax liability under the recovery charge.

5.3 The Government has considered the responses to the consultation paper ontransitional protection carefully. In the light of these responses the Government proposes analternative approach for the protection of pre A-Day pension funds against the recoverycharge. This alternative approach will be available for those people who, before A-Day,suspend pensionable service and stop contributing to their pension funds. This alternative isnot restricted to individuals with pension values exceeding £1.4 million. Under thisalternative approach post A-Day increases in the value of pension funds and benefit rightsaccrued before A-Day will be protected from the recovery charge.

5.4 People who have taken the alternative approach may resume active membership of apension scheme any time before they reach age 75.

5.5 For those who resume active scheme membership, protection from the recoverycharge will be determined by their A-Day pension value. For those whose pension value didnot exceed £1.4 million, their personal lifetime allowance will be 100 per cent of the lifetimeallowance. For those who registered pension values exceeding £1.4 million, their personallifetime allowance will revert to the percentage of the lifetime allowance which correspondedto the value of their pre A-Day fund.

5.6 People who register funds in excess of £1.4 million at A-Day will also protect any taxfree lump sum entitlement over £350,000. After A-Day they can take:

• the amount of the pre A-Day lump sum rights increased to the same extent asthe increase in the lifetime allowance.

5.7 People who choose the alternative approach to protection from the recovery chargecan take:

• a percentage of the pension value vesting after A-Day as a tax free lump sum.

5.8 At A-Day some people in occupational schemes, who have not registered fortransitional protection, will be entitled to a tax free lump sum in excess of 25 per cent of thevalue of their pension benefit. At vesting they will be able to take the tax free lump sum towhich they were entitled at A-Day, increased to the same extent as the increase in the lifetimeallowance to the date of vesting.

5.9 Those seeking transitional protection for pensions must register their pre A-Dayrights, and provide all necessary valuation information within 3 years after A-Day.

21

Pre A-Day rights

Protection fromthe recovery

charge

Lump sums

Registration

TR A N S I T I O N A L I S S U E S55.10 Transition is inevitably a complex element of the proposals. Annex C describes theproposals in more detail. In summary, the new rules will protect not only funds accrued to A-Day, but also post A-Day investment or salary growth provided there is no post A-Daycontribution or increase in pensionable service.


A TE C H N I C A L D E TA I L S


Rel ie f on contr ibut ions to a reg istered pens ion schemeA1 Anyone may join and contribute to a UK registered pension scheme. Eligibility for taxrelief on contributions to registered pension schemes will depend on the membershipcategory. Relief will be available for contributions as summarised in Table A1.

A2 Members of schemes will fall into one of three categories:

• Category 1: individuals with earnings chargeable to UK tax (“UK earnings”) orwho are resident in the UK;

• Category 2: non-resident individuals who do not have UK earnings; or

• Category 3: non-resident individuals who do not have UK earnings but whowere within category 1 within the last 5 years.

A3 An individual will fall under only one category at any time.

Table A1: Membership categories

Category 1 2 3

What contributions Unlimited personal and employer contributions provided the member is aged under 75can be made

Relief to member:personal contributions1 Higher of £3,600 and None On first £3,600

100 per cent of UK earnings gross (only under RAS)employer contributions2 Unlimited Not applicable Not applicable

Relief to employer Relief in computing profits chargeable to UK tax

Application of All contributions count Contributions do not Contributions, except those annual allowance towards allowance count towards allowance paid under RAS, do not count

towards allowance1 Contributions by someone other than the employer/former employer are deemed to be personal contributions of the member. The amount of relief available on such contributions will

depend on who pays the contribution and to what type of scheme.2 “Employer” includes current and former employers.

A4 The current methods of giving relief will continue for personal contributions toregistered pension schemes:

• Net pay – Where an individual makes contributions to an employer-sponsoredregistered pension scheme, the employer operates PAYE on the employmentincome after deducting the personal contributions. This gives tax relief at theemployee’s marginal rate of income tax and no further claim is necessaryunless, exceptionally, a contribution cannot be relieved through the operationof net pay;

This annex outlines the details of the new regime. Comments on the proposals below arewelcomed.

23

Who is eligible for

relief?

TE C H N I C A L D E TA I L SA• Relief at source (RAS) – An individual’s contribution to a registered pension

scheme is treated as having had a sum deducted equal to the basic rate ofincome tax. The scheme administrator claims a repayment of this amountfrom the Inland Revenue, which is credited to the member’s pension fund. Anindividual entitled to higher rate tax relief will, as now, need to claim higherrate relief via his or her self assessment (SA) return; and

• Individual claim – As now an individual makes a claim via his or her SA returnfor: relief for gross premiums paid to a retirement annuity contract (RAC);contributions to an employer-sponsored scheme where full relief has notbeen given through the net pay system; for corresponding relief; or a claim torelief under a double taxation agreement. Relief for contributions to a RACmay also be obtained by a repayment claim or by a PAYE coding adjustment ifthe individual is not a SA taxpayer.

A5 Employer-sponsored schemes (with active membership restricted to currentemployees) may choose whether to operate net pay or RAS. However, they must operate thesame arrangements for all members. Existing RAC schemes, established under a contractbetween the scheme member and the provider, will be given the option to either operate RASor, as now, to accept gross contributions. All other registered schemes must operate RAS.

A6 An individual, other than the employer or former employer, may contribute to ascheme on behalf of the member. Where that scheme operates RAS, the contribution will betreated as the personal contribution of the member and is grossed up by the basic rate ofincome tax. Where appropriate, higher rate relief will be available to the member. Where anindividual makes a third party contribution to a scheme operating net pay, the member, onwhose behalf the contribution was paid, can claim relief as if it were a personal contribution.Such relief must be claimed through the SA system, by a repayment claim, or by a PAYEcoding adjustment as appropriate.

A7 Employers will be able to claim a deduction in computing profits chargeable to UKtax for employer contributions paid to a registered pension scheme.

A8 Individuals will be able to obtain relief on personal contributions of up to 100 per centof their earnings. For individuals whose earnings are below £3,600, including those with noearnings, relief will be given on contributions up to £3,600 where these are paid to a schemeoperating RAS. For individuals earning more than the annual allowance (£200,000 at A-Day),contributions above the annual allowance which do not exceed 100 per cent of their earningswill still receive relief under the net pay, RAS and SA processes. However, such contributionswill give rise to a tax liability under the annual allowance rules.

A9 The level of tax relief available to individuals under the simplified regime will bemuch higher than the tax relief currently available on contributions to Inland Revenueapproved schemes. There will also be no limit on the amount that can be saved in a pension(only on the amount that is tax-privileged). Therefore, “carry back” and “carry forward” ofcontributions, facilities that currently exist primarily to allow the self-employed time tofinalise their financial affairs before calculating their maximum permissible contributions,will not feature in the simplified system.


Employers

Individuals

TE C H N I C A L D E TA I L S AA10 As now, certain types of income will not count as “earnings” under the simplifiedregime. For example, neither pension income nor investment income will count as earnings.

Annual a l lowance

A11 Individuals who have benefited from pension savings growth in excess of the£200,000 annual allowance will be taxed on the excess.

A12 In determining whether the £200,000 annual allowance has been exceeded, the valueof contributions and pensions growth will be the aggregate of:

• all contributions allocated to provide benefits for the member on a DC basis,whether made by or on behalf of the member or (re)allocated from assets orfunds already held within the scheme;

• all increases in the capital value of DB pension and lump sum rights, whetherthrough pensionable pay or any augmentation of accrued benefits, excludingdeath in service rights; and

• the capital value of increases to deferred DB pension and lump sum rightsabove RPI or, in the case of contracted-out rights, statutory revaluation,excluding death in service rights.

A13 For the purposes of testing against the annual allowance it will be possible to valuebenefits and aggregate contributions on the basis of a scheme year ending within the tax yearconcerned. There will be no requirement for schemes to align scheme years with tax years.

A14 Contributions and DB pensions growth within a registered pension may be ignoredfor the purposes of the annual allowance in any year in which the member wholly vests all thebenefits in that scheme. This applies regardless of the number of arrangements held by themember within that scheme.

A15 An individual’s contributions in excess of 100 per cent of earnings will not qualify fortax relief, so will not count towards the £200,000 allowance. NIC age-related rebates from theInland Revenue to contracted-out money purchase and appropriate personal pensionschemes will not count towards the annual allowance.

A16 Transfers of funds from one registered pension scheme to another will not counttowards the annual allowance. Transferred funds which have not benefited from UK relief thatare paid into a UK scheme from an overseas pension scheme that is recognised and regulatedas a pension scheme in the country where it is established will not count towards the annualallowance.

A17 The measure of the annual increase in capital value of pension savings in DB schemeswill be the deemed capital value of the increase in the member’s pension entitlement fromone scheme year to the next. A factor of 10:1 will be used to value such increases.

A18 Where a member of a DB scheme pays additional voluntary contributions (AVCs) tobuy added years of service these will not count as a contribution towards the annualallowance (to avoid double counting). However the increase in the member’s DB rights mustbe valued accordingly.

A19 Where AVCs are paid on a DC basis, these will count as a contribution towards theannual allowance.


TE C H N I C A L D E TA I L SA

A20 Where a scheme provides benefits on the basis of a promised level of pension fund atretirement, for example a cash balance scheme, the accrual will be determined as thedifference in the promised cash value, at the expected retirement date under the scheme,between the start and finish of the scheme’s year.

A21 In some circumstances the value of a member’s pension entitlement in a DB schememay actually fall from one year to the next, for example, where a member’s salary falls. Any fallof value in one year cannot be set off against changes in annual pension savings in another.Increases under one scheme cannot be reduced by decreases in another.

A22 Contributions on a DC basis will count towards the annual allowance regardless ofthe underlying performance of the fund.

Li fet ime a l lowance

A23 Funds will be tested against the lifetime allowance when:

• a benefit comes into payment from a fund or a part of a fund, e.g. taking apension at retirement;

• there is a discretionary increase to a pension in payment above that assumedby the factor used to value the benefit against the lifetime allowance;

• the rate of increase of a pension in payment changes to a rate greater than RPI(or, where a fixed rate of increase greater than RPI was assumed for valuationpurposes at vesting, greater than that rate). The value of such an increase willbe the amount by which the augmented pension is greater than the previousyear’s pension uprated by RPI (or the fixed rate originally assumed) andmultiplied by the 20:1 valuation factor for DB benefits;

• an authorised transfer is made to a non-registered pension scheme which isrecognised and regulated as a pension scheme in the country where it isestablished;

• a claim to corresponding relief or a claim to relief under the terms of a doubletaxation agreement ceases (this is explained in more detail at A121–A127); or

• the member reaches age 75 with unvested funds.


When willthe lifetime

allowanceapply?

Table A2: Annual value of pension savings in DB schemes example

At 5 April 2006 Julie has 10 years’ pensionable service in a scheme with a 60th accrual rate.Her pensionable salary in that tax year is £45,000.

Her pension entitlement is 10 x 1/60 x £45,000 = £7,500.

By 5 April 2007 Julie’s pensionable salary has risen to £50,000.

Her pension entitlement is now 11 x 1/60 x £50,000 = £9,167.

The increase in Julie’s pension rights is therefore £9,167 – £7,500 = £1,667.

The capital value of the increase is £16,670 (£1,667 x 10), which is within the £200,000annual allowance.

TE C H N I C A L D E TA I L S A

A24 The standard factor for determining the value, for tax purposes, of a defined benefitpension promise is £20 for every £1 of pension promised. This factor assumes that theaggregate of any survivors’ pension payable is no more than the member’s pension and thatthe member’s pension is indexed by RPI. Where a pension scheme allows commutation ofpension benefits in return for a lump sum, the dependants’ pension benefits must not exceedthe member’s gross pension before commutation. The scheme may decide whether tocommute the member’s pension, dependants’ pensions, or both. Schemes that increasepensions in payment by a fixed rate no greater than 5 per cent may use the same 20:1 factor.The factor should be applied to the net pension, after any lump sum commutation. The cashvalue of the lump sum should be added to the value of the net pension.

A25 A scheme that wishes to offer greater than RPI or fixed 5 per cent increases, or higherdependants’ pensions, can contact the Inland Revenue and agree a valuation factor to applyto benefits of that type. So, for example, a scheme that wished to offer benefits that increasedby twice RPI would agree a factor with the Inland Revenue and use that to determine the valueof pensions paid from that scheme.

A26 A scheme that wishes to pay an across the board discretionary augmentation to allmembers with pensions in payment may do so without further testing against the lifetimeallowance provided that:

• the augmentation applies equally to all pensioner members of the scheme;and

• there are at least 50 pensioner members.

A27 Where, at A-Day, an annuity or pension in payment has been restricted by pre A-DayInland Revenue limits, any surplus funds built up as a result of such a restriction may be usedto augment the benefits without being tested against the lifetime allowance provided thistakes place within the twelve months beginning at A-Day.

A28 Pensions already in payment at A-Day will be treated as having used up part of anindividual’s lifetime allowance where, after A-Day, the individual has a new benefit cominginto payment.


Administrativeeasement

Pensionsalready in

payment at A-Day

Standardfactor

Non-standard

valuations

Table A3: Operation of the lifetime allowance example

Peter decides to take his defined pension benefit of £15,000 per annum. The guaranteedrate of increase of Peter’s pension at vesting was RPI.

Using the conversion factor of 20:1, Peter’s pension provider values his pension at£300,000.

Some years later the pension provider decides to augment Peter’s pension.

Peter’s pension before the increase was £15,600.

The RPI escalation takes this to £15,823, but, the pension after the augmentation is£16,000 – an increase of £177. Using the Inland Revenue conversion factor of 20:1 this is acapital increase of £3,540. Therefore Peter has a vesting event with a value of £3,540.

TE C H N I C A L D E TA I L SAA29 The factor for valuing such pensions will be 25:1. This reflects the fact that people willgenerally have taken tax free lump sums. This factor should be applied to the annual level ofthe pension at the time of the valuation. So, where post A-Day, an individual with a pre A-Day pension of £20,000, was vesting a further benefit, the pre A-Day pension would bevalued at £500,000 and therefore only £900,000 of the lifetime allowance would be availablefor post A-Day vestings.

A30 Where pension income is being drawn from a pension fund under an incomewithdrawal arrangement (also known as income drawdown), the annual level of the pensionin payment is deemed to be the maximum permitted annual income determined at the mostrecent valuation (review) of the member’s fund. Income withdrawal may continue after A-Dayand will become subject to the new requirements for the payment of unsecured income(A51–A53 refers). The changeover to the unsecured income basis may be deferred until thedate of the next valuation (review) due after A-Day.

A31 Contributions by non-residents that have not received UK tax relief do not need to betested against the lifetime allowance.

The recovery chargeA32 The recovery charge will be assessable on the member. Registered pension schemeswill be required to withhold benefits to cover the charge. Any amount of withholding taxaccounted for by the scheme may be set against the individual’s liability.

A33 A person may disregard any dependant’s pension that he or she is receiving whendetermining the amount of unused lifetime allowance available.


Table A4: How does grossing up work?

In several places, this annex discusses grossing up. Put simply, grossing up is the paymentof the extra tax that arises when an employer or pension scheme pays the tax bill of anemployee. In its basic form the employer says to an employee liable to higher rate tax thathe is going to give him £60 net of all taxes. In order to do this the employer has to pay £40in tax. This is derived by multiplying the net amount by:

X/(1-X) where X is the marginal rate of tax applying to the payment.

This gives the tax payment needed to deliver the net benefit. This formula will work wherethe scheme decides to meet all the liabilities of the member on the original payment. Thescheme is not obliged to do this, and may only agree to meet some of the liability. In theexample, the scheme could agree to pay the higher-rate tax on the £60 and pay the InlandRevenue £24. The member would then be liable at higher rate on this £24.

TE C H N I C A L D E TA I L S AA34 Schemes will be free to decide how to meet the liability on them to withhold tax, forexample by reducing the member’s benefits or paying tax on a grossed up basis. The recoverycharge may be taken either from the pension or lump sum. Where the pension is reduced, thefactors applied must:

• be those used by the scheme to commute pensions to tax free lump sums;

• be equivalent for all members of the scheme; and

• be actuarially justified.

A35 If any of these conditions are breached any excess will be taxed .

A36 The recovery charge is intended to recover excess tax relief on amounts over the lifetime allowance. Once the charge has been applied the funds in the scheme no longer haveany special tax privileges and the Government sees no reason to prevent schemes fromallowing members to access those funds in a lump sum form if they wish to do so.


Taking amountsabove the

lifetimeallowance as

taxed lump sums

Table A5: Taking benefits above the lifetime allowance

Example 1:

Sarah decides to vest £1.12 million of her pension rights, using up 80 per cent of herlifetime allowance of £1.4 million. She takes a tax free lump sum of £280,000, using theremaining £840,000 to provide pension income. Her pension income is taxable at hermarginal rate.

When she comes to take the remainder of her pension benefits some years later these areworth £750,000 – 50 per cent of the then lifetime allowance of £1.5 million.

£300,000 of this (20 per cent of the lifetime allowance at the time of vesting, namely thelimit less the 80 per cent she has already used) must be taken as pension benefits.

Sarah therefore takes a tax free lump sum of £75,000 and uses £225,000 to secure apension. But Sarah must bear a recovery charge on the remaining £450,000, which is inexcess of her lifetime allowance. Sarah can choose how she takes the excess – all as lumpsum, all to provide a pension, or a mixture. She takes £200,000 of the £450,000 as a lumpsum. The scheme deducts 55 per cent recovery charge of £110,000, paying her £90,000net. Sarah has no more tax to pay on that lump sum.

Sarah uses the remaining £250,000 excess fund to provide a pension. The scheme deducts25 per cent withholding charge of £62,500, leaving a fund of £187,500, which will providepension income. Sarah must pay tax on her pension income at her marginal rate.

Example 2:

Fred takes £1.4 million of his pension rights in June 2005. In March 2006 he decides to takefurther benefits from a DB scheme. He could take his benefit as a pension of £20,000, butchooses instead to take all of the benefit in lump sum form. The scheme offers him a lumpsum of £300,000 in exchange for the £20,000 pension as it uses a commutation factor of15:1.

The DB scheme deducts 55 per cent from the lump sum (£165,000) paying Fred a net lumpsum of £135,000. Fred has no more to pay on the residual lump sum.

TE C H N I C A L D E TA I L SAA37 On vesting a pension, a scheme may allow a member to elect for any part of the fundsover the lifetime allowance to be paid as a taxed lump sum. This decision will be irrevocable andcan only be made at vesting. If a lump sum is taken in this way, the recovery charge will be 55per cent. This is equivalent to the 25 per cent recovery charge plus higher-rate income tax. Lumpsums paid in this way will not be taxed as income of the member.

A38 To operate the lifetime allowance, schemes must:

• within the 3 months preceding the vesting date (where known) a scheme willvalue the benefits and tell the member the percentage of the lifetimeallowance represented by the vesting benefits;

• the member must certify whether there is sufficient unused lifetime allowanceto cover this. If the vesting pension is the member’s only pension, the answerwill be yes (unless it is greater than the whole of the lifetime allowance on itsown). If the member has previously taken benefits, he or she will only need toinform the scheme of the percentage of the lifetime allowance already used bythe previous vestings if the unused percentage is less than that needed tocover the benefits being vested;

• if more than one pension is being vested simultaneously then the member willbe able to to choose which scheme should be deemed to vest benefits thatstraddle the lifetime allowance;

• for each of the other schemes the member need only declare that the benefitsare above or below the lifetime allowance as appropriate;

• the member will have to give the pension scheme proof of any increasedlifetime allowance due to A-Day protection – see Annex C;

• where a member’s fund exceeds any unused lifetime allowance, the schememay allow the member to take the excess as a lump sum, once he or she hasprovided evidence of this to the scheme. The scheme must apply the higherrate of recovery charge due of 55 per cent and pay this over to the InlandRevenue;

• any excess funds remaining once the member has exercised his or her optionto commute are then subject to the recovery charge of 25 per cent;

• if no declaration as to the value of benefits previously vested or about to vestsimultaneously is provided by the member, the scheme must assume that thelifetime allowance has been exhausted and must pay an amount equal to therecovery charge due on the full value of the benefit. Such benefits must onlybe paid in pension form;

• where benefits are paid in pension or income form the scheme must annuallyprovide the member with an indication of the cumulative percentage of thelifetime allowance used by this and any previous vestings from that scheme(rounded down to two decimal places). Where the pension is taxable underPAYE the annual P60 (substitute) might be a suitable opportunity for this; and

• where a benefit is paid wholly as a lump sum and there are no pensionbenefits in payment from that scheme, it needs only provide this informationonce.


Recovery charge:the process on

vesting apension

TE C H N I C A L D E TA I L S AA39 The member will have to declare the recovery charge due, with appropriate credit forthe withholding tax paid by the scheme, on his or her SA return. If excess withholding tax onthe recovery charge is deducted by the scheme this will be repayable to the member.

The benef i t in k ind charge

A40 Where a member or an associate has use of a scheme asset on a non-commercialbasis, there will be a tax charge in respect of this. The amount of tax to be charged willgenerally be quantified in the same way that benefits in kind are taxed on employees.Examples would be members living rent free in property owned by the scheme or where apainting owned by the scheme was kept in a member’s home. There will be additional rulesfor certain wasting assets.

Transfers between schemes

A41 A pension scheme benefits from UK tax relief to encourage the provision of aretirement income for life or, in the event of the member’s death, to make provision for themember’s dependants. It is important that rules covering transfers do not undermine thispolicy.

A42 A registered pension scheme may:

• transfer benefits to another registered pension scheme without restrictionand without testing against the lifetime allowance; and

• transfer benefits to a pension scheme which is recognised or regulated as apension scheme in the country where it is established. Such a transfer will betreated as a vesting event.

A43 A transfer to a scheme that is not recognised or regulated as a pension scheme in thecountry where it is established will be treated as an unauthorised payment, see A105 below. Ifa scheme makes a transfer in good faith based on false or incorrect information provided toit by the member seeking the transfer, then the unauthorised payment charge will not applyto the scheme.

A44 Registered pension schemes may accept transfers of funds from other registeredpension schemes. Any transfer between schemes must be made directly from scheme toscheme. Where the receiving scheme involves an insurance company or other third partypension administrator, the ceding scheme must make the transfer payment directly to theinsurance company or administrator.


Table A6: Operation of lifetime allowance further examples

Example 1:

Matt has used up 75 per cent of his lifetime allowance. He decides to take further pensionrights, worth 50 per cent of his lifetime allowance. Matt must tell the scheme that he hasalready used 75 per cent of his lifetime allowance. The scheme will calculate the recoverycharge on funds above the lifetime allowance and make an appropriate deduction.

Example 2:

Marc has used up 25 per cent of his lifetime allowance. He also decides to take furtherpension rights, worth 50 per cent of his lifetime allowance. Marc only needs to tell thescheme that he has sufficient unused lifetime allowance to cover the benefits.

Transfersfrom

a registeredscheme

Transfersinto a

registeredscheme

TE C H N I C A L D E TA I L SAA45 Any transfer from a registered pension scheme or from an overseas schemerecognised and regulated as a pension scheme in its country of establishment will not betreated as a contribution and will not count towards the annual allowance of the year in whichthe transfer is made. In addition, transfers from an overseas scheme, which is regulated andrecognised as a pension scheme in its country of establishment but which is not a registeredscheme will not count towards the lifetime allowance. This exemption is conditional on thetransfer not containing funds that have benefited from UK tax relief.

A46 Sums received from schemes that are not recognised as pension schemes in thecountry where they are established, including non-registered UK schemes, will be treated ascontributions. Such transfers in will count towards a member’s annual allowance. Anybenefits ultimately derived from those funds transferred in will count against the member’slifetime allowance.

A47 For these purposes a section 615 scheme will be counted as a registered pension scheme.

When and how pens ions must be pa id and taxedA48 All pensions from registered pension schemes will need to be paid at least annuallyand, where appropriate, PAYE must be operated. PAYE will not need to be operated forpayments from RACs. The underlying basis of assessment will be on the amount accruing(again there will be an exception for the payment of benefits from RACs). This is to align thebasis of assessment of pensions paid by registered schemes, and is a direct response torepresentations received.

A49 Generally, pensions must not be assignable nor be capable of surrender. There will beexceptions to this. For example:

• under a pension sharing order;

• where secured pensions are guaranteed to continue after the death of themember for a fixed period, when the ongoing instalments may be assigned tothe beneficiaries of the member’s estate; or

• on allocation to dependants.

Types o f pens ion benef i tA50 All pension benefits must provide an income for the life of the member. However, themeans by which this can occur may vary. Such pensions may be:

• Secured: promised by a pension scheme and backed by a sponsoringemployer, or guaranteed by the purchase of an annuity from a financialinstitution;

• Alternatively secured: where limits on income and annual reviews stop thefunds being depleted too rapidly; or

• Unsecured: where, up to age 75, rules allowing return of capital permit fundsto be invested in a range of assets, designed to deliver growth rather thansecurity.

A51 There is no compulsion to take any benefits until the day before the member’s 75thbirthday, by which time they must be secured for life. The Government recognises that thevast majority of people will need to draw income before age 75. To allow maximum flexibilityover when and how benefits are finally secured, benefits may be taken in unsecured form atany age from the minimum pension age up to the end of the day before the member attainsage 75.


Before age75:

unsecuredincome

TE C H N I C A L D E TA I L S AA52 The simplified rules from A-Day for unsecured income before age 75 are:

• annual pension income must be within minimum and maximum limits;

• subject to any greater DWP requirements, the minimum income in any year is£1;

• the maximum income in any year is 120 per cent of the annual income whichwould be paid if the funds standing to the member’s credit were used to buy aflat-rate single-life annuity on the open market, as evidenced by the FSA’scomparative tables, up to 3 months before the pension date (or up to 3months before the imminent review date); and

• the maximum pension must be reviewed at intervals of no more than 5 years.

A53 An alternative way of drawing unsecured income before age 75 may be using part ofthe fund to purchase a term-certain annuity or a series of such annuities. When assessing themaximum income to be taken under unsecured income, the income from such term-certainannuities must be taken into account. A term-certain annuity must not exceed 5 years’duration, cannot be commuted for a lump sum at any time, and must end no later than theend of the day before the member’s 75th birthday.


Table A7: Unsecured income example

Ashok, after taking his tax free lump sum on 6th April 2007 at age 60 has a pension fundvalued at £350,000 from which he intends to take unsecured income. For that sum ofmoney on the open market he could have purchased a single-life flat-rate annuity of£22,000 a year. Ashok must take a minimum £1 a year but no more than £26,400 a year(120 per cent of £22,000) until 5th April 2012.

Ashok varies the income he takes each year within these limits, and at 5th April 2012 theremaining fund is valued at £400,000. Ashok is now 65, and the fund would purchase asingle-life flat-rate annuity of £28,000 a year for him on the open market. Until the incomeis next reviewed (no later than 5th April 2017) Ashok may take income from the unsecuredfund of between £1 a year and £33,600 a year (120 per cent of £28,000).

Table A8: Use of limited period or term-certain annuities example

In the example in Table A7, if Ashok had decided in April 2007 to use, say, £45,000 of the£350,000 fund to buy a 5 year limited period annuity of £10,000 a year, the maximumunsecured income he can take in those first 5 years is £16,400 a year (the increased openmarket annuity value of £26,400 less the £10,000 income from the limited period annuity).If in April 2012 Ashok buys a £11,000 per annum 5 year limited period annuity the amountof unsecured income he can draw from the remaining fund when it is reviewed in 2017, issimilarly a maximum of £22,600 per annum (the increased open market annuity value of£33,600 less the £11,000 from the limited period annuity).

TE C H N I C A L D E TA I L SAA54 Tax relief on pension contributions is provided so that people can save for a pensionincome. It is a requirement that before age 75 income must be secured for life. Therefore nocapital sums may be paid on death on or after the member’s 75th birthday (see paragraphA58). Seventy-five is also the age before which an annuity needs to be bought to ensure thatthe influence of mortality drag is not too great. This issue was discussed in the Government’sconsultation document Modernising annuities1, published last year.

A55 Schemes will either have to provide benefits with an obligation to pay an income forlife within the general benefit rules or, if the member so chooses and the scheme so desires,may pay secured benefits in accordance with slightly different ASI rules where strict limits onincome and annual reviews prevent over-depletion of the funds.

A56 For ASI:

• annual pension income must be within £1, or any greater DWP requiredminimum, and the maximum income limits;

• the maximum income in all cases is 70 per cent of the annual amount whichwould be payable if the funds standing to the member’s credit were used tobuy a flat-rate single-life annuity on the open market for a person aged 75 (orthe age from which it is decided the pension will be secured, if earlier), asevidenced by the FSA’s comparative tables;

• the maximum income should be determined at least annually on the abovebasis using the value of the funds up to 60 days before the review date;

• the member for whom the income is secured may choose income levelsbetween the prescribed minimum and maximum. If desired, the choice maybe exercised annually. Given that there can be no return of unused funds ondeath, opting for minimum income could increase the member's ownpension when the maximum is next calculated, or boost dependants’pensions;

• the pension scheme must at all times remain responsible for ASI, and allincome payments to the member must be paid via the scheme whether or notthe administration and investment of the funds underlying the ASI have beenplaced with a financial institution; and

• if at any point the scheme is to be wound up, the ASI funds standing to themember’s credit must first be used to purchase an annuity.

A57 If the member so chooses, the funds may be used to provide a pension or to purchasean annuity at any time.


Alternativelysecured income

From age75: secured

income

1 Published jointly by Inland Revenue and DWP 5th February 2002.

TE C H N I C A L D E TA I L S ADeath benef i ts

A58 A scheme may pay death benefits where a member dies with unvested benefits.

A59 There are no restrictions on the value of the death benefit that a scheme may payfrom unvested benefits. The death benefit must be in the form of:

• a lump sum;

• a pension to one or more dependants; or

• a combination of lump sum and pension.

A60 The lump sum may be paid, at the administrators’ discretion, to dependants or to themember’s legal personal representative. Where benefits are paid to someone other than thelegal personal representative, the scheme must inform the legal personal representative of theamount of the lifetime allowance used up by the payment of the death benefit lump sum.

A61 Death benefit lump sums count as part of the member’s lifetime allowance, and thesepayments may give rise to a tax liability under the recovery charge; the charge in these caseswill be 55 per cent. The payment is made gross with the member’s legal personalrepresentatives responsible for paying the recovery charge. The value of any dependants’pension(s) put into payment does not count towards the member’s lifetime allowance.Paragraphs A71–A76 set out the terms for dependants’ pensions.

A62 If a member dies before age 75, the flexibility of the new rules means that a membermay have vested some funds, or parts of funds, while other funds or parts of funds remainunvested. Those funds, or parts of funds which have vested, may even be providing acombination of secured and unsecured income.

A63 The following rules will apply for death benefits before age 75 from any fund or partof a fund that has vested and is earmarked to provide unsecured income for the member:

• dependants’ pensions (which may be taken as unsecured income, subject tothe rules outlined at paragraph A51, until the day before the dependantreaches age 75, and then subject to the rules for members’ secured pensions –paragraph A54 above); or

• any undrawn funds can be repaid.

A64 Any resulting lump sum payment will be taxed, as now, at 35 per cent.

A65 The following death benefits may be paid from a vested fund or part of a fund that isproviding secured income for the member:

• the maximum amount payable as income may be guaranteed to continue forup to 10 annual payments from the date that benefits first vested (the benefitcommencement date). If income is secured, by annuity purchase orotherwise, more than 10 years after the benefit commencement date, noincome guarantee may be provided;


Before vesting

From a fundproviding

unsecuredincome

From a fundproviding

securedincome

After vesting

TE C H N I C A L D E TA I L SA• dependants’ pensions may be taken as unsecured income, subject to the rules

outlined at paragraph A51 until the day before the dependant reaches age 75and then subject to the rules for members’ secured pensions – paragraph A54above; or

• value protection, the return of the capital used to purchase the pensionannuity or the amount of fund which secured the income to be drawn, lessincome payments made before death. (This differs from the return of funds ondeath while in receipt of unsecured income because once income is secured,any rights to accretions to the underlying fund are relinquished in exchangefor the promise of income for life). Value protection lump sums will bepermissible only on death before age 75.

A66 Where a dependant would benefit from both a dependant’s pension and theremaining payments under a pension guarantee, the recipient may choose to defer thepayment of the dependant’s pension until the payments under the guarantee finish.

A67 After payment of the tax free lump sum, tax-privileged pension savings must, by age75, be used to provide only retirement income. From that age any funds remaining on death(i.e. which are not used for dependants’ pensions) must not be returnable, directly orindirectly.

A68 Any lump sums paid on death before age 75 by way of value protection will be taxedat 35 per cent.

A69 Income guarantee and value protection are mutually exclusive. They are essentiallyways of ensuring the same thing – a reasonable return from the underlying funds in the eventof early death.

A70 Where a lifetime pension or annuity has not been purchased for the member, i.e.where ASI is provided, any funds remaining on death on or after age 75 must revert to thescheme and must be used to provide dependants’ pensions. Where there are no dependants,the scheme may use the funds either:

• to provide or augment the benefits of any remaining members of the scheme;

• contribute towards a surplus in the scheme; or

• possibly to pay them to a registered charity nominated by the member beforehis or her death. The Government is considering whether this could be anoption and invites views on whether such an option would be welcome and ifso what safeguards might be necessary.

A71 Dependants’ pensions may be paid to spouses and minor children of the memberwithout qualification, and to anyone else who, in the opinion of the pension scheme trusteesor administrators, was dependent on the member, up to the time of death. Dependence mayinclude financial dependence, including some degree of financial interdependence with thescheme member, or dependence by reason of disability.

A72 Dependants’ benefits for spouses may continue for life or may cease on re-marriage.

A73 Dependants’ benefits paid to a child of the member must cease when the recipientreaches age 23 unless he or she was dependent on the member by reason of disability.

A74 Where dependants’ benefits are paid to an adult who was dependent on the member,other than someone whose dependency arose solely from being in full-time education, thebenefits are payable for life in the same way as a spouse’s pension may be.


General rulesfor dependants’

pensions

TE C H N I C A L D E TA I L S AA75 Dependants’ own right pension income need not be limited so as not to exceed theamount of the pension income paid to the member before death, but must carry no incomeguarantee payable after the dependant’s death nor be value protected.

A76 Subject to the above, dependants’ pensions must not be capable of surrender orassignment (other than under a pension sharing order); nor may they be commuted for alump sum except on grounds of triviality.

Tr iv ia l commutat ion

A77 Simplifying the taxation of pensions: increasing choice and flexibility for all proposedthat the limit for trivial commutation should be raised to the equivalent of a fund of £10,000from all sources but commutation would be permitted on one occasion only and not beforeage 65. It also proposed that 75 per cent of the amount commuted would be taxed as income.The first 25 per cent of the payment could be taken as a tax free lump sum if the payment isunder the lifetime allowance.

A78 In response to comments received this proposal has been refined to allow low valuepension rights and pensions in payment to be fully commuted.

A79 The Government proposes to allow members to commute voluntarily small pensionsprovided that:

• such commutations occur during a single period of 12 months, selected by themember, starting no earlier than the member’s 60th birthday and ending nolater than the end of the day before his or her 75th birthday;

• commutation must extinguish all pension rights or payments due to themember from the scheme or the annuity. If a scheme has a number ofarrangements or tranches, all the benefits from all such arrangements ortranches must be extinguished by the trivial commutation;

• no further voluntary commutation of benefits on triviality grounds outsidethe chosen twelve month period will be permitted; and

• the member may take the entire scheme benefit as a lump sum from anynumber of schemes or annuity contracts up to an aggregate of 1 per cent ofthe lifetime allowance (the total amount commuted to date must not exceed 1per cent of the lifetime allowance applicable at the date of the latestcommutation).

A80 For this purpose:

• it does not matter whether the member’s total benefits across all pensionschemes amount to more than 1 per cent of the lifetime allowance, providedthat he or she commutes no more than 1 per cent on triviality grounds; and

• any tax free lump sums in respect of non-trivial benefits that the member mayalready have taken or plans to take during the year will not count towards the1 per cent limit.


Full commutationof trivial benefits

Members right to commute

voluntarily trivialpensions


A81 The resultant payment from such a trivial commutation will count towards themember’s lifetime allowance. Schemes must therefore check before making a commutationpayment from unvested benefits whether any recovery charge is due on that payment. Wherepart or all of the commutation payment is in excess of the member’s lifetime allowance, thatpart of the payment will be subject to a recovery charge at 55 per cent on the excess. Themember will need to account for the commutation payment on their personal tax returns.The percentage of the lifetime allowance used up in any commutation of trivial benefits mustbe included in the percentage of used lifetime allowance certified by the member at anysubsequent vesting.

A82 Members voluntarily taking trivial commutations will be required to declare to thescheme that the commutation is within Inland Revenue limits. The prescribed declarationform will include a clear explanation of those limits.

A83 All trivial commutations of benefits in payment must be taxed in full as income of therecipient.

A84 Members negligently or fraudulently obtaining trivial commutation payments inexcess of Inland Revenue limits may be liable to a penalty of up to £3,000.

A85 Schemes that are winding up will be able to commute members’ trivial benefits. Thiswill be on condition that:

• the employer does not intend to pay contributions for the member under anyother registered scheme; and

• the member’s benefits under the scheme in question are valued at no morethan 1 per cent of the lifetime allowance in force during that tax year.

A86 If a scheme opts to commute trivial benefits on wind up, this will not affect amember’s entitlement to commute trivial benefits voluntarily, nor will it count towards themember’s 1 per cent limit for such commutations, or towards the member’s lifetimeallowance.


Table A9: Trivial commutation example

Jessica has already vested benefits valued at 25 per cent of the lifetime allowance and hasnot yet commuted any benefits on the grounds of triviality. She is entitled to a smalldeferred pension under a defined benefit scheme which is due to come into payment onher 65th birthday on 1st June 2005 and which will, if commuted, provide a lump sum of£7,000. In that year the lifetime allowance is £1.4 million so 1 per cent of the lifetimeallowance is £14,000. As £7,000 is less than 1 per cent of the lifetime allowance in that taxyear, Jessica can elect to commute her defined benefit pension on her 65th birthday andthe commutation payment will have used up 0.5 per cent of her lifetime allowance.

Jessica also has an unvested defined contribution fund valued at £6,000. Provided that shetakes these benefits before 31st May 2006 and, at the date of vesting, the funds have notincreased to more than the remaining 0.5 per cent of the lifetime allowance which isavailable for trivial commutation, Jessica can elect to take the whole of the small definedcontribution fund as a cash sum.

As Jessica’s previous vestings have only used up 25 per cent of her lifetime allowance andthe trivial commutations amount to less than 1 per cent of the lifetime allowance, neitherof the trivial commutation payments will result in a recovery charge.

Non-voluntarycommutation

paymentsresulting from

scheme wind ups

TE C H N I C A L D E TA I L S AA87 For the purpose of testing a trivial commutation against the 1 per cent limit forcommutations, the value of a commuted defined benefit right is the actual amount realisedby the commutation.

A88 All amounts commuted on the grounds of triviality will be taxed as income. Ifunvested benefits are so commuted, 25 per cent of these may be paid tax free.

A89 Where the main purpose of the winding up of a scheme is to create trivialcommutation payments for one or more members, the £3,000 penalty for false trivialcommutation applications will apply to each member receiving a commutation payment.

A90 Schemes will be required to report commutation payments on wind up to the InlandRevenue.

A91 Where a member dies before taking benefits from a fund or a part of a fund, thescheme may provide death benefits. A dependant’s pension may thus be commuted for alump sum, but in such circumstances it would count towards the deceased member’s lifetimeallowance. However, where the benefits include contracted-out rights, contracted-outdependant’s pensions may be commuted only on the grounds of triviality, i.e. the value of thepension under the scheme must not be greater than 1 per cent of the lifetime allowance inforce at the date of the member’s death.

A92 Where the member’s death occurs after the benefits from a scheme or from a part ofa scheme have vested, the scheme may have made provision for a dependant’s pension.Following the death of the member, the Inland Revenue has no objection to the schemeoffering the prospective recipient the opportunity to commute the benefit for a lump sum,providing the commutation occurs before the date that the member would have attained age75, had the member survived. However, where there is a contracted-out dependant’s pension,commutation is permissible only on the grounds of triviality, i.e. the value of the pensionunder the scheme must not be greater than 1 per cent of the lifetime allowance in force at thedate of the member’s death. A scheme that is winding up may require trivial dependants’pensions to be commuted on triviality grounds regardless of the age the member would haveattained had he been alive at the date of commutation. Where a dependant’s pension iscommuted as a result of the member’s death before the member had vested the benefit, thecommutation payment will be tax free. Where the dependant’s pension is commuted on themember’s death after the member has taken benefits from the fund, or that part of the fund,the resultant payment will be taxed at 35 per cent.

A93 Where the member elects to commute pension rights on the grounds of triviality thescheme will be required to notify the member of the percentage of the lifetime allowancewhich has been used at that vesting.

A94 Schemes, except those commuting pensions payable under RACs, will apply PAYE tothe taxable element of any commutation payment.

I l l hea l thA95 Currently, occupational pension schemes may commute undrawn benefits to a lumpsum if the member is terminally ill. This facility is not available to members of personalpensions or retirement annuity contracts. The simplified regime will allow all schemes tooffer this option.

A96 The Government proposes that the facility may be offered if the member’sexpectation of life is shorter than one year. The scheme administrator must obtain a writtenopinion from a registered medical practitioner confirming the member’s reduced lifeexpectancy. Schemes will be required to make this medical evidence available for inspectionby the Inland Revenue and all serious ill-health commutations will be reportable events.


Commutation ofdependants’

pensionsfollowing the

member’s death

Serious ill-healthcommutation

TE C H N I C A L D E TA I L SAA97 Serious ill-health commutation will be treated as a vesting event for the purposes ofthe lifetime allowance. Failure to obtain prior medical evidence will lead to the benefits beingtreated as unauthorised payments. However, once tested against the lifetime allowance, therewill be no income tax liability on serious ill-health benefits.

A98 Benefits may commence before minimum pension age due to the member’sincapacity. Schemes must first obtain a written opinion from a registered medicalpractitioner that the member is incapable of continuing his or her current occupation due tophysical or mental sickness or disease, injury or disability. The member must cease theoccupation to which the benefits relate before vesting them.

A99 The scheme administrator must retain the medical evidence for possible inspectionby the Inland Revenue, and failure to obtain such evidence prior to payment of benefits willlead to those benefits being treated as unauthorised payments.

A100 Early retirement on these grounds may also apply to people who have already left theoccupation in question, subject to the same medical evidence requirements.

A101 If someone receiving an incapacity pension recovers sufficiently and returns to his orher former occupation, schemes may, if they wish, stop the payment of the incapacitypension until such time as the member attains minimum pension age under the terms of thescheme or contract.

Other tax charges

A102 DWP legislation permits occupational pension schemes to make a full refund of anemployee’s contributions when the employee leaves the pensioned employment beforecompleting two years’ qualifying service.

A103 Currently where such a refund is made, the scheme pays a tax charge of 20 per cent ofthe amount refunded and may deduct that charge from the amount refunded to the member.The member is not taxed on the refund, and cannot claim repayment of the tax deducted. Inthe new regime this charge will continue along these lines. The charge will be tiered. The first£10,800 of any refund will be taxed, as now, at 20 per cent. Any part of the refund in excess ofthat sum will be taxed at 40 per cent. As now the refunding scheme will be permitted todeduct the tax from the gross refund payable to the member. The member will not be taxedon the refund nor be able to claim any repayment of the tax so deducted.

A104 The tax treatment for inheritance tax purposes of any death benefits paid by aregistered pension scheme will, as now, depend on the form in which they are paid. If paiddirectly to the deceased’s estate as a right, they will be liable to IHT. However, if paid on adiscretionary basis by the trustees or administrator, they will not normally be assessableagainst IHT.

A105 There will be a charge on the member at his or her marginal rate, or on the employer,on any unauthorised payments made by the scheme. The scheme deducts this charge underPAYE where payment is made to a member. In addition, the scheme will be liable for a 40 percent charge on the amount of the payment, although it may claim a credit for tax paid by themember up to a maximum of 25 per cent. This credit will only be available if the scheme haspaid any PAYE liability on the payment. Further details on the charge on the scheme are setout in Annex B. In addition, if an unauthorised payment received by a member is greater than25 per cent of his or her fund (25 per cent of the whole fund if the payment is from a trust-based occupational scheme) there may be a further penalty of up to 15 per cent.


Short servicerefunds

Inheritance tax

Unauthorisedpayments

Early retirementdue to incapacity

TE C H N I C A L D E TA I L S A

A106 The new legislation will set out what payments a scheme may make. Payments withinthe rules will be authorised payments. Any other payment will be an unauthorised paymentand subject to the unauthorised payment charge.

A107 To prevent any double taxation on the member or the employer the unauthorisedpayment charge will take precedence over any other tax charge arising on them in respect ofthe same payment.


Table A10: Unauthorised payment example

Sinita, aged 35, is paid £10,000 from her scheme for an asset worth £5,000. There is anunauthorised payment of £5,000.

Sinita is liable on the £5,000 at her marginal rate of 40 per cent and pays tax of £2,000,less the basic-rate tax that the scheme should have deducted under PAYE. There is also acharge on the scheme of £5,000 at a rate of 40 per cent. The scheme will get credit for taxpaid by the member of up to 25 per cent. The tax due to be paid by the scheme is £2,000on which it can claim a credit for tax paid by Sinita of £1250 and therefore pays £750.

Table A11: Authorised payment examples

The following are authorised payments:

• any payment of benefits allowed by the new regime;

• any payment made on open market, commercial terms for the use or purchase ofassets, goods and services and loans unless it is specifically deemed to be anunauthorised payment by the investment rules. For example, where the schemeuses the services of the employer’s administration staff and pays the employer forthe services at more than a commercial rate then that would be an unauthorisedpayment;

• “authorised transfer transactions”, which are:

– transfers to a registered scheme; or

– transfers which are treated as a vesting event by the exporting scheme;

• any payment which is expenditure properly incurred in respect of theadministration of the scheme;

• any payment the scheme administrator is obliged to make to the employer tomake good a loss to the employer by a member’s criminal, negligent or fraudulentactions which reduces the benefits payable to the member;

• the reimbursement of a payment to an employer of a state scheme premium towhich Section 55 of the Pension Schemes Act 1993 applies; and

• where the scheme chooses to do so, refunds of net personal contributions in excessof 100 per cent of earnings, or the greater of 100 per cent of earnings and £3,600in a RAS scheme.

Authorisedpayments

TE C H N I C A L D E TA I L SAA108 There will be a single set of investment rules underpinning the simplified regime.They will be simple, flexible and impose as few restrictions as are compatible with prudentstandards. They will, of course, be subject to any DWP requirements. For all schemes, fromA-Day:

• there will be a limit for holding shares in the sponsoring employer andassociated/connected companies of 5 per cent of fund value;

• loans to members will not be allowed;

• loans to employers, other than in the form of bonds issued on the open marketmust:

– be secured as a first charge on assets that are and will remain of at leastequal value to the face value of the loan;

– have an interest rate at least equal to the Corporation Tax SelfAssessment rate (currently base rate plus 1 per cent) up to the normaldue date ;

– not last for more than 5 years;

– not be more than 50 per cent of the value of the fund at the date the loanis taken out; and

– be repaid either by equal annual instalments of capital or by equalannual instalments;

• scheme borrowing will be limited to 50 per cent of scheme assets at the datethe loan is taken out.

A109 In order to help employers who are experiencing financial difficulties towards the endof a loan period that prevent the loan from being repaid, there will be a facility to allowschemes a single opportunity to roll over each loan. The maximum extension period allowedwill be three years. Any other change in the terms of a loan will be treated as if a new loan hadbeen taken out.

A110 Any debts between the scheme and employer or member must be repaid oncommercial terms. Any proportion that is not so paid will be treated as an unauthorisedpayment. It will become chargeable in the tax year that a similar debt from a third party wouldhave been collected.

A111 The simplified regime will include rules to discourage schemes from “investing” infinancial instruments that are designed to remove value from tax-privileged funds. These ruleswill:

• provide that all investments must be acquired, disposed of or leased oncommercial terms;

• prevent the use of investments and changes to investments that allow forvalue to be taken out of scheme assets;

• prevent the use of annuities which provide that certain payments can bemade directly or indirectly on the death of members (e.g. payments made byan item sold as a package with the annuity which allow for the balance fundsto be repaid on death); and

• provide that all loans to 3rd parties must be on normal commercial terms.


Rolling overloans

Debts

Value strippinginvestments

Schemeinvestments

TE C H N I C A L D E TA I L S AA112 Where any of the rules are breached, the non commercial part of the investment willbe deemed to be an unauthorised payment. The scheme will be subject to a 40 per centcharge on the amount of any unauthorised payment. In addition, any payments made to themember or employer will be charged on them at their marginal rate. Whether schemes caninvest in connected party transactions will be revisited if there is evidence of abuse post A-Day.

A113 It will no longer be an Inland Revenue requirement to have a pensioner trustee, andtax reliefs will not be conditional on appointment or continued presence of such a trustee.However, DWP rules may require certain schemes to retain independent trustees.

A114 As now, schemes will be taxable on any trading income. This will need to be returnedunder Self Assessment.

A115 Where a scheme winds up, the new tax rules will require that benefits continue to beprovided within the general benefit rules by:

• an authorised transfer to another registered pension scheme; or

• the issue to the member of a contract under a registered pension scheme.

Any surplus funds repaid to an employer will be taxed on the scheme at 35 per cent.

A116 The scheme may also be able to offer to the member the option of:

• trivial commutation within the new limits; or

• subject to DWP requirements, a refund of employee contributions in the eventthat the member has less than two years’ pensionable (qualifying) service atthe date that the scheme winds up.

A117 If a scheme is not wound up in accordance with Inland Revenue and DWPrequirements, any payments may be treated as unauthorised payments or, in some cases,schemes may be liable to the de-registration tax charge (broadly, the scheme is liable to a taxcharge of 40 per cent on the value of its assets. This is explained in more detail at Annex B).Where the de-registration charge applies, any payments to members will be treated asunauthorised payments and will be chargeable at the member’s marginal rate.

A118 All existing Inland Revenue requirements for schemes of all kinds to carry out fundingreviews and reduce surpluses will cease to apply from 6 April 2005. Information for periodsbefore A-Day will still need to be provided even where the filing date falls after A-Day.

A119 Because benefits will be unlimited, the concept of surplus falls away almost entirelyin DC schemes. However for DB schemes a surplus of assets in relation to the benefits that thescheme itself promises to pay its members could arise. DWP rules will be relied on todetermine when a surplus arises in a DB scheme. Legislation will set out when a surpluspayment can be made from a DC scheme.

A120 When a surplus payment is made to an employer, the scheme trustees will berequired to deduct a tax charge of 35 per cent.


Winding up

Surpluses

TE C H N I C A L D E TA I L SAOther routes to re l ie f

A121 Currently, corresponding relief allows individuals who come to work in the UK to getrelief for contributions to their overseas pension scheme. This applies where a member of anoverseas scheme who is not domiciled in the UK is employed in the UK by an overseasemployer. The scheme must correspond to a UK scheme by providing relevant benefits andbeing established either in a country where the employee was working or residentimmediately before coming to the UK, or in a country where the employer has an operatingpresence.

A122 After A-Day, migrants who come to the UK will be able to claim relief under thesimplified regime provided they agree that in return for accepting the relief, they will beresponsible for payment of any recovery charge. The claimant will be asked to provideconfirmation from the scheme that the Inland Revenue will be notified when the benefits vestfrom the scheme. Alternatively, there will be an option to pay any recovery charge at the timewhen UK relief finally ends. All such contributions will count towards the annual allowance.

A123 To preserve rights that accrued before A-Day, any corresponding relief receivedbefore A-Day will not count towards the calculation of the recovery charge.

A124 Migrant treatment will be afforded to an individual who:

• was not UK resident at the time they joined an overseas occupational pensionscheme that is either registered as a pension scheme within the EuropeanEconomic Area, or, if not so registered, is treated as a corresponding schemeunder tests similar to those that currently apply to corresponding relief;

• then comes to UK as an existing member of that scheme; and

• wishes to claim UK relief against UK chargeable earnings on contributionspaid to that scheme.

A125 The UK currently has several treaties with other countries under which relief is givenon contributions paid to schemes established in the other country.

A126 After A-Day, relief will be granted to qualifying claimants under these treaties subjectto the same conditions regarding the amount of relief as those that apply to members ofregistered pension schemes. The claimant will be asked to provide confirmation from thescheme that the Inland Revenue will be notified when the benefits vest from the scheme.Alternatively, there will be an option to pay any recovery charge at the time when UK relieffinally ends. Contributions will count towards the annual allowance.

A127 As with corresponding relief, any relief received under these treaties prior to A-Daywill not count towards any recovery charge.

A128 These schemes are not UK approved pension schemes, although they do have to beestablished for the sole purpose of providing superannuation benefits. They are establishedunder irrevocable trust for non-resident employees by employers whose business isundertaken wholly or in part outside the UK. Benefits can be taken on retirement or leavingservice at any age and wholly as a lump sum. Benefits paid from these schemes are not liableto UK tax when paid to non-UK residents and, by concession, lump sums paid to UK residentsare not chargeable.


Relief underdouble taxation

treaties

Section 615schemes

Migrants andcorresponding

relief

TE C H N I C A L D E TA I L S AA129 With the extension of the eligibility rules, members of such schemes could now bemembers of a UK registered pension scheme. The scheme would be eligible for fullinvestment relief. From the scheme member’s point of view, while the annual and lifetimeallowances would apply, and the tax free lump sum would be restricted to 25 per cent, theamount of pension payable would be unrestricted.

A130 Members could transfer their funds to a UK registered pension scheme, with theamount being treated as a transfer from a recognised overseas scheme.

A131 Given that the new regime should accommodate s615 members, the Governmentbelieves that there is no continuing need for this type of scheme.

A132 However, as this type of scheme meets a specialised need, comments are invited fromemployers on any continuing need for such schemes.

Misce l laneous i ssues

A133 The first consultation document proposed bringing all RACs within the simplifiedregime. This would mean PAYE would need to be operated on the payment of RACs and taxrelief on contributions would be delivered via RAS, the system used by personal pensions,rather than the current system of contributions being made gross to the provider and theindividual claiming relief through his or her SA return or via a repayment claim.

A134 The responses to the consultation were:

• applying PAYE to existing RACs in payment would be problematic and RACproviders would prefer therefore if the introduction of PAYE on existing RACscould be delayed until, say, 2010; and

• putting RACs into the personal pension RAS scheme would significantlyincrease the implementation costs of simplification for the insuranceindustry.

A135 The Government is committed to making the changes but recognises the costs andproblems this would create for the insurance industry. The Government proposes that RACswill be within the simplified regime from A-Day for the purposes of the lifetime and annualallowances, subject to transitional protection. However, the proposals to change the basis oftaxing pensions from RACs will be delayed until at least 2006. Providers will be free to moveRACs into the RAS scheme at any time but there will be no compulsion for them to do so by acertain date.

A136 Some personal pensions and RACs offer what is known as “waiver of premium”insurance.

A137 The changes to introduce stakeholder pensions removed the facility to offer suchinsurance as part of the pension scheme because it was no longer a requirement to haveearnings in order to make pension contributions.


Waiver ofpremium

Retirementannuity contracts

TE C H N I C A L D E TA I L SAA138 Personal pension contracts that were in place on 6 April 2001 that were eitheraccepting contributions to waiver of premium insurance or included an option for themember to start such contributions were allowed to continue. However, any contractestablished after 6 April 2001 could not include waiver of premium. Post A-Day, a registeredpension scheme will not be able to use contributions to provide waiver of premium insuranceunless it is on the basis of a contract dated on or before 6 April 2001.

A139 Under the simplified regime, that portion of any contribution to a personal pensionor RAC taken out prior to 6 April 2001 which is used to provide premium waiver insurancemust be tested against the annual allowance. Contributions paid by an insurer under theterms of such premium waiver insurance will not count towards the member’s annualallowance, as they do not attract tax relief. All benefits vested from personal pensions andRACs which include such premium waiver insurance will count against the member’s lifetimeallowance, regardless of whether those benefits are in part funded by contributions paid outunder premium waiver insurance. The bar on premium waiver insurance in contracts issuedafter 6 April 2001 will remain in place.

A140 All existing lump sum certificates can be ignored post A-Day once any valuation fortransitional protection has taken place.

A141 Some pre 1970 schemes – “old code schemes” – still enjoy tax privileges. Theseschemes or arrangements were formerly approved under section 208 ICTA 1970 and, subjectto certain conditions being satisfied, enjoy continued tax exemptions by virtue of section 608ICTA 1988. Figures provided by the Association of British Insurers suggest that the funds heldin these schemes are relatively small.

A142 Unless they choose to opt out, such schemes will transfer into the simplified regime.Where such old code schemes receive contributions or vest benefits after A-Day, thecontributions will be tested against the annual allowance and the benefits will be testedagainst the lifetime allowance in the normal way.

A143 Schemes that opt out will be subject to the rules applicable to non-registeredschemes or, as an alternative, these schemes may be wound up and all benefits commuted toa lump sum, 25 per cent of which may be tax free. A wind up in these circumstances must becompleted in the year following A-Day. Schemes remaining in the new regime will be subjectto the new rules for winding up.

A144 Section 628 of the Taxes Act contains rules to determine the extent that an annuitypaid to a person who ceases to be a member of a partnership on retirement would be treatedas earned income.

A145 The provision was introduced in 1974 to give relief from the then Investment IncomeSurcharge on an annuity received as a direct result of previous partnership earned income. Ittreated the annuity, up to a limit, as earned income. The retirement aspect distinguished thisfrom ordinary annuities that were treated wholly as investment income and subject to theInvestment Income Surcharge.


Partnershipretirement

annuities

Lump sumcertificates

Old codeschemes

TE C H N I C A L D E TA I L S AA146 Since the abolition of the Investment Income Surcharge from 1984–85, the sectionhas been superfluous, and it will be repealed as part of the simplification measures.

A147 Partnership annuities are not akin to approved pension arrangements and will not besubject to the lifetime allowance or the recovery charge. Nor will the capital used to securethem count towards the annual allowance.

A148 From A-Day, buyout policies will need to be fitted into the new rules and thegovernment will require life offices providing new buyout policies to provide these under aregistered scheme, rather than making them free standing as now. Post A-Day all monetarylimits will be removed from s32 buy outs and they may pay tax free lump sums of up to 25 percent.

Non-reg istered pens ion schemes

A149 The new regime will not accord any tax advantages to non-registered pensionschemes, treating them like any other arrangement to provide benefits to employees. Unlessthey choose to register, and meet the conditions required, arrangements currently describedas FURBS and UURBS will not be treated as registered pension schemes.

A150 Under the new regime:

• employer payments to non-registered pension schemes will not be taxable orliable to NICs as they are made, nor will the employer get any deduction for itscontributions until benefits start to be paid to, and taxed on, the employee;

• all investment income and capital gains received and liable to UK tax by non-registered pension schemes set up by way of a trust will be liable at the rateapplicable to trusts, as opposed to the lower rates some currently enjoy oninvestment income;

• non-registered schemes which are discretionary trusts will be subject to thenormal IHT charging rules;

• amounts in non-registered pension schemes will not count towards anindividual’s lifetime allowance;

• subject to transitional protection, benefits paid out of non-registered pensionschemes after A-Day will be liable to tax;

• there will be no NIC charge on any benefits paid out, provided they are withinthe limits of benefits that could be paid out of a registered scheme. This issubject to the condition that the employment relationship between employerand employee, including any relationship with a connected employer or via aconsultancy arrangement or a subsidiary or a shell scheme, has ceased; and

• in relation to unfunded non-registered arrangements, employers will beallowed to continue to provide suitable security and/or underwriting forpromised benefits subject to the individual paying a benefit in kind charge onthe cost to the employer of providing the security.


Section 32contracts

A151 Transitional protection will be available to pension rights accrued before A-Daywithin non-registered pension schemes. This will include:

• where, before A-Day, an employee has been taxed on employer contributionsas they were made to a FURBS, contributions can continue to be made and anadjustment will be made to the tax free element of any lump sum benefitfinally paid out. This will take into account any employee contributions andthe proportion of the fund which has been taxed under the old rules;

• amounts in a FURBS at A-Day will continue to retain their pre A-Day IHTtreatment. Where additional contributions are made after A-Day, funds will beapportioned;

• there will be no transitional provisions for FURBS that were in existencebefore A-Day where the employee has not been taxed on contributions as theywere made;

• any UURBS in place on the day before A-Day may be consolidated and rolledinto a registered scheme within a period of 3 months of A-Day. The increase invalue of benefits in the registered scheme caused by the incorporation of theUURBS will not count towards the annual allowance but will be tested againstthe lifetime allowance when vested;

• an UURBS consolidated and rolled into a registered scheme at any other timewill count towards both the annual allowance and the lifetime allowance;

• approved schemes will have the choice of opting out of the new regime at A-Day. Where they do so, the new regime will impose a 40 per cent tax charge onfund assets immediately before opt-out. This charge will recover the tax reliefgiven at the time the scheme exits from the tax-approved regime; and

• funds withdrawn from the scheme after A-Day will be liable to tax and NICwith no entitlement to a tax free lump sum.


Transitionalprotection


B AD M I N I S T R AT I V E I S S U E S


Registrat ion

B1 New schemes will no longer need to seek formal approval from the Inland Revenue.Instead there will be a registration process with the Inland Revenue carrying out post-registration checks to ensure that the scheme is complying with the tax rules. Under the ,simplified regime the same registration treatment will apply to all schemes.

B2 The Government is considering how schemes that are established overseas andregulated as pension funds within their own jurisdiction might be able to register.

B3 The shift from an approval to a registration process will provide deregulatory benefitsto pension scheme administrators. Existing approved schemes will automatically beregistered under the new system, unless they choose to opt out. For new schemes, there willbe a straightforward registration procedure.

B4 At present, there are nine different application forms for pension schemes seeking taxapproval. Schemes have to provide up to 68 pieces of information when applying for taxapproval. Under the simplified regime there will only be one registration form for UK-basedschemes reducing the information burden. Schemes will be expected to notify any changes tothe core registration information as they occur.

B5 As part of the registration process, a scheme will need to declare in writing that it willmeet statutory requirements. The Inland Revenue will acknowledge registration, and thescheme will need to retain this acknowledgement. Where the application to register isincorrect or incomplete the Inland Revenue may reject the registration at the time of receiptor may undertake later checks on the information provided. Subject to the registration beingvalid, tax relief will be allowed on pension contributions made after the date that theacknowledgement was issued.

This annex contains further details on administrative issues including the proposedregistration, information and compliance regimes.

49

Registrationprocess

Table B1: Information required when registering a new scheme

The core information required for newly-registering schemes is likely to include:

• a declaration that the scheme will meet the codified conditions for registeredschemes (for example this will include a requirement that the scheme’s assets arealienated from those of the person establishing or sponsoring the scheme);

• details of the scheme (name, address, date of establishment and if auditedaccounts are required, the accounting year end);

• details of the person establishing or sponsoring the scheme;

• details of the chargeable person (should there be a tax charge on the scheme); and

• for schemes operating relief at source, details of their banking arrangements, anyUK administrator and signatories appointed to sign repayment claims.

AD M I N I S T R AT I V E I S S U E SBB6 The change to a registration process also provides an opportunity to moderniseservice delivery. Currently tax approval is a completely paper-based process. In line with theGovernment’s commitment to e-business, and demand from the pensions industry, theInland Revenue will look to develop the facility for electronic registration, maintenance andreporting of scheme information. Making e-business the mandatory method for registeringand subsequently amending and reporting scheme details and information could lead to astep change in service delivery. Views would be welcomed on this approach.

Se l f Assessment procedures for ind iv iduals

B7 Under the simplified regime, the vast majority of individuals will not need to beconcerned about the tax consequences of pension saving decisions.

B8 As now, taxpayers served with a tax return will be required to declare their pensionincome. As now, they will be able to copy their pension and PAYE tax paid details from theirP60s, which pension payers must provide at the end of the tax year. Taxable trivialcommutation payments will in future be treated as taxable pension income.

B9 Those who are liable to any tax charges will be required to declare and pay thesecharges via their SA tax returns. The general rules on: obligations to notify chargeability;interest and surcharges for late payment; and penalties for failure to notify liability or formaking late or incorrect returns will apply.

B10 Where tax relief in excess of 100 per cent of earnings has been given in a schemeoperating RAS, this will be recovered from the member’s fund. When this happens the schemeoperating RAS will be free to choose whether or not also to repay unrelieved contributions.Unrelieved contributions may not be repaid in any other circumstances.

B11 There will be a charge on individuals whose tax relieved pension savings exceed theannual allowance. There will be a new question on the SA return to enable taxpayers todeclare liability under this charge.

B12 The SA return guide notes will include simple questions to enable the vast majority ofindividuals quickly and easily to confirm that they are below the threshold, and need notperform any detailed checks. There will be a new Helpsheet to enable those at or near thethreshold to calculate accurately the value of their annual pension savings and declare anychargeable excess.

B13 DWP disclosure requirements ensure that members of DC schemes receive annualstatements of contributions into their fund. Scheme members will use this information toquantify their annual pension savings for the tax year in which the statement date falls.

B14 The vast majority of DB members will not need to ask their scheme to quantify thevalue of their annual pension savings. The SA return guidance notes will include simplecharts and questions to allow the vast majority of pension savers in DB schemes to determinethat their savings fall well within the new allowance.

B15 As with other entries on the SA return, taxpayers can make provisional entries wherethey do not have the necessary information by the SA filing date.


Annual allowance

E-delivery

AD M I N I S T R AT I V E I S S U E S BB16 There will be a new question on the SA return where individuals will declare amountsto which a recovery charge applies.

B17 There will be a new question in the Pension Income section of the individual taxreturn where taxpayers will declare any pension benefits in kind derived from pensionscheme assets. Schemes which permit such benefits will be obliged to report them to theInland Revenue, and to supply details to the member of the report made in respect of them.

The compl iance and audit reg ime

B18 As part of the new compliance regime, the Inland Revenue proposes to work inpartnership with the industry to raise awareness of the new compliance requirementsthrough supported workshops and seminars. The aim is to enable those involved withpension schemes to understand the new rules and the obligations on schemes, members andindividuals.

B19 Clear guidance will be provided for both schemes and individuals to help and supportthem through the changes.

B20 Taxpayers will be asked by their scheme to complete a simple declaration form whenthey vest their pension. Individuals who are served with returns or otherwise fall within SAwill, as now, declare their pension income and claim any higher rate relief on theircontributions via their SA tax return.

B21 The information provided by schemes will be risk-assessed by the Inland Revenue toinform compliance activity. In addition, there will be information powers requiring schemesto submit or make available particulars and documents within a prescribed period. Penaltiesmay apply if the information is submitted late, incorrect or incomplete.

B22 Where a scheme makes unauthorised payments in excess of 25 per cent of thescheme’s asset value, the Inland Revenue may de-register the scheme. Where a scheme is de-registered, there will be a 40 per cent tax charge on the value of the fund on the day thedecision to de-register the scheme was made. De-registration may also occur in certain othercircumstances, for example where the scheme’s assets are no longer alienated from those ofthe person establishing or sponsoring the scheme or a failure to provide informationrequested by the Inland Revenue.

B23 Schemes will have the right to appeal (to an independent tax appeals body) againstInland Revenue decisions not to register or to de-register a scheme.

B24 If a scheme is de-registered the funds in the scheme at de-registration will remainsubject to the unauthorised payment charge. Any payments from those funds to or for thebenefit of members or employers will therefore be taxed as unauthorised payments.


Recovery charge

Pension benefitsin kind

The complianceregime forindividuals

The complianceregime for

schemes

De-registration

Table B2: Unauthorised payment charge example

A scheme with one member, Caroline, pays out an unauthorised lump sum of £80,000,which is 40 per cent of the total fund value of £200,000. The scheme is de-registered.

The scheme is liable to a 40 per cent charge on the funds still in the scheme on the day thedecision to deregister the scheme was made. Assuming £120,000 remains in the scheme,the tax charge on the scheme will be £48,000.

Any net funds that remain in the fund which are paid to Caroline will be taxed on her ather marginal rate.

AD M I N I S T R AT I V E I S S U E SBB25 Where a pension scheme is set up with separate arrangements for individuals, the de-registration will apply to individual arrangements and any charge incurred when anarrangement is de-registered will be targeted at the individual concerned. Equally the 25 percent de-registration limit will apply to the funds within a person’s individual arrangement.

B26 The prime responsibility for ensuring that recovery charge liabilities are correctlypaid rests with the member whose fund is being vested. The member will have to inform theInland Revenue of any liability under SA, and normal SA penalty and interest provisions willapply. Schemes will have to deduct the charge in line with the declaration made by themember and then pay this tax to the Inland Revenue. The Government is considering whetherany additional rules are required where the scheme does not withhold, and the member doesnot meet, his or her liability.

B27 There will be a new civil penalty for those who perpetrate, market or facilitateextraction of pension fund monies, commonly known as “trust busting”. A penalty of up to£3,000 per offence will apply to those who plan or organise trust busting or related activities,for example by intentionally making a false request to transfer funds from a registeredscheme. For example, a scheme “busting” the rights of 100 members, penalties of up to£300,000 could be charged by the Inland Revenue.

B28 Elements of Pensions Update 132 (Improper Transfers: Trust Busting) issued by APSSTechnical, IR Savings, Pensions and Share Schemes, 17 May 2002 on the mechanism formaking transfers will also feature in the new regime. To help prevent such abuse arising in thefirst instance there will be a requirement for transfers to insured schemes to be made directlyto the insurer rather than to the trustees of the new scheme or any intermediary agent.

B29 Schemes will be selected for audit through a combination of random selection andrisk assessment.

B30 The audit will cover:

• contributions (including relief at source);

• investments/scheme growth;

• payments out; and

• general administration and controls.

In format ion and report ing requirementsB31 Existing reporting requirements, for periods from A-Day, on schemes will beremoved. In future, schemes will only need to make reports when certain events occur andsome schemes will need to provide information about their financial position on a newscheme return.

B32 Schemes that have taxable income to return or are seeking a repayment will need tocomplete an SA return. The return will be on a fiscal year basis unless a scheme is required toproduce audited accounts, when the return will be based on the accounts information for theaccounting period ending within that tax year.

B33 The new Pension Scheme Return is likely to ask for information about fund values,assets, membership numbers and movements of funds in and out of the scheme.

B34 The Pension Scheme Return can be served on any pension scheme. In keeping withthe intention to keep reporting requirements to a minimum, the return will not be sent to allpension schemes. It will be served on a limited number of schemes, particularly those wherean audit approach is not appropriate. Returns will also be issued randomly.


Recovery charge

Trust busting

The audit regime

Scheme to InlandRevenue – post

registration

AD M I N I S T R AT I V E I S S U E S BB35 Schemes will be required to make an Event Report if a reportable event has arisen inthe fiscal year. Views are welcomed on the list in Table B3.

B36 There will also be a new form – the Scheme Charge Accounting Form (SCAF) – forschemes to make quarterly accounts, based on the accounting quarter dates, to the InlandRevenue of tax and recovery charges due under:

• the recovery charge;

• the charge on payment of a scheme surplus to the employer; and

• the charge on the residual fund on death before age 75 and the charge on shortservice refunds.

B37 It is intended that both the form and payment can be sent electronically. In respect ofboth the charge on scheme surplus to the employer and short service refunds, the SCAF willreplace the 1(SF) and 2(SF) that are currently used for reporting these charges. Other existing1(SF) and 2(SF) charges will no longer apply:

• the charge on refund of surplus AVCs falls away;

• the charge on triviality commutation now falls within PAYE; and

• the charge on serious ill-health commutation is now replaced by the recoverycharge.

B38 The new approach will also remove the need to issue assessments for each charge. Infuture, assessments will only be issued in cases where the scheme has:

• not returned or has incorrectly returned the liability; or

• not made the correct payment.

B39 Schemes will need to provide to members:

• the value of funds at vesting and the percentage of the lifetime allowance usedin that vesting (this will need to be included on subsequent P60s issued by thescheme); and

• details of benefits in kind provided during each tax year (this is to be providedby 19 July next following the tax year end).


Table B3: Reportable events

Reportable events might include:

• schemes commencing or completing winding up;

• schemes ceasing to meet one or more of the core registration criteria;

• certain substantial vestings including those where enhanced transitionalprotection has been claimed;

• details of claims to tax free lump sum protection;

• certain uplifts to pension entitlements for pensions in payment or deferredmembers;

• details of benefits taken before age 50 (age 55 after 2010);

• pension benefits in kind provided;

• compulsory trivial commutations on winding up; and

• serious ill-health commutations.

Scheme tomember

AD M I N I S T R AT I V E I S S U E SBB40 Penalties may apply, similar to the penalties for an employer failing to provide P11dsto employees by the due date.

B41 New members will need to provide to schemes:

• full name, National Insurance number or tax reference, address and residencestatus for tax purposes (this will need to be provided only once, whencontributions start to be made); and

• a declaration to any registered scheme operating RAS that gross contributionsto all schemes will not exceed the higher of £3,600 and 100 per cent of theirearnings.

B42 In addition, members will need to provide to schemes at relevant times:

• a prescribed declaration when vesting pension benefits;

• notification when contributions in any tax year have exceeded the higher of£3,600 and 100 per cent of their earnings;

• a prescribed declaration to the scheme when opting for trivial commutation;and

• a transfer certificate to the transferee scheme where the member is notmaking further contributions from A-Day – see Annex C.

B43 The normal penalties applicable under Self Assessment will continue to apply to anyfailure to notify, incorrect returns or late returns.

B44 The penalties will include:

• a penalty of up to £3,000 per offence on any person who, for example:

• fraudulently or negligently makes a false statement in registering ascheme;

• fails to comply with scheme record keeping and preservationobligations;

• makes a false statement to obtain relief from or repayment of tax underthe pension rules; and

• plans, organises or promotes trust busting activities.

• tax-geared penalties where, for example:

• a scheme fails to pay the correct amount of tax on certain payments, e.g.payments of short service refunds to members and surplus refunds toemployers;

• a scheme fails to operate RAS correctly; and

• a scheme, or member fails to notify chargeability.

B45 Standard rights of appeal against penalty determinations and mitigation of penaltieswill apply.


Member toscheme

Penalties

C PR E A -DAY P E N S I O N R I G H T SA N D T R A N S I T I O N


Note: the term “statutory lifetime allowance” (£1.4 million in 2005-06) is used throughout thisannex to distinguish it from an individual’s “personal lifetime allowance” which may be greaterthan the statutory lifetime allowance because of transitonal protection.

C1 The simplified regime introduces a statutory lifetime allowance for tax-privilegedpension savings of £1.4 million, indexed by RPI. Funds vesting under the new system thatexceed the lifetime allowance will be liable to a recovery charge. For lump sums, the new ruleswill allow schemes to pay 25 per cent of the capital value of the pension up to a maximum ofthe statutory lifetime allowance, to be taken as a tax free lump sum. This means that in2005–06 a tax free lump sum of £350,000 could be taken from a pension fund of £1.4 million.

C2 All individuals will be able to protect their pre A-Day pension rights from the recoverycharge, provided that these are not excessive by reference to pre A-Day limits. Rights to pre A-Day tax free lump sums in excess of the new limits can also be protected.

C3 Individuals with pre A-Day rights or benefits in payment which were acquired ondivorce (sometimes known as pension credit rights) will be able to claim an additionalpersonal lifetime allowance to safeguard these rights and benefits from the recovery charge.

The recovery charge

C4 There will be two options for transitional protection from the recovery charge.Individuals will be free to choose whichever suits them best:

• primary protection – protection will be given to the value of pre A-Daypension rights and benefits in excess of £1.4 million. The pre A-Day value willbe indexed in parallel with the indexation of the statutory lifetime allowanceup to the date that benefits are taken; or

• enhanced protection – this will be available to individuals who cease activemembership of approved pension schemes before A-Day. Provided that theydo not resume active membership in any registered scheme, all benefitscoming into payment after A-Day normally will be exempt from the recoverycharge.

C5 This means that, for DC benefits, all post A-Day fund growth will be exempt from therecovery charge. For DB benefits, pre A-Day pension rights may be based on earnings whenthe benefits or a part of the benefits are first taken, rather than on historic earnings. So, thetaking of the first benefits under a DB scheme sets the maximum final pensionable salary.

C6 For the purpose of enhanced protection of DB rights, final pensionable salary mustbe no greater than that determined using prescribed rules. The current assumption is thatpensionable salary must not exceed any single year’s earnings in the three years before firsttaking benefits from the scheme.

C7 The maximum pensionable salary cannot exceed one-fourteenth of the lifetimeallowance for any individual whose pensionable salary is currently subject to the earningscap.

This annex explains how pre A-Day pension rights may be protected.

55

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O NCC8 These rules will be modified for any individual who at A-Day:

• has a pensionable salary not subject to the earnings cap;

• is a member of a scheme that requires earnings over £100,000 to be averaged;and

• at vesting has a pensionable salary of more than one-fourteenth of the lifetimeallowance.

For any such people, pensionable salary must not exceed the average of earnings receivedimmediately before first taking benefits from the scheme. The averaging period must be atleast three years.

C9 Any averaging can, as now, take account of increases to RPI.


Table C1: Protection of pension rights from the recovery chargeexamples

Example 1 – Primary protection.

Before A-Day, Linda has an unvested fund of £2.8 million and makes further contributionspost A-Day to a registered scheme.

At vesting her fund value is £4.0 million and the indexed pre A-Day fund value is £3.5million (£2.8 million increased at the same rate as the statutory lifetime allowance). Thereis a recovery charge on the £0.5 million that has accrued since A-Day.

Example 2 – Enhanced protection.

Before A-Day, Michael has an unvested DC fund of £4.2 million and makes no furthercontributions to any registered scheme.

At vesting his fund value is £5.5 million and the indexed pre A-Day fund value is £4.9 million(£4.2 million increased at the same rate as the statutory lifetime allowance).

There is no recovery charge to pay even though the fund has increased above the value ofthe indexed pre A-Day fund because Michael has not been an active member of aregistered scheme since A-Day.


Before A-Day, Jasmine has an unvested DC fund of £1.12 million and makes no furthercontributions to any registered scheme.

At vesting her fund value is £2.0 million and the statutory lifetime allowance has increasedfrom £1.4 million to £1.8 million. As her fund was below the statutory lifetime allowanceat A-Day, she had no right to primary protection, but because she has enhancedprotection, her fund is not tested against the current statutory lifetime allowance.

There is no recovery charge to pay because she has not been a member of a registeredscheme since A-Day.


Before A-Day, Robin has a pension in payment valued at £1 million plus an unvested fundof £1 million. No further contributions are made to any registered scheme.

At vesting his fund value is £1.5 million and the pre A-Day pension is still valued at £1million. The indexed value of the pre A-Day pension plus the fund is £2.2 million(£1 million plus £1 million increased at the same rate as the statutory lifetime allowance).

There is no recovery charge to pay even though the value of total benefits is greater thanthe value of the indexed pre A-Day pension and fund because Robin has not been an activemember of a registered scheme since A-Day.

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O N CC10 Enhanced protection is available to all individuals irrespective of the value of their preA-Day pension rights, not just those with values above £1.4 million. Individuals can revokethis option at any time before they reach age 75 simply by resuming active membership of aregistered scheme.

Pre A -Day r ights to tax f ree lump sums

C11 There are two kinds of lump sum rights which can be given transitional protection:

• the right to take a tax free lump sum greater than that usually permitted underthe post A-Day system where that lump sum does not exceed 25 per cent ofthe value of the pension rights. For example, an individual who has a personalpension plan valued at £10 million the day before A-Day will have a right totake a tax free lump sum of £2.5 million. See paragraph C13 below; and

• the right to take a tax free lump sum of more than 25 per cent of the value ofthe benefit coming into payment. Such a right will only arise in anoccupational pension scheme or a buy-out contract. For example, a schemeprovides a lump sum at retirement of 3/80ths of salary for each year of servicewith the employer and provides no benefit in pension form at all. Seeparagraph C16 below.

C12 For the very small number of people who fall into both categories, tax free lump sumrights will be protected, but the mechanism for doing so will not follow exactly either of themethods described in this annex: it will involve a combination of both.

C13 The method of protecting the lump sum will depend on the option taken to protectpension values from the recovery charge:

• where primary protection is chosen for the pension value, the pre A-Day lumpsum will be indexed in parallel with the indexation of the lifetime allowanceup to the date that benefits are taken; and

• where enhanced protection for the pension value is chosen, the tax free lumpsum can be taken as a percentage of the vesting funds – the same percentageas the value of pre A-Day tax free lump sum rights bore to the value ofunvested pre A-Day pension rights.

C14 The process of paying tax free lump sums with transitional protection is complex. Thedetails of the process are set out in the section “Vesting benefits” below.

C15 The examples immediately below illustrate the eventual income tax position of theselump sum benefits.


Tax free lumpsums where

pension rightsare protected

from therecovery charge

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O NC

C16 These rights will only arise in pre A-Day occupational pension schemes and buy-outcontracts (also known as Section 32 policies). Schemes and buy-out providers will be allowedto pay tax free lump sums above 25 per cent of the value of the pension at vesting. So someonewho was entitled to 30 per cent of their pre A-Day pension rights as a tax free lump sum willcontinue to be entitled to receive a lump sum of that value after A-Day. Any post A-Daypensionable service can only generate a lump sum of 25 per cent so the overall value of thelump sum will be somewhere between 25 per cent and 30 per cent of the final pension fundat vesting. The pre A-Day lump sum rights can be indexed in parallel with the indexation ofthe statutory lifetime allowance up to the date that benefits are taken. Further details of theprocess are set out in the section “Vesting benefits” below.

C17 Protection will be specific to the scheme or contract under which the benefits areheld at A-Day. It will be lost if the member chooses to transfer out of the scheme or contractbefore vesting.

C18 Individuals who have acquired pre A-Day rights on divorce will be able to protectthose rights from the recovery charge if they register such rights with the Inland Revenuewithin three years of A-Day. Upon registration the Inland Revenue will issue a certificateshowing that the individual has an increased personal lifetime allowance with a value of thepension credit rights and pension credit benefits in payment. For example an individual whoregisters a pension credit fund of £140,000 will be given a certificate showing +10 per cent ofthe statutory lifetime allowance.


Pre A-Daypension credit

rights

Tax free lumpsums above 25per cent of the

value of thepension

Table C2: Tax free lump sum examples

These examples show the lump sum rights arising from the pension values in Table C1.

Example 1 – Primary protection

Linda has lump sum rights of £500,000 and makes further contributions after A-Day.

At vesting she obtains an aggregate tax free lump sum of £625,000 (£500,000 increased atthe same rate as the statutory lifetime allowance).

Example 2 – Enhanced protection

Michael has lump sum rights of £700,000 which is 16.67 per cent of the value of the £4.2million pension rights.

At vesting he obtains an aggregate tax free lump sum of £916,850 which is 16.67 per centof the vesting benefit of £5.5 million.


Jasmine has lump sum rights of £280,000 which is 25 per cent of the value of her £1.12million pension rights.

At vesting she obtains an aggregate tax free lump sum of £500,000 which is 25 per cent ofthe vesting benefit of £2 million.


Robin has lump sum rights of £200,000 which is 20 per cent of the value of the £1 millionpension rights.

At vesting he obtains an aggregate tax free lump sum of £300,000 which is 20 per cent ofthe post A-Day vesting benefit of £1.5 million.

NB: Where pension benefits have already been taken before A-Day tax free lump sum rights ofless than £350,000 may need transitional protection.

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O N CC19 Where the recipient of the pension credit rights has other pension rights accrued asan employee/self-employed person/non-earner, the two types of rights must not beaggregated when claiming transitional protection. An individual may need to make twoseparate claims for transitional protection, one for the pension credit rights and the other forpension rights accrued, for instance, as an employee. There will be a specific registration formfor claiming transitional protection for pension credit rights.

Mechanics o f trans i t ional protect ion

C20 All pension rights held on the day before A-Day in approved schemes, statutoryschemes, buy-out contracts and retirement annuity contracts will need to be valued ifprotection under the registration process is to be claimed. The value of any pensions andannuities already in payment at A-Day from the same types of arrangement should be addedto the value of unvested pension rights. Pensions and annuities in payment should be valuedon the basis in paragraph A29.

C21 Pension credit rights transferred away before A-Day as a result of a pension sharingorder should not be valued, nor should such benefits already in payment. An individual whotransferred away rights on divorce must exclude them when valuing his or her remainingpension rights. However, the transferred rights must still be taken into account, whereappropriate, when calculating Inland Revenue limits on pre A-Day rights in occupationalschemes.

C22 Rights in DB and DC arrangements must be valued as at the end of the day before A-Day. DC rights should be taken to be the market value of the individual’s fund. DB rightswhere pensions are promised should be valued using a factor of 20:1. If the DB scheme givesrights to separate lump sums (also known as lump sums by allocation) the lump sum must bevalued on a 1:1 basis and added to the pension value. DB schemes which promise a capitalvalue (sometimes known as cash balance schemes) should value the capital on a 1:1 basis.

C23 All rights to pensions and lump sums arising under occupational schemes are subjectto the pre A-Day limits permitted by the Inland Revenue. For this purpose, people who at A-Day remain in the employment to which the benefits are attributable must be deemed to haveleft pensionable service on the day before A-Day. The DWP preservation legislation that canoverride normal Inland Revenue limits for occupational scheme rights will not apply unlessthe individual has in fact left pensionable service before A-Day. Benefits held under buy-outcontracts remain subject to the limits written into them. When testing DC funds againstInland Revenue limits the pension provided from the DC fund should be taken to be thatdetermined by the scheme actuary, or as an easement the value of the fund divided by 20.Buy-out contracts providing DC benefits must use 20. By way of further easement, whencalculating Inland Revenue limits, retained benefits may be ignored for all scheme memberswith earnings (P60 plus P11d) in the tax year preceding A-Day of less than £50,000.

C24 Amounts in occupational schemes and buy-out contracts above Inland Revenuelimits must be excluded from valuations for the purpose of protection from the recoverycharge.

C25 Individuals who wish to gain protection from the recovery charge and who haveunvested pension rights in occupational pension schemes must therefore contact theadministrators of those schemes and request that an Inland Revenue limit check is made onthose rights. Similarly, individuals with buy-out contracts holding DC rights should contacttheir provider to check that the market value of their policy, when divided by 20, does notexceed the maximum pension written into the policy. Individuals with buy-out contracts withDB rights should contact their provider to ascertain the maximum amount of pensionpayable for the contract.


Valuation:pensions and

lump sums

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O NCC26 Where an individual has pension and lump sum rights in more than one schemeattributable to a single employment, the lump sum rights must be apportioned. Each schememay be credited with the percentage of the lump sum rights that the value of the member’spension rights bear to the aggregate value of the member’s pension rights (attributable to theemployment in question).

C27 For example, David has pension rights in 3 schemes totalling £100,000 and has lumpsum rights totalling £20,000. Schemes A, B and C hold pension values of £50,000, £30,000 and£20,000 respectively. David’s lump sum rights must be apportioned accordingly – £10,000 toA, £6,000 to B and £4,000 to C. The apportionment must be strict; David can not attribute hispre A-Day lump sum to a single scheme.

C28 There should be no adjustment for any pension rights which are not commutable inthe pre A-Day system, e.g. certain contracted-out rights and funds in free-standing additionalvoluntary contribution schemes.

C29 Rights to lump sum benefits in personal pension schemes and retirement annuitycontracts should be taken to be 25 per cent of the value of the individual’s fund. However,where a personal pension arrangement holds Protected Rights, the lump sum available fromthe Protected Rights account is deemed to be zero. Where a personal pension arrangementholds rights transferred from an occupational scheme the lump sum should not be given avalue greater than that permitted by any lump sum certificate.

C30 Individuals who have unvested pre A-Day rights must register with the InlandRevenue if they wish to safeguard these rights from the recovery charge

C31 Failure to register rights within 3 years of A-Day will mean that no transitionalprotection, either primary or enhanced, will be granted in respect of those rights.

C32 Rights to a tax free lump sum exceeding 25 per cent of the value of pension benefitsshould not be registered with the Inland Revenue unless protection from the recovery changeis being sought for those rights.

C33 The Inland Revenue will provide a registration form detailing the informationrequired. The information required on registration for transitional protection will include:

• the deemed capital value of pre A-Day unvested pension rights;

• aggregate value of pension and annuities in payment at A-Day;

• pre A-Day lump sum rights as a monetary amount;

• the current location of pension funds, e.g. personal pension, stakeholderpension, retirement annuity contract, occupational pension scheme, buy-outcontract or free standing additional voluntary contribution scheme;

• certain details of assets in DC funds where the assets do not have a ready openmarket value;

• form of recovery charge protection being claimed – primary or enhanced;

• a declaration that the rights on which protection is being claimed did notexceed pre A-Day Inland Revenue limits; and

• a declaration that information provided is correct and complete, and, whereenhanced protection is claimed, that the individual has suspendedpensionable service in, and stopped making contributions to, any registeredpension scheme(s) before A-Day.


Registering preA-Day rights

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O N CC34 On receipt of the registration form the Inland Revenue will issue a certificateconfirming the extent of transitional protection.

Changes a f ter reg istrat ion and before a l l benef i ts vest

C35 An individual with registered transitional protection who suffers a reduction in his orher unvested pension rights (not merely a fall in value) must inform the Inland Revenue. TheInland Revenue will then adjust his or her transitional protection. For instance such asituation may arise after A-Day where pension rights are shared as part of a divorcesettlement.

C36 Voluntary loss: having opted for enhanced protection against the recovery charge, anindividual may choose to resume active membership of a registered scheme at any timebefore he or she reaches age 75. An individual may resume active membership even wheresome benefits have already been taken after A-Day on the basis of enhanced protection.

C37 Loss due to failure to comply with the following restrictions for enhanced protection:

• in a DC scheme all contributions by and on behalf of the individual mustcease before A-Day (a contracted-out rebate received after, but relating to atax year falling before, A-Day does not count for this purpose); and

• in a DB scheme the individual must become an “inactive member”. This is amember whose period of pensionable service ceased before A-Day and whoseaccrual rate for pension benefits remains unchanged after A-Day and who haspaid no personal contributions to the scheme since A-Day.

C38 To maintain enhanced protection, DB rights, excluding rights to death in servicebenefits, cannot be augmented in any way after A-Day. In a DC scheme death benefits mayonly be paid from unvested funds or from the proceeds of annual life assurance where thatassurance was taken out before A-Day. In a DC scheme no contributions may be made afterA-Day except a contracted-out rebate received after, but relating to a tax year falling before, A-Day.

C39 Whenever unvested pension rights relating to a member who has opted for enhancedprotection are transferred between registered schemes after A-Day, the ceding scheme mustpass a certificate to the receiving scheme confirming either that the transfer contains no postA-Day contributions or that the individual has been an “inactive member” since A-Day.

C40 If enhanced protection ceases, the individual will revert to primary protection on thebasis of their personal lifetime allowance acquired at registration. For example, an individualwho registered pre A-Day rights of £2.1 million (and originally opted for enhanced protection)will revert to the indexed value of that fund. On vesting no recovery charge will be due onbenefits with a value, in this example, of up to 150 per cent of the statutory lifetime allowancein the year of vesting.

C41 Individuals with registered rights who lose enhanced protection must inform theInland Revenue.

C42 There will be no on-going transitional protection from the recovery charge onceenhanced protection ceases for individuals whose pre A-Day pension rights and pensions inpayment did not exceed £1.4 million. The recovery charge will apply to subsequent vestingswhere benefits are paid in excess of the statutory lifetime allowance.


Reductions inprotected

pension rights

Loss of enhancedprotection

Consequence oflosing enhanced

protection

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O NCVest ing benef i ts

C43 When benefits are due to vest in any registered scheme after A-Day, and the value ofthe vesting benefits plus the value of previously vested benefits exceeds the statutorylifetime allowance, an individual with transitional rights should inform the schemeadministrator.

C44 In all cases where an individual has declared that he or she has transitional rights, thescheme administrator must obtain evidence of the value of all other vested benefits andobtain a copy of the registration certificate. Administrators must check the records of theirown scheme regarding benefits, contributions and inward transfers before accepting thevalidity of a member’s claim to enhanced protection.

C45 Scheme administrators will not apply the recovery charge to benefits for those withenhanced protection and will apply a recovery charge only to benefits valued in excess ofpersonal lifetime allowances for those with primary protection.

C46 Scheme administrators will value vesting benefits and issue valuation certificates inthe usual manner required for the lifetime allowance. Additionally they will report details tothe Inland Revenue of vestings for all individuals with transitional protection.

C47 Where an individual dies before vesting all of his or her protected pension rights, ameasure of protection from the recovery charge will be retained. A lump sum death benefitmay be paid, in substitution for the pension which cannot now be paid. The lump sum willnot be liable to the recovery charge insofar as it does not exceed the value of any remainingprotected pension rights. For example, Steve opted for primary protection for his pensionrights valued at £2 million. After vesting £1 million worth of pension rights, he dies, leavingprotected pension rights of £1 million unvested. A lump sum death benefit of up to £1 millioncan be paid free of the recovery charge.

C48 From A-Day registered schemes will be able to pay a tax free lump sum of up to 25 percent of the value of the vesting pension benefits where those benefits, and any previouslyvested benefits, do not exceed 100 per cent of the statutory lifetime allowance (£1.4 million in2005-06).

C49 Where the value of pension benefits exceeds the statutory lifetime allowance but norecovery charge is due, a registered scheme may pay a taxed lump sum of up to 25 per cent ofthe value of benefits above the 100 per cent level and below the recovery charge threshold.Income tax will be due on the lump sum at the recipient’s marginal rate. The taxed lump sumcan be paid in addition to any tax free lump sum benefit. For example, an individual vests aDC fund with a value of £2 million. Because of transitional protection no recovery charge isdue on any part of the £2 million fund. In the year of vesting the statutory lifetime allowanceis £1.4 million. The scheme may pay a tax free lump sum of £350,000 (25 per cent of £1.4million) and a taxed lump sum of £150,000 (25 per cent of £600,000) as £600,000 is the residueof the fund above the statutory lifetime allowance.

C50 Individuals who have registered rights to pre A-Day tax free lump sums (usually thosewith rights above £350,000) must, therefore, take a combination of taxed and tax free lumpsums if they wish to receive their full pre A-Day lump sum rights. They may then claim relieffor any overpaid tax on their lump sum. The examples in Table C4 illustrate this process.


Tax free lumpsums where

pension rightsare protected

from therecovery charge

Pension benefitsand the recovery

charge

Death afterA-Day beforetransitionally

protectedpension rights

have vested

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O N CC51 On the day before A-Day some individuals in occupational pension schemes or withbuy-out contracts will be entitled to a tax free lump sum in excess of 25 per cent of the valueof their pension benefit. The pre A-Day tax free lump sum rights may be indexed in parallelwith indexation of the lifetime allowance up to the date that benefits are taken. Schemes andbuy out providers will be able to pay lump sums wholly tax free provided that the member’scumulative benefits do not exceed 100 per cent of the statutory lifetime allowance. Lumpsums paid from benefits above the 100 per cent level must be taxed.

C52 Schemes must keep records detailing the calculation of the rights to these pre A-Daylump sums for six complete tax years after vesting.

C53 Some individuals will have lump sum rights arising from service before and serviceafter A-Day. In these circumstances the scheme may pay a lump sum based on the figurecalculated for the pre A-Day service, indexed, and a second lump sum on the basis of the postA-Day service, as shown in the example in Table C3.

C54 After A-Day lump sums paid out of pension benefits and funds that are liable to therecovery charge will be taxed at 55 per cent. Rights to pre A-Day tax free lump sums can onlybe taken from pension benefits and funds that are not liable to the recovery charge. All rightsto tax free lump sums will be extinguished once an individual has used up his or her personallifetime allowance.


Table C3: Lump sum protection example

Fred has rights to a pre A-Day lump sum of £50,000 from pension rights valued at£100,000. Fred remains in pensionable service for a further ten years after A-Day and thentakes all his benefits from the scheme. Fred’s pension benefit from the scheme attributableto post A-Day service has a value of £220,000. The statutory lifetime allowance (£1.4million) has increased by 20 per cent as a result of annual indexation between A-Day andthe year of vesting. The same increase is applied to Fred’s pre A-Day lump sum. Fred maytherefore receive a lump sum of £50,000 x 1.20 plus 25 per cent of {£220,000 less(£100,000 x 1.20)}. Fred receives a lump sum of £85,000 (£60,000 plus £25,000).

Lump sums fromfunds liable to

the recoverycharge

Tax free lumpsums above 25per cent of the

value of thepension



Table C4: Fully worked examples of transitional protection forregistered rights

For clarity the examples assume that:

• transitional rights have been fully registered and no pension benefits were takenbefore A-Day;

• all benefits vest in a single scheme 10 years after A-Day – “vesting day”;

• the scheme pays benefits on a DC basis; and

• 25 per cent of the value of the fund which is not liable to the recovery charge istaken as a lump sum.

Parameters:

• the statutory lifetime allowance at A-Day is £1.4 million;

• the statutory lifetime allowance in the year of vesting is £1.9 million;

• the recovery charge rate is either 25 per cent where benefits are taken in pensionform or 55 per cent where benefits are taken in lump sum form;

• up to 25 per cent of the value of vesting benefits can be taken in lump sum formfrom any funds, or that part of a fund, that is not liable to the recovery charge;

• where lump sums are paid and the statutory lifetime allowance is not used up thescheme pays the lump sum tax free;

• where lump sums are paid from funds that exceed the statutory lifetime allowance,but on which there is no liability to the recovery charge, the scheme taxes thelump sum paid. The lump sum is liable to income tax at the recipient’s marginalrate. Where appropriate the recipient may apply to the Inland Revenue for arefund of tax paid on lump sums;

• PP status – someone who has claimed primary protection; and

• EP status – someone who has claimed enhanced protection.

Example 1

John registered “EP status” which still exists when benefits vest.

Registration day

His pre A-Day rights were a pension value of £2.1 million and a tax free lump sum of£210,000.

The Inland Revenue registered a personalised lifetime allowance of 150 per cent and a“growth” lump sum of 10 per cent of pension value (derived from £210,000 and £2.1million).

Vesting day

The scheme pays benefits valued at £3.42 million. No recovery charge is payable becauseof his “EP status” even though John’s personal lifetime allowance is £2.85 million (150per cent of £1.9 million).

John takes a lump sum of £855,000 (25 per cent of £3.42 million).

As John has taken no benefits previously the scheme pays £475,000 (25 per cent of thestatutory lifetime allowance – £1.9 million) of the lump sum tax free. The balance of thelump sum (£380,000) is taxed at John’s marginal rate.

His registered rights to a tax free lump sum entitle him to £342,000 (10 per cent of thepension value of £3.42 million) which is less than the £475,000 he commuted for a tax freelump sum. In these circumstances John’s registered lump sum rights do not lead to anincrease in his total tax free lump sum.

PR E A -DAY P E N S I O N R I G H T S A N D T R A N S I T I O N C


John cannot claim a refund of the tax paid on the £380,000 lump sum as he has alreadyreceived his maximum tax free lump sum.

John is paid a pension from the residual fund of £2.565 million (£3.42million less his£855,000 lump sum).

Example 2

Susan registered “EP status” which still exists when benefits vest.

Registration day

Her pre A-Day rights were a pension value of £4.2 million and a tax free lump sum of£840,000.

The Inland Revenue registered a personal lifetime allowance of 300 per cent and a“growth” lump sum at 20 per cent of pension value (derived from £840,000 and £4.2million).

Vesting day

The scheme pays benefits valued at £7 million. No recovery charge is payable because ofher “EP status” even though Susan’s personal lifetime allowance is £5.7 million (300 percent of £1.9 million).

Susan takes a lump sum of £1.75 million (25 per cent of £7 million).

As Susan has taken no benefits previously the scheme pays £475,000 (25 per cent of thestatutory lifetime allowance – £1.9 million) of the lump sum tax free. The balance of thelump sum (£1.275 million) is taxed.

Susan can claim a partial refund of the tax paid on the £1.275 million lump sum as she hasnot received her maximum tax free lump sum. Her registered rights to a tax free lump sumentitle her to £1.4 million (20 per cent of the pension value of £7 million). She claims arefund of the tax paid on £925,000 of her lump sum benefit from the Inland Revenue.£925,000 is the balance of £1.4 million after receiving £475,000 tax free from the scheme.

Susan is paid a pension from the residual fund of £5.25 million (£7 million less her£1.75 million lump sum).

Example 3

John registers “PP status”, which therefore applies when benefits vest. The values for pre A-Day rights in this example are the same as those in example 1.

Registration day

His pre A-Day rights were a pension value of £2.1 million and a tax free lump sum of£210,000.

The Inland Revenue registered a personal lifetime allowance of 150 per cent. No value isregistered for John’s lump sum rights as they do not exceed £350,000 i.e. 25 per cent ofthe statutory lifetime allowance in 2005/06 (£1.4 million).

Vesting day

The scheme pays benefits valued at £3.85 million.

John’s personal lifetime allowance is £2.85 million (150 per cent of £1.9 million) leaving abalance of £1 million which is liable to the recovery charge.

John opts for the 55 per cent recovery charge rate because he wants to take a lump sumfrom the £1 million which is liable to the recovery charge. So John is paid a net lump sumof £450,000 as the scheme deducts £550,000 in tax. The £450,000 lump sum is tax free inhis hands.


C55 There will be appropriate sanctions which will apply to false claims to transitionalrelief and payments paid by schemes not in accordance with the transitional rules.

C56 Inevitably, the transitional arrangements proposed here are more complicated thanthe transitional proposals in Simplifying the taxation of pensions: increasing choice andflexibility for all. The Government would be interested in any practical suggestions on howthe transitional arrangements might be simplified, especially the valuation process, whilehaving regard to Exchequer costs.


Compliance

From the £2.85 million fund which is free from the recovery charge John takes a lump sumof £712,500 (25 per cent of £2.85million)

As John has taken no benefits previously the scheme pays £475,000 (25 per cent of thestatutory lifetime allowance – £1.9 million) of the lump sum tax free. The balance of thelump sum (£237,500) is taxed.

John cannot claim a refund of the tax paid on the £237,500 lump sum as he has alreadyreceived his maximum tax free lump sum of £475,000.

John is paid a pension from the residual fund of £2,137,500 (£2.85 million less his £712,500lump sum).

Example 4

Susan registers “PP status”, which therefore applies when benefits vest. The values for preA-Day rights in this example are the same as those in example 2.

Registration day

Her pre A-Day rights were a pension value of £4.2 million and a tax free lump sum of£840,000.

The Inland Revenue registered a personal lifetime allowance of 300 per cent and lump sumrights of £840,000.

Vesting day

The scheme pays benefits valued at £7.7 million.

Susan’s personal lifetime allowance is £5.7 million (300 per cent of £1.9 million) leaving abalance of £2 million which is liable to the recovery charge.

Susan opts for the 25 per cent recovery charge rate because she wants to take the balanceof her £2 million fund as a pension. So, the scheme deducts £500,000 in tax leaving £1.5million to support a pension.

From the £5.7 million fund which is free from the recovery charge Susan takes a lump sumof £1.425 million (25 per cent of £5.7 million).

As Susan has taken no benefits previously the scheme pays a tax free lump sum of £475,000(25 per cent of the statutory lifetime allowance – £1.9 million). The balance of the lumpsum (£950,000) is taxed.

Susan can claim a partial refund of the tax paid on the £950,000 lump sum as she has notreceived her maximum tax free lump sum. Her registered rights to a tax free lump sumentitle her to £1.14 million (the monetary lump sum of £840,000 indexed on the same basisas the statutory lifetime limit). She claims a refund of the tax paid on £665,000 of her lumpsum benefit. £665,000 is the balance of £1.14 million after receiving £475,000 directly fromthe scheme.

Susan has a balance of £4.275 million (£5.7 million less the £1.425 million lump sum) fromthe fund which was not liable to the recovery charge. She also has a balance of £1.5 millionfrom the £2 million which was taxed at 25 per cent. She is paid a pension from thecombined fund of £5.775 million.

D QU E S T I O N S F O R F E E D B AC K


D1 Inevitably, the transitional arrangements proposed here are more complicated than thetransitional relief proposals in the first consultation document. The Government would beinterested in any practical suggestions on how the transitional arrangements might besimplified, especially the valuation process, while having regard to exchequer costs.

D2 What do you estimate the transition cost of simplification to be, e.g. new systems,documentation, training staff, educating and providing for advice to members etc.?

D3 Section 615 schemes: the Government believes there is no continuing need for this typeof scheme. However, as this type of scheme meets a specialised need, comments are invited fromemployers on any continuing need for such schemes.

D4 Where possible, what would you estimate are the potential long-term savings inoperating the new regime? What are the absolute savings (i.e. in financial terms) and thepercentage of your total administration costs these savings represent?

D5 What are your estimates of the benefits for employers of extending flexible retirement tooccupational schemes? It would be helpful if employers responding could indicate theirnumber of employees.

D6 What will be the impact of removing the mandatory requirement for pensioneertrustees from SSASs?

D7 The Government seeks views on its proposals for Alternatively Secured Income (ASI), inparticular the use of funds remaining on the death of a member with no surviving dependants.Should these funds:

• be used to provide or augment benefits on any remaining members of thescheme;

• contribute towards a surplus in the scheme;

• be paid to a registered charity nominated by the member prior to his/herdeath?

D8 The shift from an approval to a registration process for setting up schemes offers aunique opportunity to modernise delivery of services. In line with its commitment to e-business,the Government seeks views on making e-business the mandatory method for registering andsubsequently amending and reporting scheme details and improvements.

D9 Schemes will be required to report certain events to the Inland Revenue. An illustrativelist is at Table B3 of the types of event that might be reported. Views are welcome on this list.

This annex lists questions on which the Government welcomes feedback. If you arereplying, it is not essential to stick to these questions or indeed to attempt to cover eachof them in your response. If you do answer specific questions please refer to the numberof the question.

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E GLO S S A RY O F T E C H N I C A L T E R M S


A-Day the implementation date of the proposed reforms, which the Government has announced as 6 April 2005.

Additional voluntary extra payments an occupational pension scheme member can choose to make contributions (AVCs) to their scheme to obtain greater benefits.

Alternatively secured income a method of ensuring that a pension continues for the life of the member by (ASI) means of strict limits on annual income and annual reviews to prevent the

underlying funds being over-depleted.

Annual allowance the maximum annual amount after which tax relief on contributions to a DCscheme or the increase in the value of benefits in a DB scheme will give rise toa tax charge.

Annuity insurance contract that guarantees to pay annual amounts for a fixed period. Pension annuities, that are not limited period annuities, must guaranteepayments for life.

Benefit in kind non-cash benefit provided as remuneration for an employment, taxed as income.

Buy-out policy a deferred annuity securing pension rights that accrued in an occupational pension scheme.

Carry back the right to make pension contributions in a current year greater than the normal limits by making use of all or part of a previous year’s unused rights to contribute with tax relief.

Commutation conversion of pension rights into a lump sum payment.

Concurrency simultaneous active membership of both a personal pension scheme and anoccupational pension scheme.

Defined benefit a type of occupational pension scheme where the scheme rules define the (DB) pension scheme benefits payable independent of the level of contributions and the scheme’s

investment returns. Includes final salary schemes.

Defined contribution a type of pension scheme where the size of members’ retirement benefits are (DC) pension scheme determined by the level of contributions to the scheme, their subsequent

investment growth and the rate at which the fund is converted to an income(e.g. the annuity rate).

Drawdown the facility for a pension scheme member to draw a retirement income directlyfrom their pension fund and postpone securing an income up to a maximum age of 75.

Earnings cap the maximum annual level of earnings that may count towards calculation of pension scheme benefits or limits, normally indexed by price movement. The cap was set at £99,000 for 2003–04. It does not apply to people who joined theircurrent pension scheme before 1989.

Employee share scheme a scheme which encourages employees to acquire shares of the company inwhich they work, usually on favourable terms.

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GLO S S A RY O F T E C H N I C A L T E R M SEFinal remuneration the level of earnings in a period close to retirement, used to calculate a

person’s maximum retirement benefits from an occupational pension scheme.

Financial Services Authority the independent regulator for financial services business, including some (FSA) private pensions. Empowered under the Financial Services and Markets Act

2000.

Flat-rate annuity an annuity that provides level payments for its whole term.

Flexible retirement the facility for people to phase in the transition from work to retirement.

Funded unapproved a funded retirement benefit scheme to provide benefits outside an retirement benefit schemes approved retirement benefits scheme.(FURBS)

General benefit rules the proposal that from A-Day the same rules will apply to retirement benefits paid out from all types of pension scheme.

Group personal pension an arrangement for employees of a particular employer to participate in a personal pension scheme, usually on common terms and conditions with an employer’s contribution.

Guaranteed annuity an annuity where payments are guaranteed to continue for an agreed period ofup to ten years even if the annuitant dies before expiry of the period.

Indexed annuity an annuity where payments increase at regular intervals in line with a specified index, usually prices.

Individual Savings Account an account which can include cash, equity and insurance products with no (ISA) income tax or capital gains tax on investment returns.

Level annuity see flat-rate annuity

Life expectancy the most likely length of life at a particular age. May be based solely on the general population or take account of additional factors such as lifestyle and illness.

Lifetime allowance a control to limit an individual’s total tax relief on contributions and fund buildup in registered pension schemes.

Limited period annuity a pension annuity designed to provide payments for a fixed period rather than for life.

Marginal rate an individual’s highest rate of income tax.

Minimum pension age the youngest age at which a pension scheme may normally allow a member to take benefits.

Modernising annuities consultation document on developing the pension annuity market published jointly by the Inland Revenue and the Department for Work and Pensions on5 February 2002.

Mortality drag the combined effect of deferral of annuity purchase, income drawdown andthe tendency for life expectancy to rise with age – increasing investmentreturns are required if the fund is to maintain parity with the annuity thatcould have been secured at the outset.


GLO S S A RY O F T E C H N I C A L T E R M S EMyners report a review of institutional investment, commissioned by the Chancellor,

published 6 March 2001.

Net pay arrangement the facility for employers to deduct pension contributions from employees’ pay before applying income tax so that employees receive tax relief on pensioncontributions at their marginal rate.

Normal retirement age (NRA) the age specified in a pension scheme’s rules at which a member is normally expected to retire.

Occupational pension scheme a scheme established by an employer to provide retirement benefits for employees; can be DB, DC or a combination of both.

Pension sharing on divorce an arrangement under a pension sharing order, agreement or equivalent provision in accordance with the Welfare Reform and Pensions Act 1999 whereby pension rights are shared between both parties to the divorce.

Personal pension scheme a pension scheme, membership of which is not dependent upon employment.

Pickering report a report on possible simplification of pension regulation, commissioned by theSecretary of State for Work and Pensions, published 11 July 2002.

Protected rights part of a person’s pension, funded by a rebate in national insurancecontributions in return for forgoing part of the State earnings related pension(SERPS) or the second State pension (S2P) – and required to provide retirementbenefits in specified form.

Prudential standards investment and other rules designed to protect the stability of a financial institution in the public and its customers’ interests.

Recovery charge the tax charge to be levied on any pension rights having a value above thelifetime allowance when benefits are to be drawn.

Relief at source (RAS) the facility for individuals to make contributions to a pension scheme net of basic rate income tax. The pension scheme then claims basic rate tax relief from the Inland Revenue.

Retained benefits retirement benefits deriving from an earlier period of employment or self-employment.

Retirement annuity a pension annuity contract between an individual and an insurer predating thecontract (RAC) personal pension scheme arrangements that were introduced in July 1988.

Sandler review a review of medium and long-term retail investment, commissioned by the Chancellor of the Exchequer, published 9 July 2002.

Secured income pension income supported either by an employer’s covenant, or an annuity.See also alternatively secured income.

Self-invested personal a personal pension scheme where the member has some freedom to control pension (SIPP) investments.

Serious ill-health the facility for people with severely reduced life expectancy to withdraw the fullcommutation value of their pension fund as a lump sum.

Small self-administered an occupational pension scheme which manages its own investments andscheme normally has fewer than 12 members.


GLO S S A RY O F T E C H N I C A L T E R M SEStakeholder pension a type of personal pension scheme which meets set criteria, including a ceiling

on charges and flexibility.

Surplus rules rules setting out the methods for reducing pension scheme assets when their value exceeds that required to match the scheme’s liabilities.

Tax free lump sum the benefits from a pension scheme that can be taken as a cash payment, not subject to income tax, at vesting. Normally up to 25 per cent of the value of the pension fund.

Taxable as income income taxable the Income Tax Earnings and Pensions Act 2003.

Trivial commutation the facility for people to convert small aggregate pension funds to a lump sum; the proportion above the normal tax free lump sum element is taxed as income.

Unfunded unapproved a retirement benefits scheme where an employer covenants to provide retirement benefit a future retirement benefit, which will be paid from its general resources.schemes (UURBS)

Unsecured income pension income which is not secured income or alternatively secured income.

Value protection a guarantee that a person will receive benefits equivalent to the value of theirpension fund at vesting. In the case of an annuity, early death of the annuitant would result in the return of the difference between the original purchase priceand the total of annuity payments before death. Capital payments are to betaxed at 35 per cent.

Vesting the point at which benefits are drawn from a pension scheme.

Vesting event the payment of a benefit that needs to be valued and tested against the lifetimeallowance.


Documents

Simplifying the taxation of pensions: the Government’s …webarchive.nationalarchives.gov.uk/20091222074811/http:...ABOUT THIS CONSULTATION HM Treasury Inland Revenue Public Enquiry