Golden Years, Golden Rules
Sweeping changes to UK pensions will take hold in 2006
Are you prepared?
This year the rules governing UK pensions are being rearranged into one simplified regime. The new legislation is extremely extensive and in this article we will provide a brief synopsis of the main changes.
- The rules come into effect on 6 April 2006.
- There is a new lifetime limit on the amount of money in a pension that is tax exempt. This will commence at £1,500,000 and increase to £1,800,000 by 2010.
- Contributions can be 100% of salary (or up to £3,600 if you have no earnings), but will be subject to an annual input limit of £215,000. This limit also rises and will be £255,000 by 2010 and will continue to be reviewed after that.
- Any benefits taken that exceed the lifetime allowance will be subject to a recovery charge of 55% if taken as a lump sum, or if taken as pension then 25% of the fund is taxed as income. If you are a higher-rate payer, the rate is 40% which means an effective tax charge of 55%.
- The recovery charge is there to prevent excess pension funds from being built up in a tax-free environment. This is in effect ‘social engineering’ with the treasury/government deciding what is a reasonable sum to be tax exempt (an anti ‘Fat Cats’ measure). For example: if an individual reaches retirement in October 2009 with a fund of £2m the lifetime limit will then be £1,750,000 so the recovery charge will apply to £250,000. Therefore £250,000 x 55% = £137,000 recovery tax charge with the balance of £112,500 taken as cash.
- 25% of the fund is allowed as a tax-free cash sum up to the lifetime limit and includes additional voluntary contributions and protected rights.
- Non-UK residents will be allowed to contribute to their UK pension schemes, but will not receive tax relief.
- Retirement age is being raised to 55 from 2010 unless the individual has a contractual right to take benefits from 50 if granted before 10 December 2003.
- Death benefit is tax free up to lifetime limit of £1.5m.
- Retirement income can be taken before the age of 75 via an annuity or as drawdown subject to a minimum amount of nil and a maximum amount of 120% of the single life annuity. After 75 income can be drawn via an annuity or an alternative secured income subject to a minimum amount of nil and maximum amount of 70% of single life annuity.
- Residential property is now available as a pension asset for the first time! Although there are moves to restrict this.
What are the advantages of contributing to a UK pension?
An individual would have the convenience of having one savings plan rather than many provided by various parties, and tax relief would be available on contributions made when residency is taken up again in the UK. The ability to take 25% as a tax-free cash sum would be attractive as would all gains being made free of income tax and capital gains tax.
- Access to funds is limited until retirement age unless an individual retires early due to ill health.
- Any contributions made when a non-UK resident will contribute towards the lifetime allowance.
- No tax relief is available on contributions while outside of the UK.
- Original capital is turned into taxable income if placed into a UK pension fund.
A possible alternative may be to contribute to a life policy, regular or single premium, while non-resident and incorporate an offshore policy within a retirement portfolio. There are fairly compelling reasons why an expatriate may wish to consider a life policy as an asset class of a retirement portfolio:
- The tax treatment of offshore policies is exactly the same for a UK pension after tax relief on contributions. All income and gains are tax free apart from the dividend tax credit on UK shares which cannot be reclaimed.
- There are no restrictions on when benefits can be taken – 5% tax deferred withdrawals are available at any time.
- Life policies are freely assignable for example, the ability to split tax bill between husband and wife.
- On surrender, 100% of the capital is deducted from the proceeds when calculating gains.
- The fund can be left to heirs via inheritance tax planning.
- An open architecture structure and the ability to appoint the investment manager similar to Self Invested Personal Pension Plans.
- Gains from offshore policies should attract non-residents relief for any expatriates returning to the UK and top slicing relief for those individuals within the basic rate tax band.
A combined approach to retirement planning is likely to become more popular combining pension, offshore life policies, collective investment schemes and cash. When combined with the new drawdown legislation the retirement/exit strategies can become very interesting and tax advantageous. Clearly in light of these changes many questions arise and we encourage UK expatriates to contact their financial advisers to arrange a confidential pensions review.
Brendan Moloney has been an independent financial adviser for 27 years, 21 in the UK and the remainder in Indonesia.