UK: Briefing Note - Autumn Statement 2012 - Taxation Of Pensions

Last Updated: 21 December 2012
Article by Smith & Williamson

In the Autumn Statement 2012 the Chancellor announced three measures related to the taxation of value in and out of registered pension schemes:

  • a reduction to the annual allowance for pension savings from £50,000 to £40,000;
  • a reduction to the lifetime allowance for pension benefits from £1.5m to £1.25m; and
  • an increase to the capped drawdown limit.

Reduction to the annual allowance for 2014/15

The amount of an individual's pension savings which benefits from tax relief is limited to an annual allowance (AA). It is proposed that from 2014/15 the AA is to be reduced from the current £50,000 to £40,000.

Although an individual's tax relief for pension contributions is given in the tax year in which it is paid, for the AA one has to consider the combined value of all pension savings and benefits accruing in respect of each policy's pension input period (PIP) ended in the tax year. This includes employer's contributions and an amount based on the accrual of benefits in defined benefit (final salary) schemes.

A PIP usually covers 12 months but doesn't have to match the tax year. It is also likely that the PIP for different schemes will be different.

The reduced AA will apply to pension savings counting towards the AA for 2014/15 onwards, That is, it will first apply to the total of savings made in PIPs that end in the tax year 2014/15. The value of any pension funding and benefits accruing over the AA is subject to an annual allowance charge, calculated as if the top slice of taxable income.

For a pension scheme with a PIP of 1 May to 30 April a contribution in May 2013 will fall in the PIP ending 30 April 2014 and hence be taken into account in considering the position against the reduced 2014/15 AA figure. It is therefore important to recognise and understand the importance of PIPs.

There is the ability to carry forward and utilise any unused allowance from the previous three years. It is understood that this will continue and the amount of any unused allowances arising from the tax years 2011/12 to 2013/14, and available for carry forward to 2014/15 and subsequent years, will still be based on the £50,000 limit.

There are a number of planning points to consider in relation to the pension savings:

  • additional rate taxpayers obtaining tax relief at 50% for contributions before 5 April 2013 rather delay and receive tax relief at 45%;
  • those with income in and just over the high marginal rate bands of £100,000 to £116,210 (who lose their personal allowance) and £50,000 to £60,000 (where the high income child benefit is in point) making addition pension contributions to reduce their taxable income;
  • maximise the use of the current £50,000 AA limit; and
  • utilise any unused AA available for 2012/13 from 2009/10 onwards.

Reduction to the lifetime allowance from 6 April 2014

From 2014/15 the lifetime allowance (LTA) for pension savings is to be reduced from £1.5m to £1.25m.

The LTA is the overall maximum value of pension benefits that someone can accumulate in registered pension schemes over their life with any excess taxed at 55% if taken as a lump sum and 25% in other cases. This concept of a LTA was part of the 'A' Day changes introduced in April 2006. The initial LTA was £1.5m, but this had increased over the years to £1.8m. The LTA was reduced in April 2012 to £1.5m as part of the Coalition Government's restriction to pension benefit tax reliefs.

When the LTA was brought in in 2006 two types of protection were available to be applied for by those with large pension pots.

  • Primary protection - Where the value of pension rights exceeded £1.5m an election could be made for a greater personal LTA based on the value relative to the standard LTA.
  • Enhanced protection - The value of funds within pension schemes would be able to grow and be taken without limit, but with the proviso that active membership ceased in all registered pension schemes and no additional funding was made.

With the reduction to the LTA in April 2012, if someone ceased to accrue benefits in, or fund, any registered pension scheme, and did not have either of the protections mentioned above, an application could be made for 'fixed protection' from the reduction in LTA from that date. Where this applies the individual's pension benefits received continue to be measured against a £1.8m limit until such time as the actual LTA exceeds that amount.

In connection with the proposed reduction in the LTA from 6 April 2014, the Government is set to again offer a fixed protection regime to individuals to prevent retrospective taxation. This fixed protection regime is expected to work in a similar manner to that for the reduction in the LTA from £1.8m to £1.5 in April 2012.

Individuals who apply for fixed protection 2014 will have a LTA of the greater of £1.5m and the standard LTA (£1.25m from April 2014). Any pension savings above £1.5m will be subject to a LTA charge when benefits are taken.

The Government is also looking to offer a personalised protection regime for individuals, in addition to fixed protection. The suggestion is for a personalised protection to give individuals a LTA of the greater of the value of their pension rights on 5 April 2014 (up to an overall maximum of £1.5m) and the standard lifetime allowance (£1.25m from April 2014). However unlike fixed protection, individuals with this personalised protection would be able to carry on saving in their pension scheme, without loss of protection, so as to make up any underperformance in growth.

Personalised protection will only be available to those with pension pots over £1.25m on 5 April 2014 and will probably be dealt with in a similar manner as for Primary Protection on the 'A' Day transition in 2006.

Increase to the capped drawdown limit

The Government will increase the capped drawdown limit for pensioners of all ages with these arrangements from 100% to 120% of the value of an equivalent annuity.

A drawdown pension is an alternative to buying an annuity and allows someone to leave their pension fund invested while drawing an income from it by using income withdrawals or by using a 'short-term annuity'. The income withdrawals can be a capped or flexible drawdown pension arrangement.

With a capped annuity drawdown arrangement the amount of pension income that can be withdrawn is between 0% and 100% of the amount of the annuity that could be provided. That amount is based on the Government Actuary Department's drawdown tables.

This maximum capped amount must be calculated at least every three years until age 75 and annually thereafter. At a time of reducing and historically low annuity rates has led to drops in income following a review. Increasing the cap will give pensioners with these arrangements the opportunity to increase their income.

Draft legislation and a Tax Information and Impact Note will be published in January 2013. The effective date for the change has not yet been announced.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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