UK: Executive Countdown to A Day-For Executives and Other Senior Employees

Issue 1
Last Updated: 4 December 2003

Welcome to the first in a series of bulletins detailing the impact of the coming changes in pension legislation on high earners – executives and other senior employees. 6 Apri1 2005, or A Day, is expected to see the biggest pension shake up in living memory.

Towards the end of 2002, the Government issued its proposals for the future tax treatment of pensions. It is clear that the proposals, if implemented, will radically alter pension provision for all. For high earners, there could be far reaching consequences. Actions taken or omitted now may impact significantly on future tax bills. The remainder of this bulletin will consider specific cases where action may be appropriate.

The changes will affect all individuals with pension savings, whether they have occupational pensions, Personal Pensions, Stakeholder Pensions or old Retirement Annuity policies. Companies will be able to pay far larger pension contributions than before for some individuals, while for others there will be no reason to contribute further to pensions. As well as company contributions, member contributions need to be considered. It is not yet clear how unapproved schemes (eg FURBS) will be affected.

Very brief details of the main impact of the proposed changes (which come into force from 6 April 2005) are as follows:

Lifetime limit - a new "lifetime limit" of £1.4m will apply to an individual’s total pension assets (though there has been speculation that the figure may be changed). Benefits from funds above this amount are expected to be taxed at 60%. Individuals with accrued funds of over £1.4m on A day will be able to register their accumulated fund at A day, which will then become substituted for the £1.4m figure and become their personal lifetime limit. The value of final salary or ‘defined’ benefits for this purpose will be calculated using actuarial factors provided by the Government. The lifetime limit is to be increased annually in line with the RPI or some other index. The proposals may render pension savings above the limit pointless. Planning ahead may be essential to ensure that contributions now do not lead to penal tax bills later.

Retirement age - the earliest possible retirement age will move from 50 to 55 from 2010. Once more is known about how this change will be phased in, those aged 50 before 2005 may wish to consider taking benefits at A day. Taking benefits need not coincide with actually retiring from work.

Annual limit - in any tax year, the value of inflows for any member (i.e. increase in defined benefit rights, contributions to defined contribution arrangements during the year) in excess of £200,000 will be subject to tax at a person's marginal tax rate. Employee contributions cannot exceed 100% of earnings (or £3,600 if greater).

Maximum annual contributions will increase for most, though the Lifetime Limit may mean that it is not tax efficient to pay up to the maximum. Individuals may wish to take the opportunity to contribute to a pension plan for a spouse or other family members.

Payment of benefits – Tax-free cash sums will be permitted of up to 25% of funds accrued subject to the lifetime limit. Cash sums from funds above the lifetime limit will be taxable. There will be new options available in annuity purchase, and income drawdown limits are to be relaxed. Income drawdown before actual ‘retirement’ might prove to be one way to cope with the Lifetime Limit.

Unapproved Benefits – it is not clear yet how unapproved schemes (such as FURBS) will be affected and there has been much speculation. It is possible that funded schemes will be included in the lifetime limit. If so then this could be penal, as tax has already been paid on contributions. Alternatively they could fall outside the lifetime limit but their current tax status could be changed. It is difficult to see how unfunded schemes could be brought within the new regime.

Suggested action - the proposed tax of 60% on benefits stemming from funds above the lifetime limit dictates that immediate planning is required. Individuals (with their employers) should now be taking action to assess the value of their total pension benefits. It will be worth planning now to ensure that contributions paid now do not lead to penal tax later.

Individuals who have total pension fund assets close to or exceeding £1.4m may wish to consider maximising contributions now in order to maximise their personal lifetime limit. (However, it may be worth waiting to see how the lifetime limit is to be indexed before making any commitment.) The proximity of an individual’s intended retirement date will also influence whether maximising contributions now is appropriate or not. Companies may be prepared to pay more now in lieu of contributions later, or individuals can pay more via AVCs, or bonus/salary sacrifice. Individuals not subject to the Earnings Cap are likely to have more scope to take advantage of current planning opportunities.

Other individuals, those with pension assets worth less than £1.4m, may wish to continue to contribute to plans normally, or to take advice now to see how their future pension contributions and retirement planning may be affected.

Over the course of the Executive Countdown bulletins, we will look at some of these areas in more detail. These comments are based on our current understanding of the proposed legislation and how it might impact on high earning executives. Some of these areas may change before the legislation is enacted.

Lifetime limit

Perhaps the biggest proposed change is the lifetime limit. Our discussions with the Inland Revenue suggest that this concept is non negotiable (although there has been speculation that there is disagreement over this at the highest government levels).

The proposals are that everyone will have a limit on the amount of tax preferred pension benefits that they can enjoy, and that this will start at £1,400,000 and will be indexed annually.

It will be possible to "register" a higher personal lifetime limit if pension fund assets already exceed the lifetime limit. This will help protect existing benefits, although the extent of this protection may be limited depending on how indexation works.

All benefits, whenever taken after A day, will be tested against the lifetime limit.

Recovery charge

When an individual starts receiving pension benefits, their fund value will be compared against the lifetime limit or their own personal lifetime limit at that date. Any excess funds over the lifetime limit will be subject to a recovery charge of 33.33%.

Of the remaining fund, 25% will be able to be taken as a lump sum and the remainder as taxed income. For a 40% taxpayer, this leads to an effective tax charge of 60% on funds above the lifetime limit. If the proposals are accepted, there will clearly be no incentive to accrue such excess funds

Retirement planning

We will look at further developments and at changes in retirement planning in Executive Countdown issue 2

Need help?

The proposals represent the most radical changes to affect executive retirement provision for many years. This bulletin has concentrated on the issues directly affecting high earners but companies will need to consider their strategic approach. We appreciate that companies and their executives will be looking for high quality advice in this area and are therefore pleased to be able to offer the following services

  • advice to individuals on their specific circumstances and how to optimise their position · seminars and/or surgeries for individuals, updating them on current issues such as the changes to pensions or options in drawing benefits
  • pre retirement benefit health check
  • executive pensions review
  • design of senior executive pension arrangements
  • advice at retirement, especially in relation to annuity purchase and income drawdown for defined contribution benefits

Aon has designed a Lifetime Limit Model spreadsheet that enables you to project funds, contributions and the lifetime limit. This allows you to plan pension contributions, in order to ensure that excess funds do not accrue. There is a defined benefit and a defined contribution version. If you would like free copies of the models, please call or email.

This bulletin is based on our current understanding of the proposed changes to pension legislation expected to apply from 6 April 2005. It is possible that not all of the proposals will be implemented as proposed.

This bulletin should not be construed as constituting advice to any individuals. If you require advice on your personal circumstances, Aon Consulting Limited would be happy to help. Alternatively, you should seek independent financial advice.

Aon Consulting Limited is authorised and regulated by the Financial Services Authority.

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