Pension Benefits from 6 April 2011

R E T I R E M E N T PL A N N I NG Pension Benefits from 6 April 2011 Overview The rules governing the way in which benefits are taken from Registered Pension Schemes changed on 6 April 2011. These changes will impact on everyone, but in particular high earning and/or contributing individuals. The changes do not alter the need for Retirement Planning and, in reality, the need for Retirement Planning is greater than it has ever been in view of the fact that we are, on average, all living longer. The purpose of this factsheet is to provide details of the changes that will affect pension benefits from both 6 April 2011 and then from 6 April 2012. Summary of changes Options at retirement from 6 April 2011 There will be two pension drawdown options: Capped Drawdown and Flexible Drawdown oo oo Capped Drawdown Minimum income 0%; maximum income of 100% of GAD Tax charge on lump sum death benefits increases from 35% (prior to age 75) to 55% Five year reviews of income levels reduced to three years (prior to age 75) Annual reviews post age75 New, generally reduced, GAD tables from 6 June 2011 (with a transition period from 6 April 2011). Flexible Drawdown Unlimited income, providing minimum income requirement met Minimum income requirement of pension income in payment of 20,000 pa No contributions can be made to any pension scheme in the tax year in which Flexible Drawdown is taken (or, in practice, in any future year). Alternatively Secured Pension abolished No need to cystallise benefits at age 75 From age 75, any uncrystallised benefits paid as a lump sum on death will be subject to 55% tax charge. Lifetime Allowance from 6 April 2012 The Lifetime Allowance will reduce to 1.5 million. Individuals who have been granted Enhanced and/or Primary Protection will retain it Primary Protection Factors will be based on 1.8 million rather than the reduced Lifetime Allowance 1

Individuals who have already made contributions with a view to targeting benefits between 1.5 million and 1.8 million will be granted the ability to protect these rights. This will be known as Fixed Protection and will work in a similar way to existing Enhanced Protection The Triviality limit has been set at 18,000 (rather than 1% of the reduced Lifetime Allowance). The detail of these changes is considered below. Options at Retirement from 6 April 2011 The ways in which benefits can be taken from a pension from 6 April 2011 are similar to those which applied before 6 April 2011. However the distinctions between Alternatively Secured Pensions (income drawdown from age 75) and Unsecured Pensions (income drawdown prior to age 75) have been removed so there is now (broadly) one set of rules that applies, irrespective of age. Both have been renamed Pension Drawdown and it will be possible to take benefits in two ways Capped Drawdown and Flexible Drawdown. These are explained in more detail below. Capped Drawdown Although Capped Drawdown works in broadly the same way as Unsecured Pensions did before 6 April 2011, there are a number of significant differences. From 6 April 2011, individuals who crystallise benefits into drawdown for the first time will be able to draw a maximum income of 100% of the rate specified by the Government Actuary s Department ( the GAD rate ). This is a reduction from the 120% maximum that would have applied if benefits had been crystallised before 6 April 2011. Individuals already in drawdown at 6 April 2011 For individuals who are already in drawdown, the maximum income of 120% of the GAD rate will be available until the individual s next, pre-existing, five year review date. At the five year review, the maximum income will reduce to 100% of the GAD rate and subsequent reviews will take place every three years thereafter until the individual reaches age 75, when the reviews will take place annually. Edward vested all of his pensions before 6 April 2006. He was taking part of his benefits via income drawdown and the level of income was reviewed on 1 March 2007 at which point 120% of the prevailing GAD rate was 24,000pa. This amount will remain unchanged until 1 March 2012 (the first five year anniversary after 6 April 2011), at which point the maximum will reduce to 100% of the GAD rate applicable at that time. His income level will next be formally reviewed on 1 March 2015, three years later. Where additional funds are crystallised into an existing drawdown arrangement by Additional Fund Designation, the maximum income will remain at 120% of the GAD rate until the next five year review. Although the 120% level will remain after June 2011, the rate used will be taken from the new, generally lower, GAD tables. Jane is taking benefits by phased drawdown. She initially crystallised her first tranche of money in December 2007. If she crystallises her next tranche in July 2011 using Additional Fund Designation, although this will mean that the level of income from her existing tranche will need to be recalculated, the maximum income from both tranches will be 120% of the new GAD rate applicable at that time using the total value that has been crystallised. Any further tranches that are crystallised before December 2012 will also be based on 120% of the prevailing GAD rate. 2

If new tranches are crystallised by Additional Fund Designation and the new maximum income from both tranches is less than the existing maximum level (eg due to a stock market fall), then the reduced maximum will not apply until the next anniversary. Drawdown to drawdown transfers Where an individual transfers an existing drawdown arrangement to another scheme, the maximum income will be reduced to 100% of the GAD rate on the next anniversary date of the original plan. Elizabeth crystallised all her benefits with Provider A on 1 September 2008. On 1 July 2011 she transfers her benefits to Provider B. As a result, on 1 September 2011 (ie the next anniversary of crystallising benefits with Provider A), the maximum income will be reviewed and will be based on 100% of the GAD rate applicable at that time. The next formal review of Elizabeth s maximum income will be 1 September 2014, ie three years later. Flexible Drawdown From 6 April 2011, the legislation allows individuals who are in receipt of relevant income of at least 20,000 a year (known as the Minimum Income Requirement ) to access the whole of their drawdown funds as pension income, without any limit on the amount that can be withdrawn. Relevant income for the purposes of the Minimum Income Requirement means income from any of the following: payments of a scheme pension (or dependants scheme pension) provided by a Registered Pension Scheme (provided there are 20 or more pensioner members in the scheme), payments of a lifetime annuity (or dependants annuity) made by a Registered Pension Scheme, payments of a social security pension (eg Basic State Pension). Although it would theoretically be possible to make new contributions to a pension scheme once an individual has entered Flexible Drawdown, they will not receive tax relief as they will automatically be subject to the Annual Allowance charge. Where an individual wants to continue to invest for their retirement and use Flexible Drawdown, it may therefore be preferable to consider investing for retirement via a different investment vehicle. It will be possible to start taking benefits via capped drawdown and elect for Flexible Drawdown later. James crystallised his benefits in a money purchase scheme in February 2010 when he was 55. He used the tax free cash to buy a holiday home in France but did not take an income. At age 60 he stops work and receives a pension of 15,000pa from his DB scheme and starts taking maximum income from his money purchase scheme via Capped Drawdown. At age 66 his State Pension is paid and he now has relevant income of more than the Minimum Income Requirement (currently 20,000). As a result, he decides to move from Capped Drawdown to Flexible Drawdown and starts taking more than 100% of the GAD rate as income. HMRC has confirmed it will not be possible to take Flexible Drawdown from arrangements containing protected rights funds. Income from Flexible Drawdown will be subject to Income Tax at the individual s marginal rate. Therefore it is important that the individual gives due consideration to their Income Tax position in the year Flexible 3

Drawdown is taken. It is equally important that individuals consider their plans for the income, as it will remain in the individual s estate if it is not spent and could therefore also be subject to Inheritance Tax. A number of providers have commented that they will not be offering Flexible Drawdown. Having carefully considered the technicalities of Flexible Drawdown, St. James s Place fully intends to launch Flexible Drawdown once all the draft legislation has been finalised. Options at age 75 From 6 April 2011 there will no longer be a need to crystallise benefits at age 75, which means that (subject to the rules of the Scheme so permitting) individuals will be able to take a tax free cash sum (of up to 25% of the remaining unused Lifetime Allowance) from any previously uncrystallised amounts after age 75. Any uncrystallised benefits and any crystallised benefits will continue to be tested against the Lifetime Allowance at age 75, in a similar way to that used before 6 April 2011. To enable the Scheme Administrators to do this, the member will need to provide the Scheme with information about the level of benefits they have already taken from other pension schemes. If the member does not provide this information, the Scheme Administrators are obliged to assume that all benefits exceed the Lifetime Allowance and the benefits will be taxed accordingly If benefits exceed the Lifetime Allowance, a 25% Lifetime Allowance Charge will apply to the excess as it is not possible to take the excess over the Lifetime Allowance as a taxed cash sum after age 75. As a result, if the individual wants to take the excess as a taxed cash sum, they will need to crystallise benefits before age 75. There will be no further test against the Lifetime Allowance after age 75 The ability to delay taking benefits after age 75 does not necessarily mean that it will be appropriate to do so due to the way in which benefits on death will be taxed. Death Benefits Whilst the options regarding the way in which benefits can be paid on a member s death remain unchanged (ie dependant s pensions, lump sum payments to individuals or lump sum payments to charity), the tax on any lump sum payment from crystallised funds where a member dies on or after 6 April 2011 will be 55% - an increase from the 35% level that applied if the member died before 6 April 2011 aged under 75 and a reduction from a potential 82% tax that applied if the member died aged 75 or over before 6 April 2011. This change affects all existing and new drawdown arrangements. As mentioned above, from 6 April 2011, there is no need to crystallise a pension fund at age 75. However, where an individual with an uncrystallised fund dies after age 75, any lump sum payment will be subject to 55% tax. Therefore it is likely that the majority of individuals will wish to crystallise benefits at age 75 to gain access to 25% tax free cash, thereby reducing the value of the fund that would otherwise be subject to 55% tax. Individuals in receipt of Alternatively Secured Pensions Where a member/dependant is in receipt of an alternatively secured pension (ASP) prior to 6 April 2011, their benefits will become subject to the new drawdown pension rules, including the income limits with effect from 6 April 2011. Their ASP pension year, which commenced prior to 6 April 2011, will become a drawdown pension year for the balance of that year from 6 April 2011 up to the anniversary date of the last ASP review. This will mean that in this year there will be no requirement to take a minimum income while maximum income of up to 100% of the relevant annuity can be taken. The following example will illustrate this. 4

Mary commenced taking ASP on her 75th birthday on 1 June 2010. Her alternatively secured pension year runs from 1 June 2010 to 31 May 2011. Based on the HMRC/GAD tables her relevant annuity was 10,000, meaning her maximum drawdown in that ASP year was 9,000 (90 per cent of the relevant annuity). However, prior to 6 April 2011 she had only taken withdrawals totalling 3,000. From 6 April 2011 Mary s ASP pension fund becomes a drawdown pension fund. Her drawdown pension year runs to 31 May 2011 and the maximum income drawdown she can take in the year is now 100 per cent of the existing relevant annuity. So Mary can take up to 10,000 in total for the drawdown pension year ending on 31 May 2011. As she has already taken 3,000 as drawdown pension before 5 April 2011 the maximum she can take between 6 April 2011 and 31 May 2011 is a further 7,000. Under the pre 6 April 2011 ASP rules, Mary had to take a minimum of 55% of the relevant annuity in each pension year - 5,500 in her case. However, the requirement for a minimum amount no longer applies from 6 April 2011 so if she decides that she does not want to take any further pension drawdown after 5 April 2011 she can do so without any tax penalty. Reduction in Lifetime Allowance from 6 April 2012 The Lifetime Allowance (the value that can be invested in pension schemes in a tax advantaged way) will be reducing from 1.8 million to 1.5 million from 6 April 2012. Fixed Protection The Government accepts that the reduction in the Lifetime Allowance will create a challenge for individuals whose pension benefits are either already over the 1.5 million level or whose benefits are likely to exceed that level in the future, even if no more contributions are paid. As a result, a form of pension growth protection, known as Fixed Protection, will be introduced which will enable individuals who have either already built up pension funds over the 1.5 million level, or whose benefits are likely to exceed that level in the future, to retain a Lifetime Allowance of 1.8 million. The individual s tax free cash entitlement under Fixed Protection will be 25% of the lower of their accrued pension benefits or 1.8 million. Individuals who want to protect their pensions in this way will have the opportunity to register for Fixed Protection until 5 April 2012. The forms to register for Fixed Protection will be published on HMRC s website once the Finance Bill has received Royal Assent. We expect this to be the week commencing 18 July. In order to maintain Fixed Protection, the following conditions will have to be met: No new contributions can be paid to a money purchase arrangement The amount of benefits an individual can build up each year under a defined benefits arrangement or a cash balance arrangement will be limited to the relevant percentage which is either: oo oo An annual rate used to increase rights and which was specified in the scheme s rules on 9 December 2010 or, if none, The percentage by which the Consumer Prices Index (CPI) increased in the year ending in September of the previous tax year. So for the tax year 2012/13 it will be the percentage increase in the CPI for the 12 month period ending September 2011 (ie 3.1%). If there is no increase or a fall in the CPI in this period, then the percentage will be nil. No new pension arrangement may be started, other than to receive a transfer of rights from an existing pension arrangement. 5

If any of these conditions are broken, Fixed Protection will be lost and HMRC must be informed. Individuals who were granted Enhanced and/or Primary Protection prior to 6 April 2009 will retain this form of protection and will not be permitted to apply for Fixed Protection. Primary Protection Even though the level of the Standard Lifetime Allowance is reducing to 1.5 million from 6 April 2012, individuals with Primary Protection will continue to have their enhanced Lifetime Allowance calculated by reference to the underpinned Lifetime Allowance of 1.8 million. Therefore, the amount protected will not reduce. On April 2006 (when the Standard Lifetime Allowance was 1.5 million), Charles had pension rights of 3.75 million and applied for Primary Protection. He was issued with a certificate showing an enhanced Lifetime Allowance factor of 2.5 ( 3.75 m / 1.5m). In 2011/2012 (when the Standard Lifetime Allowance is 1.8 million), Charles can receive benefits of: 2.5 x 1.8 m = 4.5 m without incurring the Lifetime Allowance charge. Any benefits in excess of 4.5 million would be subject to the Lifetime Allowance charge. On 6 April 2012, (when the Standard Lifetime Allowance has reduced to 1.5 million), Charles s protected amount remains at 4.5 million. If the individual who had been granted Primary Protection had a protected tax free cash sum of more than 375,000, the HMRC certificate will confirm the monetary value of their protected tax free cash sum. Prior to 6 April 2011, this amount was revalued in line with the increase in the Standard Lifetime Allowance. The reduction in the Lifetime Allowance will not reduce this value as it will be revalued in line with the underpinned Lifetime Allowance of 1.8 million from 6 April 2012. However, if an individual who has been granted Primary Protection did not have a protected tax free cash sum, their tax free cash sum will be 25% of the reduced Lifetime Allowance of 1.5 million after 6 April 2012. Enhanced Protection Under Enhanced Protection, the amount that can be taken without incurring a Lifetime Allowance Charge is not linked to the Lifetime Allowance and individuals with Enhanced Protection are therefore unaffected by its reduction. Likewise, where an individual has been granted a protected tax free cash sum under Enhanced Protection, this will also be unaffected as it is expressed as a percentage of the amount that is being crystallised. However, if an individual who has been granted Enhanced Protection did not have a protected tax free cash sum, their tax free cash sum will be 25% of the reduced Lifetime Allowance of 1.5 million after 6 April 2012. Tax free cash protection where entitlement was greater than 25% on 5 April 2006 Prior to 6 April 2006 ( A Day), some members of occupational pension schemes had the right to take more than 25% of their benefits as a tax free cash sum. Such entitlement was protected at A Day and, in the first stage of the revaluation process, increased by the increase in the Lifetime Allowance. The amount of such protected tax free cash sums will not reduce with the reduction in the Lifetime Allowance as the protected tax free cash sum will continue to be calculated using the underpinned Lifetime Allowance of 1.8 million. 6

At A Day William was a member of an occupational pension scheme with a total fund value of 100,000 and tax free cash entitlement of 40,000 (ie 40%). As his tax free cash entitlement was greater than 25%, William qualified for scheme specific lump sum protection. In 2012/13, William decides to crystallise his benefits, when the fund is valued at 200,000. His tax free cash entitlement will be: 40,000 x 1.8m/ 1.5m = 48,000 PLUS 25% of the deemed increase in the fund since A Day: 200,000 ( 100,000 x 1.8m/ 1.5m) = 80,000; 25% of 80,000 = 20,000 Therefore his maximum tax free cash sum is 48,000 + 20,000 = 68,000, rather than 50,000 (25% x 200,000). No Protection Individuals with no protection will face a Lifetime Allowance charge on benefits in excess of 1.5 million after 6 April 2012. If the excess benefits are taken as a lump sum, the Lifetime Allowance charge will be 55%. If the excess benefits are taken as income, the Lifetime Allowance charge will be 25%. The income will continue to be taxed at an individual s marginal Income Tax rate. Mary has total pension benefits of 1.7 million and crystallises her benefits in 2011/12. She has no protection. As the fund is within the Lifetime Allowance of 1.8 million in 2011/12, she does not face a Lifetime Allowance charge. Anne also has total pension benefits of 1.7 million and crystallises her benefit in 2012/2013. She also has no protection. As the fund exceeds the Lifetime Allowance of 1.5 million, Anne faces a Lifetime Allowance charge: If the excess is taken as a lump sum, the tax charge is 200,000 x 55% = 110,000 If the excess is taken as income, the tax charge is 200,000 x 25% = 50,000 The Government had considered changing the way that benefits in excess of the Lifetime Allowance were taxed, but does not see a pressing reason for amending these charges. This means that someone who is a 40% tax payer when they take benefits will continue to suffer an effective tax rate of 55% irrespective of how they take the excess, but someone who is a 50% tax payer when they come to take benefits will pay a higher rate of tax if they take the excess as income. George s pension from his defined benefit scheme means that he will be a 50% tax payer when he retires. He also has a money purchase scheme valued at 200,000, all of which is above the Lifetime Allowance. If he takes this as a taxed lump sum, he will receive 90,000 ( 200,000 55%), but if he takes it as income, the fund will incur a 25% Lifetime Allowance Charge and the remaining 150,000 ( 200,000 25%) will be subject to 50% income tax, which effectively reduces the value to 75,000 (ie 25,000 less than that available if taken as a lump sum). 7

Conclusion The new regime that will apply from 6 April 2011 is a welcome return to pensions simplification for most individuals however these changes do not alter the need for Retirement Planning. In reality the need for Retirement Planning is greater than it has ever been in view of the fact that we are, on average, all living longer. The removal of ASP and the attendant reductions in income available and adverse tax liability on death is welcome, as is the ability to take benefits via Flexible Drawdown. It is clear that only a few people will ever be able to take advantage of Flexible Drawdown but the fact that you can extract money from a pension at the rate you choose removes one of the barriers to investing for retirement via pensions. However it is also clear that the reduction in the Lifetime Allowance will mean that a number of people will need to seek alternative strategies for investing for their retirement and the need for advice is as important as ever. Members of the St. James s Place Wealth Management Group are authorised and regulated by the Financial Services Authority. St. James s Place Wealth Management Group plc. Registered Office: St. James s Place House, Tetbury Road, Cirencester, Gloucestershire GL7 1FP United Kingdom Registered in England Number 2627518 SJP3511-VIR1 (04/11)