Pensions tax simplification:
Are you ready for A-Day?

New tax regime
You will no doubt be aware from the numerous articles in the press, that a new pensions tax regime comes into force on 6 April 2006 (known as “A-Day”). HM Revenue & Customs (“HMRC”) are calling this change “pensions tax simplification”. Unfortunately, however - like most things in pensions - it is anything but simple!

The new tax regime is contained in the Finance Act 2004 and related regulations. It consists of a single set of rules applying to both occupational and personal pension schemes, which will replace the numerous existing regimes. The new regime is intended to improve choice and flexibility, reduce administration and compliance costs and encourage individuals to save more for their retirement.

Key features

The main aspects of the new regime are as follows:

• The current system of HMRC approval of schemes for tax relief purposes is being replaced by a new system of scheme registration.
• The existing HMRC limits on benefits and contributions are being abolished – including the “earnings cap”.
• There will be a new “lifetime allowance” – initially £1.5m. A tax charge will be made where the total value of an individual’s benefits from all registered schemes exceeds this amount.
• There will be no limit on the contributions that members and employers can pay into a registered scheme. However, members will only get tax relief on contributions up to the higher of £3,600 and 100% of their UK earnings.
• A new “annual allowance” - initially £215,000 - is being introduced. A tax charge of 40% will be made on increases in pensions savings in excess of this allowance.
• The maximum tax free lump sum on retirement will be 25% of an individual’s pension fund up to the lifetime allowance.
• Flexible retirement will be possible, allowing members of occupational pension schemes to continue working while drawing retirement benefits.
• The minimum pension age will be raised from 50 to 55 by 2010.
• Individuals can protect pension rights they have built up before A-Day which will, or are likely to, exceed the lifetime allowance, by registering with HMRC (by 6 April 2009).

Financial implications
In the longer term, the new tax regime could have a significant effect on pension scheme design. However, its introduction could also have more immediate financial consequences for some schemes. These include the following:

• The abolition of the existing HMRC maximum benefits limits and the earnings cap may result in some schemes having to pay benefits which are higher than anticipated. (The likelihood of this in practice depends largely on how many high earners are in the scheme.)
• Some existing scheme benefits are likely to become “unauthorised payments” after A-Day; in particular, rules relating to ill-health early retirement, dependants’ benefits and trivial commutation need to be looked at. Under the new regime, unauthorised payments will trigger tax penalties, some of which could be severe.
• After A-Day, some scheme rules will no longer make sense; for example, definitions in the rules relating to the existing tax regimes.

The Modification Regulations
The Government has published draft Regulations - known as the “Modification Regulations” - which will protect schemes that do not change their rules before A-Day from having to pay higher than intended benefits. These Regulations are also expected to prevent schemes from being required to pay benefits that are unauthorised payments.

However, it is still not clear what the final form of the Regulations will be, and when they will come into force. Also, they are likely to be of limited effect (for example, they will not make current benefits into authorised payments), and will provide only temporary protection. We think, therefore that in many cases the Modification Regulations alone will not be adequate.

Action required
The issues relating to pensions tax simplification are complicated, and should be considered carefully (with the benefit of professional advice) before decisions are reached. Time is, however, running out, and some employers and trustees will not be in a position to do this before A-Day. Others, wish to avoid having to make detailed amendments now, because they intend to carry out wider reviews of their pension schemes at a later date, and wish to address pensions tax simplification as part of this exercise.

One possible solution in such cases could be for employers and trustees to make temporary changes to their schemes before A-Day by means of a relatively short, interim deed of amendment. This would maintain the status quo and avoid unintended liability increases, while allowing the employer and trustees time to consider the issues properly, and decide on any more detailed rule amendments they wish to make.

Cobbetts’ Pensions Team is able to prepare interim deeds of amendment for employers and trustees, as well as advise on all legal aspects of pensions tax simplification.

For further information, please contact:

Richard Shelton
Tel: 0845 404 1577
Email: richard.shelton@cobbetts.com

Helen Davies-Williams
Tel: 0845 404 2262
Email: helen.davies-williams@cobbetts.com

The content of this briefing note is merely informative and should not be relied upon as a substitute for legal advice. Copyright 2006 Cobbetts – All Rights Reserved – February 2006