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Guide to Pensions
Personal Pensions (PPP’s) are subject to the same tax regime as all registered pension schemes. These types of arrangements are known as Money Purchase pension plans. Whilst monies remain in the pension, there is no liability to tax on capital gains and all forms of investment income are also tax free.
To be eligible to invest in a PPP and receive tax relief on personal contributions, an individual investor must be under 75 years of age, and resident in the UK (there are some exemptions for individuals who work for the UK Government or have left the UK in the last few years).
Contributions can also be made by your employer or a third party e.g. parent or spouse.
Contributions to Personal Pensions generate direct tax savings. Contributions are made net of basic rate tax relief, which means that you will only actually contribute £80 net for every £100 of contributions paid. Higher and additional rate taxpayers likewise make contributions net of basic rate tax and can then claim additional relief via their Inspector of Taxes/Self Assessment return.
An employer is able to contribute, and receive corporation tax relief on any amount that their local Inspector of Taxes is satisfied meets the “wholly and exclusively” rule for the purpose of the business test.
Personal contributions can be up to the greater of £3,600 or 100% of annual earnings each tax year. However, where the total employer and/or employee (personal) contribution exceeds the Annual Allowance a tax charge will apply. Depending on an individual’s taxable income the excess pension savings can be charged to tax in whole or in part at 45%, 40% or 20%. For the 2019/2020 tax year the Annual Allowance has been set at £40,000. It may be possible for contributions in excess of the Annual Allowance to be paid in some circumstances under new rules which allow unused Annual Allowance from the 3 previous tax years to be brought forward and added to the current year’s Annual Allowance, known as Carry Forward.
From 6 April 2016, individuals who have adjusted income (income plus employer pension contributions) for a tax year of greater than £150,000 will have their annual allowance for that tax year restricted. It will be reduced, so that for every £2 of income over £150,000, their annual allowance is reduced by £1.
The maximum reduction will be £30,000, so anyone with income of £210,000 or more will have an annual allowance of £10,000. High income individuals caught by the restriction may therefore have to reduce the contributions paid by them and/or their employers or suffer an annual allowance charge.
The tapered reduction does not apply to anyone with threshold income (income less personal pension contributions) of no more than £110,000.
- Individual Protection 2016 (IP2016) – available to those with total pension savings greater than £1 million on 5th April 2016. IP2016 will allow those individuals meeting certain criteria to fix their lifetime allowance at the value of their pension fund as at 5th April 2016, with the maximum protection being £1.25 million. Pension funding can continue but further funding is likely to be subject to a lifetime allowance charge.
- Fixed Protection 2016 – doesn’t require a minimum fund value but is aimed at those who expect their pension funds to exceed £1 million at retirement. It fixes the individual’s lifetime allowance at £1.25 million but doesn’t allow any further pension funding after 5th April 2016.
The value of the pension fund is available to your beneficiaries on your death and can normally be withdrawn as a lump sum or left within the pension wrapper to be drawn on to provide a regular or ad-hoc income. The pension will be outside of your estate if the monies benefit from the new pension freedoms introduced in 2015 and can be carried through future generations through use of a successive pension.
Death benefits, whether drawn as a lump sum or income, are normally payable tax free to your beneficiaries if you die before age 75. If you die after age 75, death benefits withdrawn as income are taxable on the recipients as earned income and lump sum death benefits are taxed at the beneficiaries’ marginal rate of income tax.
The only death benefits that are tested against the lifetime allowance are those payable from uncrystallised funds (i.e. funds you have not yet drawn on at all) either as lump sums or into flexi-access drawdown on death before age 75. If those benefits exceed your remaining lifetime allowance there will be a 55% tax charge on the excess if taken as a lump sum or 25% if used to provide income (includes placing the funds in drawdown).
Your pension can be written into an individual trust. By doing so you can ensure that, in the event of your death, the benefits are available to the trustees for distribution without unnecessary delay. By placing in trust you are ensuring that your chosen trustees have the discretion over payment of the death benefits, which might include loans to beneficiaries (which can bring added inheritance tax planning opportunities for the beneficiaries as the repayment of the loan on the beneficiary’s death will reduce their own estate). It is possible that tax charges could be incurred within the trust after your death, i.e. on 10 yearly anniversaries and when funds are paid out of the trust, depending on the amounts involved.
Alternatively, you can complete a nomination form that directs where those death benefits are to be paid. Although not binding, you can ensure that in the event of your death, the administrator takes into account your wishes as to where benefits should be paid without unnecessary delay. The benefits payable will not normally form part of your estate for Inheritance Tax purposes. Nomination forms can be altered at any time prior to your death and should be revisited regularly. If there comes a time when it might be preferable for your death benefits to be paid to individual beneficiaries rather than into a trust, your nomination form can be altered to reflect this.
All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs’ practice. Levels and bases of tax relief are subject to change.