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April 2011

April 2011. Shropshire County Pension Fund Introduction to UK taxation / National Insurance and pension reforms 2010/2011. Matt Hawkins Tel +44 121 644 3768 matt.hawkins@mercer.com. Contents/Agenda. 1. How pensions used to work. 2. What has come in 2010 and what’s in store for 2011?.

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April 2011

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  1. April 2011 Shropshire County Pension Fund Introduction to UK taxation / National Insurance and pension reforms 2010/2011 Matt Hawkins Tel +44 121 644 3768 matt.hawkins@mercer.com

  2. Contents/Agenda 1 How pensions used to work 2 What has come in 2010 and what’s in store for 2011? 3 Outline of new pension tax regime 4 Further considerations

  3. How pensions used to work Employee contributions Employer contributions • Corporation tax & NI deductible • No imputed tax charge on employee • Tax deductible at the employee’s marginal rate Pension Fund Build up mostly free of tax • Tax-free cash sum • Taxed pension Limits on benefits and employee contributions

  4. Pension limits and allowances since ‘A-day’ – April 2006 No benefit limits “Allowances” determine favourable tax treatment – but don’t breach them! Annual contribution/benefit allowance (“Annual Allowance”) Risen from £215,000 in 2006/07 to £255,000 in 2010/11 Cumulative “Lifetime Allowance” for pension Risen from £1.5m in 2006/07 to £1.8m in 2010/11 From 6 April 2010, minimum age 55 for early retirement Up to 25% tax-free cash

  5. Lifetime Allowance Valuing benefits at retirement Defined benefit plans Comparison with Lifetime Allowance at ‘crystallisation’ date Gross pension £20: £1 per annum Lump sum £1: £1 Example: Pension received = £60,000 per annum Lump sum = £375,000 Value = [£60,000 x 20] + £375,000 = £1,575,000 One factor for all ages, types of pension increase (up to RPI or 5%) and dependant’s benefits Defined contribution plans (AVC’s, Personal Pension arrangement) Value of Fund at crystallisation date

  6. Lifetime Allowance (LTA) – expected scenario pre April 2009 Budget } 25% Lifetime Allowance charge on excess 55% “marginal” rate of tax Cash or pension (taxed) Retail Prices Index increases expected originally £1.8m £1.5m Remainder as pension (taxed) Up to 25% tax free cash max £450k in 2010 Retirement 2006 2010

  7. What’s coming?Major changes to tax/NI introduced/proposed via Budget 2009/ Finance Act 2009 / Budget April 2010

  8. April 2010 tax changes Introduction of new top rate of income tax of 50% for incomes > £150,000 p.a. MARCH 2010 APRIL 2010 NI Contributions increase Rapid elimination of personal tax allowance for incomes > £100,000 p.a. Extra 1% National Insurance contributions (NICs) payable by employer and employees – retained by the new Coalition Government

  9. 2010 changes – removal of the Personal Allowance

  10. Outline of the new pension tax regime – originally announced via the Coalition Government’s emergency Budget in June 2010 and detail revised on 14th October 2010

  11. Annual Allowance – how will the calculations work Annual Allowance (AA) – restricted to £50,000 No plans to increase this AA threshold – at present Valuation of annual DB pension accruals: • ‘real’ increase in accrued pension (over CPI) over the year, multiplied by • a flat factor of 16, irrespective of the member’s age • Valuation of annual AVC pension savings • total employee contributions Pension value in excess of AA would normally incur a tax charge at employee’s marginal rate Members’ contributions will enjoy full tax relief

  12. Annual Allowance – how will the calculations work – LGPS example Accrued pension at end of year = £55,000 pa Accrued pension at beginning of year = £50,000 pa Accrued additional lump sum at end of year = £130,000 Accrued additional lump sum at beginning of year = £120,000 CPI inflation = 2.5% pa Real increase in pension = £55,000 – [£50,000 x (1.025)] = £3,750pa Real increase in lump sum = £130,000 – [£120,000 x (1.025)] = £7,000 Deemed value of pension savings = (£3,750 x 16) + £7,000 = £67,000 So (ignoring mitigation techniques), excess of value of pension accrual over AA = £67,000 - £50,000 = £17,000 Annual pension tax due (for 40% taxpayer) = 40% of £17,000 = £6,800

  13. Generic LGPS Examples

  14. Annual Allowance – what’s exempt? Death and ‘severe’ ill- health benefits Revaluation of deferred pensions is exempt

  15. Annual Allowance – but what gets caught? Augmentations to benefits on redundancy Increases to accrued benefits due to salary increases, e.g. on promotion But no penal charges will arise on early retirement

  16. Possible mitigation techniques – carry forward of unused AA Ability to carry forward the previous three years’ unused Annual Allowance to offset excess pension savings Special transitional rules will apply for 2008 - 09, 2009 - 10, and 2010 -11 – based on an assumed AA of £50,000

  17. Possible mitigation techniques – Scheme Pays Members whose benefits exceed the Annual Allowance (of £50,000) in a tax year can request the scheme to pay the additional tax, and have their benefits reduced in the scheme. The main points are: • Scheme pays will be available if the benefits built up in one scheme exceed the Annual Allowance and the Annual Allowance charge exceeds £2,000; • It will be compulsory for schemes to offer scheme pays for members that exceed the Annual Allowance outright in that scheme; and • Schemes will have flexibility on how they implement scheme pays, as long as it 'fair to all members'. Employer could phase in pensionable salary increases following salary increases/ promotions

  18. Proposed changes to the Lifetime Allowance Government will reduce the Lifetime Allowance (LTA) to £1.5m on 6 April 2012 Maximum tax free cash lump sum will also fall to £375,000 DB pensions will still be valued for LTA purposes at 20:1 but will this remain on early retirement? AVC benefits valued at “face value” LTA charge will remain at 55% if taken as cash or 25% if taken a pension (with the pension then taxed in the normal way)

  19. Lifetime Allowance Proposed changes to the Lifetime Allowance – from 2012? 25% Lifetime Allowance charge on excess Excess – penal taxation applies Potential for 62½% tax pension (taxed) £1.8m £1.5m £1.5m (frozen indefinitely?) Total HMRC value of retirement benefits Pension (taxed) Up to 25% tax free cash - max £375k from 2012 2010 Retirement 2006

  20. Proposed changes to the Lifetime Allowance - Fixed Protection Special transitional protection will apply to any member who wishes to elect for the existing LTA of £1.8m. Any member seeking this new form of ‘Fixed Protection’ will need to elect for and obtain the Fixed Protection certificate before 6 April 2012. Details of the election process with HMRC are not yet known. Any member seeking Fixed Protection would need to opt out of all registered pension provision completely before 6 April 2012. Any contribution or benefit accrual by or on behalf of such a member after 5 April 2012 will result in the Fixed Protection election being lost. Members with Fixed Protection will also be able to retain a maximum tax free cash opportunity of £450,000.

  21. Other aspects – Information Requirements Schemes need to provide information on the value of pension accruals (if > AA) within 6 months after the end of the tax year If requested by the member, by the later of 3 months of the request or 6 months after the end of the tax year Employers must provide information on pensionable pay and benefits by 3 months after the end of the tax year Special concessions apply in the first year – deadlines are extended by a year to 6 July 2013 or 6 October 2013

  22. Further considerations

  23. Issues for impacted employees to consider • High level - Should I stay in the registered plan beyond April 2011? • there may be an annual allowance charge to worry about • however, for many, there may be no AA charge, and • the opportunity to utilise any unused AA carry forward may be available • and you can always reduce AVCs • but don’t forget about the Lifetime Allowance • for older members on substantial salaries, should early retirement be pursued before 6/4/12 to get the £450k tax free cash? • Should pension contributions actually be boosted next year? • tax relief for member’s contributions will be available at the highest marginal rate • can utilise unused AA carried forward - particularly in 2011/12, perhaps due to anti - forestalling

  24. Issues for impacted employees to consider • The opt out vs stay in the pension plan dilemma • on opt out, you avoid the AA charge • and perhaps encounter a lower LTA charge (if any) • but what would you get in return? • pension contributions attract full marginal tax relief (while the AA is not exceeded) while the post retirement tax rate could be lower and there is tax free cash! • New form of Fixed Protection under the LTA – opt out before 6 April 2012 to keep the £1.8m LTA • Should you allow for the LTA/AA to increase in the future? • The current defined benefit Pension Plan is unlikely to remain in its current format for long. Lord Hutton proposals for the reform of LGPS in March 2011

  25. Appendices

  26. Anti-forestalling rules introducedTransitional period - until 5 April 2011 Intended to stop high earners paying too much into pensions before 2011 These apply to employees: • whose ‘relevant income’ is £130,000or more and • who increasetheir normal ongoing regular pension savings on a money purchase basis** (the ‘Protected Pension Input Amount’), and • whose annual total pension savings exceed £20,000 (or rarely up to £30,000) “Relevant income” for anti-forestalling period is broadly total income (from all sources) less charitable donation deductions. If all three conditions above are met, a ‘special annual allowance’ test will apply ** Normal ongoing regular pension savings would include your DB pension accrual and any AVCs, paid at least quarterly, where AVCs started before 22 April 2009, if relevant income is above £150,000, or before 9 December 2009 where relevant income is between £130,000 and £150,000

  27. Illustration of carry forward calculation for AA purposes The calculation below assumes no AVC payments have been made. Estimated Accrued Pensions: £32,000 as at 5 April 2008 £36,000 as at 5 April 2009 £40,000 as at 5 April 2010 £44,000 as at 5 April 2011 Estimated Additional Lump Sums: £96,000 as at 5 April 2008 £100,000 as at 5 April 2009 £104,000 as at 5 April 2010 £108,000 as at 5 April 2011 Inflation - Consumer Price Index: For the 2008/09 tax year 1.80% For the 2009/10 tax year 5.20% For the 2010/11 tax year 1.10% Pension Input Amount: 2008/09 - [(36,000 – 32,000 * 1.018) * 16] + (100,000 – 96,000 * 1.018) = £57,056 Carry forward = 0 2009/10 - [(40,000 – 36,000 * 1.052) * 16] + (104,000 – 100,000 * 1.052) = £32,848 Carry forward = £17,152 2010/11 - [(44,000 – 40,000 * 1.011) * 16] + (108,000 – 104,000 * 1.011) = £59,816 Excess £9,816 Adjusted Unused Annual Allowance available to carry forward to 2011/12: 2008/09 - nil 2009/10 - £17,152 - £9,816 = £7,336 2010/11 - nil

  28. Carry forward of unused Annual Allowance – further example Suppose value of pension accrual in 2014 -15 = £75,000 So Annual Allowance for 2014 -15 = 50,000 + 45,000 = £95,000 There is an excess of AA over value of pension savings Hence tax due in 2014 -15 = Nil Residual AA carried forward to 2015 -16 = £95,000 - £75,000 = £20,000

  29. Carry forward of unused Annual Allowance – different example BUT, unused annual allowance can only be carried forward if it hasn’t been used up in a subsequent year Suppose value of pension accrual in 2014 -15 = £75,000 So the unused annual allowance for 2011-12 is reduced to zero in 2014-15 as it has been used up in the 2013-14 year. Annual Allowance for 2014 -15 = 50,000 + 10,000 = £60,000 There is an excess in the value of pension savings over the AA. Hence tax is due in 2014 -15 at the marginal rate of income tax on £15,000, i.e. between £6,000 and £7,500, and there is no residual AA to carry forward

  30. Answer depends on whether you would pay AA or LTA charge on the pension. If marginal tax rate is 50% before retirement and 40% after: Approximate value of £100 invested in pension vs cash under different scenarios (noting that there is scope to build up £50,000 of pension savings tax efficiently each year) Tax-effectiveness of pension savingIf you pay £100 into pension fund just before retirement, how does net pension compare with cash cost? Notes • Assumes member’s marginal tax rate is 50% before retirement and 40% after retirement • No allowance for NI contributions • Assumes that 25% of pension could be taken as tax-free cash sum (if LTA doesn’t apply)

  31. Answer depends on whether you would pay AA or LTA charge on the pension. If marginal tax rate is 40% before retirement and 40% after: Approximate value of £100 invested in pension vs cash under different scenarios (noting that there is scope to build up £50,000 of pension savings tax efficiently each year) Tax-effectiveness of pension savingIf you pay £100 into pension fund just before retirement, how does net pension compare with cash cost? Notes • Assumes member’s marginal tax rate is 40% before retirement and 40% after retirement • No allowance for NI contributions • Assumes that 25% of pension could be taken as tax-free cash sum (if LTA doesn’t apply)

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