Pension funding options

Dependants’ pension

Under HMRC rules for registered pension schemes a dependant is defined as:

A person who was married to the member at the time of the member’s death (including partners in civil partnerships)

A person who was married to the member when the member first started to receive a pension but who was divorced from the member before the date of the member’s death (including partners in civil partnerships)

A child of the member who is aged under 23 at the date of the member’s death

A child of the member who is aged 23 or over but who in the scheme administrator’s opinion was dependent on the member because of their physical or mental impairment at the date of the member’s death

A person who, at the date of the member&rsq...

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The payment of a lump sum death benefit from either a defined benefit or defined contribution scheme is a benefit crystallisation event and therefore requires a lifetime allowance test against the value of the lump sum. Potentially there could be a tax charge of 55% on the excess above the lifetime allowance paid although this can be avoided by using the excess to purchase dependants’ pensions instead. Please note that the 25% tax charge that would apply where the excess over the lifetime allowance is used to provide income only applies when the member his/herself crystallises benefits, and does not apply to dependants’ pensions payable on death.

What are the 2 main types of death benefit?

Answer : Purchase course for answer

Contributions to a registered pension scheme are unlimited, though there is a limit as to how much of the contribution will receive tax relief.

Member contributions

The maximum personal contribution paid by a member who is a relevant UK individual that can receive tax relief under the simplified regime is 100% of relevant UK earnings or £3,600 gross (£2,880 net) whichever is higher. However, as we shall see if total contributions in respect of a member exceed the annual allowance, a tax charge could apply.

Usually, all pension schemes have to operate relief at source for personal contributions, whereby member contributions are paid to the pension provider net of basic rate tax relief at source, with any higher or additional rate relief claimed via their Self Assessment tax return.

There are 3 main exceptions to this rule:

Occupational schemes can run a ‘net pay’ system, whereby personal contributions are deducted from gross pay for income tax purposes. The net pay system has to be in place for all members of the scheme who are employees of the scheme sponsor(s). A group personal pension set up under a separate employer trust for the benefit of employees counts as an occupational scheme for this purpose;

Contributions to retirement annuities carry on being paid gross with the member claiming back all tax relief via HMRC. The original intention was for these plans to move over to tax relief at source from A-Day but industry objections con...

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The decision to reduce salary cannot be revoked and an employee's salary cannot be reduced below the national minimum wage. 

Recycling the pension commencement lump sum

Legislation was brought into effect to prevent PCLS being reinvested back into a registered pension scheme and so automatically generating further tax relief on the contribution. This is commonly referred to as tax-free cash recycling.

These rules impose tax charges where much larger pension payments are made for an individual as a direct and pre-planned result of drawing a PCLS from a registered pension scheme after 5 April 2006. The rules apply when:

The PCLS (together with any other PCLS taken in the previous 12 month period) is more than 1% of the lifetime allowance.

AND

The pension payments made are significantly (generally 30%) larger than might have been expected.

AND

The total of the increases in pension payments in the tax year is at least 30% of the PCLS.

However, these rules only apply to pre-planned recycling exercises. HMRC guidance makes it clear that unplanned recycling will not be caught by the rules.

Any lump sum that is caught by the recycling rules will be treated as an unauthorised payment. This will mean a tax charge of up to 55% of the lump sum for the individual and up to 40% for the pension scheme (although the scheme can escape tax charges where it was not aware of the recycling plan).

If a pension scheme member does not meet any of the relevant UK individual criteria then what is their position regarding contributions to the scheme?

Answer : Purchase course for answer

The unauthorised payments charge

This is an income tax charge applied at a rate of 40% of the unauthorised payment made (or deemed to...

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De-registration charge

This charge is mainly aimed at trust busting but is most likely to become payable when a scheme invests in ‘taxable property’. The charge is levied on the scheme at the rate of 40% of the total value of the funds held by a scheme immediately before its registration is withdrawn by HMRC.

On whom is an unauthorised payments charge levied?

Answer : Purchase course for answer

The scheme member is responsible for making the following reports to HMRC:

Self-assessment tax return to report any tax charge they are liable to and claim any refunds of excess tax paid

Crystallising benefits – member has to declare on an appropriate form that benefits being crystallised do not make the whole value of benefits from all registered pension schemes, exceed the maximum amount

Registering transitional protection – prior to 6 April 2009, when applying for primary protection or enhanced protection the member had to fill in a registration form. The same applied for fixed protection 2012 and fixed protection 2...

Shortened demo course. See details at foot of page.

Employer information

The employer must provide specific information about any unauthorised employer payment to HMRC by their normal filing date.

Other scheme administrator information

The scheme administrator is also obliged to provide the following information to other parties:

Information to scheme members particularly in relation to tax deducted, unauthorised payments and pensions in payment.

Information to legal personal representatives particularly regarding details of benefit crystallisation events.

Introduction

When the original proposals to pensions simplification were made, it was believed that there should be few restrictions to the investments that could be made by pension schemes. This resulted in a lot of excitement that investors would be able to use their pension schemes to in vest in buy-to-let residential property, overseas villas and personal items, such as classic cars, art, antiques and other chattels.

However, in December 2005 the then Chancellor, Gordon Brown decided to back track on the investment proposals for the simplified regime, legislation for which was contained in the Finance Act 2006.

Following A-Day the main investment controls now cover:

Investments in a sponsoring employer

Loans made by a scheme to a member or employer

Borrowings by a scheme

Value-shifting investments (i.e. investments designed to shift value out of a scheme to the member or sponsoring employer)

Investment in ‘taxable property’

Investments that benefit members, e.g. property that is let to an employee at below the market rent.

The pre 6 April 2006 regulations that disallowed dealings between a scheme and its members were in the main removed by the Finance Act 2004.

Where investments made under the old rules fall outside the simplified regime, they can generally remain under transit...

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Assets used by scheme members

Before the u-turn regarding residential property investment, the Finance Act 2004 introduced legislation to treat benefits to the member as unauthorised payments taxable on the member, rather than taxing the scheme. The exception to this is where a scheme invests in a wasting asset (one effectively with a predictable life of not more than 50 years). In these circumstances, a scheme sanction charge would apply.

The 2004 legislation remains in force, even though it is hard to imagine that it will need to be used because the tax treatment of taxable property takes priority.

Generally the legislation applies the benefit in kind rules in the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) to arrive at the taxable value of any member benefit. For instance, if the benefit is the ‘use of assets’ other than property, the member will be taxed each year on 20% of the value of the market value of the asset when it was first applied for their use.