Pension Reform

A Quick Guide to Pension Reform

Very shortly after taking up the reins of government the Conservative-LibDem coalition published an emergency budget. The budget proposed some significant changes for pensions and was followed by a number of reviews and consultations, including the much publicized ‘Spending Review’. The purpose of this factsheet is to identify the main issues under review and the potential effect it may have on individuals.

Background

It is important to remember that these reforms are necessary in order to guide people towards better pensions over an ever-lengthening retirement.

 The key facts are:

  • People are living longer and as a result their pension will have to last longer.
  • In order to provide income over a longer period people must save more and/or retire later.
  • At the same time the government has a stated policy to reduce the budget deficit. This means they need to avoid or minimise any increased costs, and must also reduce their existing spending on incentives. This will be achieved via a number of proposed reforms to pension legislation which fall into two main groups:

Increasing state pension benefits. This will be paid for (largely) by increasing the age from which they will be paid.

Proposals include:

Linking increases in the state pension to the greatest of CPI, NAE or 2.5%.

  • Increasing the state pension age to 66 by 2020.
  • Removing the default retirement age from employer schemes.

These changes together with the phase equalisation of the dates at which men and women are able to claim the State Pension have left many people uncertain as to when they are eligible for their state pension. This will depend on your gender and date of birth and there is a very useful ‘state pension calculator’ available at www.pensionadvisoryservice.org.uk.

 Encouraging personal savings (whilst ensuring incentives are targeted at the right savers).

 Proposals include:

  • Automatically enrolling all eligible employees into a suitable pension scheme.
  • Restricting tax relief to savings below £50,000.
  • Removing the requirement to purchase an annuity at any given age.

 In order to assess their effectiveness the government carried out a review of automatic enrolment and a formal consultation on tax relief and annuitisation.

 Auto-enrolment

The results of the review into auto-enrolment and NEST were published on 26 October 2010 and it was confirmed both auto-enrolment and NEST will go ahead from 2012.

The main proposals are:

 All employers with eligible staff will have to:

1. Automatically enrol them into a Qualifying Workplace Pension arrangement (QWP).  There will be no exemption for small employers.

 2. Pay a minimum contribution of 8% of a prescribed band of earnings, of which a minimum of 3% must be funded by the employer. To avoid very small contributions the percentage contribution rate will apply to earnings above the NI threshold (£5,715 in 2010/11). The upper threshold for contributions will be initially be set at £38,185.

Contributions will be limited to a maximum of £3,600 until 2017 when it will be reviewed and possibly abolished.

Employees are eligible for auto-enrolment if:

1. They are aged between 22 and State Pensions Age (SPA).

2. Earnings exceed a qualifying threshold of £5,035 in 2006 terms. The qualifying earnings threshold will rise to the income tax threshold (£7,475 in 2011/12).

Employers will have 3 months from the day they become eligible to auto-enrol an employee into a QWP. The legal requirement to comply rests with the employer.

  • Those who do not comply may face considerable fines.
  • The employer may auto-enrol their staff into a private pension arrangement which meets these conditions, or they may auto-enrol their employees into a national savings plan called National Employment Savings Trust (NEST).
  • Employers who choose to auto-enrol staff into their own pension arrangement (rather than NEST) will be able to complete a simple self-certification test to ensure QWP requirements are met.
  • Transfers into and out of NEST will be prohibited although this may also be abolished from 2017.
  • Employees may opt out within a month of being autoenrolled.
  • If they opt out they must be auto-enrolled again 3 years later.

Restriction of higher rate tax relief

  •  In order to raise necessary revenues the government will restrict the tax relief available to higher rate (HR) taxpayers on their pension contributions.
  • Proposals from the previous government to introduce restrictions based on individual income levels will be dropped.
  • They will be replaced by a simpler assessment based on the Annual Allowance (AA).
  • which will be set at £50,000.
  • Contributions up to this level will attract tax relief, at the full marginal rate.
  • Contributions in excess of the AA will attract an AA tax charge which effectively removes all tax relief on these amounts.
  • The new limit will apply to all contributions made to any plan where the current Pension Input Period (PIP) ends after 5 April 2011.
  • Anti-forestalling remains in place until 6 April 2011 for “high income individuals”.
  • Defined benefit accruals will be revalued by a factor of 16 and tested against the AA.
  • PIPs will not be aligned to the tax year end and the new AA will apply to any contributions made in PIPs which end after April 2011.
  • Transitional arrangements will apply to payments made after 14 October 2010.
  • The Lifetime Allowance (LTA) will also be reduced to £1.5m from April 2012.
  • Protection for savings up to the existing LTA will be available (details to follow).

The compulsion to buy an annuity at age 75, or any other age, will be removed.

The new legislation will apply from 6 April 2011.

  •  The existing options of annuity or income drawdown will still be available to those taking retirement benefits.
  • The existing ‘drawdown’ arrangements will be referred to as ‘capped drawdown and the maximum income level from these plans will be 100% of Government Actuarial Department (GAD) tables.  This limit will apply to all ages, the GAD tables will be altered to include age specific rates after 75.
  • The maximum income limit must be reviewed every 3 years (instead of 5 years).
  • A further option, to be called flexible drawdown, will be available to those who have the means to support themselves.
  • This will be assessed by means of a Minimum Income Requirement (MIR) which will be set at £20,000 The MIR must be provided by “lifetime pensions income”. This will include annuities and scheme pensions from both DB and DC arrangements.
  • A recovery tax charge of 55% will apply to lump sum death benefits paid from all crystallised pension plans, including where death occurs before age 75.
  • The recovery tax charge will also apply to uncrystallised plans where death occurs after age 75.
  • Transitional arrangements are in place to allow those reaching age 75 before the new legislation comes into force to continue in unsecured pension (drawdown).