Motty Korman, Author at Cogent Accountants

Types of pension schemes

There are two broad types of pension schemes from which an individual may eventually be in receipt of a pension:

• Workplace pension schemes

• Personal Pension schemes.

A Workplace pension scheme may either be a defined benefit scheme or a money purchase scheme.

A defined benefit scheme pays a retirement income related to the amount of your earnings, while a money purchase scheme instead reflects the amount invested and the underlying investment fund performance.

The number of defined benefit pension schemes has declined in recent years in part due to the regulations imposed upon the schemes and the cost of such schemes to the employer.

All employers will soon need to provide a workplace pension scheme due to auto-enrolment legislation and these are likely to be money purchase schemes.

A Personal Pension scheme is a privately funded pension plan but can also be funded by an employer. These are also money purchase schemes. Self-employed individuals can have a Personal Pension.

We set out below the tax reliefs available to members of a money purchase Workplace scheme or a Personal Pension scheme.

It is important that professional advice is sought on pension issues relevant to your personal circumstances.

What are the tax breaks and controls on the tax breaks?

To benefit from tax privileges all pension schemes must be registered with HMRC. For a Personal Pension scheme, registration will be organised by the pension provider.

A money purchase scheme allows the member to obtain tax relief on contributions into the scheme and tax free growth of the fund. If an employer contributes into the scheme on behalf of an employee, there is, generally no tax charge on the member and the employer will obtain a deduction from their taxable profits.

When the ‘new’ pension regime was introduced from 6 April 2006 no limits were set on either the maximum amount which could be invested in a pension scheme in a year or on the total value within pension funds. However two controls were put in place in 2006 to control the amount of tax relief which was available to the member and the tax free growth in the fund.

Firstly, a lifetime limit was established which set the maximum figure for tax-relieved savings in the fund(s) and has to be considered when key events happen such as when a pension is taken for the first time.

Secondly, an annual allowance sets the maximum amount which can be invested with tax relief into a pension fund. The allowance applies to the combined contributions of an employee and employer. Amounts in excess of this allowance trigger a charge.

There are other longer established restrictions on contributions from members of money purchase schemes (see below).

Key features of money purchase pensions

• Contributions are invested for long-term growth up to the selected retirement age.

• At retirement which may be any time from the age of 55 the accumulated fund is generally turned into retirement benefits – an income and a tax-free lump sum.

• Personal contributions are payable net of basic rate tax relief, leaving the provider to claim the tax back from HMRC.

• Higher and additional rate relief is given as a reduction in the taxpayer’s tax bill. This is normally dealt with by claiming tax relief through the self assessment system.

• Employer contributions are payable gross direct to the pension provider.

Persons eligible

All UK residents may have a money purchase pension. This includes non-taxpayers such as children and non-earning adults. However, they will only be entitled to tax relief on gross contributions of up to £3,600 per annum.

Relief for individuals’ contributions

An individual is entitled to make contributions and receive tax relief on the higher of £3,600 or 100% of earnings in any given tax year. However tax relief will generally be restricted for contributions in excess of the annual allowance.

Methods of giving tax relief

Tax relief on contributions are given at the individual’s marginal rate of tax.

An individual may obtain tax relief on contributions made to a money purchase scheme in one of two ways:

• a net of basic rate tax contribution is paid by the member with higher rate relief claimed through the self assessment system

• a net of basic rate tax contribution is paid by an employer to the scheme. The contribution is deducted from net pay of the employee. Higher rate relief is claimed through the self assessment system.

In both cases the basic rate is claimed back from HMRC by the pension provider.

A more effective route for an employee may be to enter a salary sacrifice arrangement with an employer. The employer will make a gross contribution to the pension provider and the employee’s gross salary is reduced. This will give the employer full income tax relief (by reducing PAYE) but also reducing National Insurance Contributions. There are special rules if contributions are made to a retirement annuity contract. (These are old schemes started before the introduction of personal pensions).

The annual allowance

The level of the annual allowance for 2015/16 was increased from £40,000 to £80,000 for ‘pension input periods’ ending in, or contributions paid from, 6 April 2015 to 8 July 2015. This was as a result of changes made to pension input periods in the Summer Budget 2015. The annual allowance for contributions from 9 July 2015 to 5 April 2016 is the balance of the unused allowance of £80,000 with an overriding cap of £40,000. For 2016/17 and 2017/18 the annual allowance is £40,000.

Any contributions in excess of the £40,000 annual allowance are potentially charged to tax on the individual as their top slice of income. Contributions include contributions made by an employer.

The stated purpose of the charging regime is to discourage pension saving in tax registered pensions beyond the annual allowance. Most individuals and employers actively seek to reduce pension saving below the annual allowance, rather than fall within the charging regime. Individuals who are eligible to take amounts out of their pension funds under the flexibilities introduced from 6 April 2015 but who continue to make contributions into their schemes may trigger other restrictions in the available annual allowance.

Changes from April 2016

From April 2016 a taper has been introduced which restricts the annual allowance available for those with ‘adjusted annual incomes’ over £150,000. Adjusted income means, broadly, a person’s net income and pension contributions made by an employer. For every £2 of adjusted income over £150,000, an individual’s annual allowance will be reduced by £1, down to a minimum of £10,000.

To ensure the measure works as intended, pension input periods are to be aligned with the tax year (rather than the complex rules which applied before 9 July 2015).

The rate of charge if annual allowance is exceeded

The charge is levied on the excess above the annual allowance at the appropriate rate in respect of the total pension savings. There is no blanket exemption from this charge in the year that benefits are taken. There are, however, exemptions from the charge in the case of serious ill health as well as death.

The appropriate rate will broadly be the top rate of income tax that you pay on your income.

Carry forward of unused annual allowance

To allow for individuals who may have a significant amount of pension savings in a tax year but smaller amounts in other tax years, a carry forward of unused annual allowance is available.

The carry forward rules apply if the individual’s pension savings exceed the annual allowance for the tax year. The annual allowance for the current tax year is used before any unused allowance brought forward. The earliest year unused allowance is then used before a later year.

Unused annual allowance carried forward is the amount by which the annual allowance for that tax year exceeded the total pension savings for that tax year.

This effectively means that the unused annual allowance of up to £40,000 (2013/14 and prior years £50,000) can be carried forward for the next three years.

Importantly no carry forward is available in relation to a tax year preceding the current year unless the individual was a member of a registered pension scheme at some time during that tax year.

The lifetime limit

The lifetime limit sets the maximum figure for tax-relieved savings in the fund at £1 million for 2016/17. The limit will then be indexed annually in line with CPI from 6 April 2018.

If the value of the scheme(s) exceeds the limit when benefits are drawn there is a tax charge of 55% of the excess if taken as a lump sum and 25% if taken as a pension.

Accessing your pension – freedom

The government have amended the rules for how individuals use their pensions savings. In 2014, George Osborne announced ‘pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want’. The changes came into effect on 6 April 2015 for individuals who have money purchase pension funds.

Under the previous system, there was some flexibility in accessing a pension fund from the age of 55:

• tax free lump sum of 25% of fund value

• purchase of an annuity with the remaining fund, or

• income drawdown.

For income drawdown there were limits, in most cases, on how much people could draw each year.

An annuity is taxable income in the year of receipt. Similarly any monies received from the income drawdown fund are taxable income in the year of receipt.

From 6 April 2015, the ability to take a tax free lump sum and a lifetime annuity remains but some of the restrictions on a lifetime annuity have been removed to allow more choice on the type of annuity taken out.

The rules involving drawdown have changed.

Access a pension fund from the age of 55

Access to the fund will be achieved in one of two ways:

• allocation of a pension fund (or part of a pension fund) into a ‘flexi-access drawdown account’ from which any amount can be taken over whatever period the person decides

• taking a single or series of lump sums from a pension fund (known as an ‘uncrystallised funds pension lump sum’).

When an allocation of funds into a flexi-access account is made the member typically will take the opportunity of taking a tax free lump sum from the fund (as under the previous rules).

The person will then decide how much or how little to take from the flexi-access account. Any amounts that are taken will count as taxable income in the year of receipt.

Access to some or all of a pension fund without first allocating to a flexi-access account can be achieved by taking an uncrystallised funds pension lump sum.

The tax effect will be:

• 25% is tax free

• the remainder is taxable as income.

Plans to introduce a market for secondary annuities scrapped

The government has cancelled plans to create a market for secondary annuities. Following a consultation with industry, financial regulators and consumer groups, the government has decided not to take forward plans to introduce a market for secondary annuities as the consumer protections required may have undermined the market’s development.

Money Purchase Annual Allowance

The government is alive to the possibility of people taking advantage of the flexibilities by ‘recycling’ their earned income into pensions and then immediately taking out amounts from their pension funds. Without further controls being put into place an individual would obtain tax relief on the pension contributions but only be taxed on 75% of the funds immediatelyy withdrawn.

The ‘annual allowance’ sets the maximum amount of tax efficient contributions. Under the rule from 6 April 2015, the annual allowance for contributions to money purchase schemes was reduced to £10,000 in certain scenarios. There is no carry forward of any of the £10,000 to a later year if it is not used in the year.

The main scenarios in which the reduced annual allowance is triggered is if:

• any income is taken from a flexi-access drawdown account, or

• an uncrystallised funds pension lump sum is received.

However just taking a tax-free lump sum when funds are transferred into a flexi-access account will not trigger the £10,000 rule.

The Chancellor announced in the Autumn Statement 2016 that the allowance will be reduced from £10,000 to £4,000 from April 2017.

How we can help

This information sheet provides general information on the making of pension provision. Please contact us on 0208 952 2264 for more detailed advice if you are interested in making provision for a pension.

If you are unsure about anything to do with this charge or would like to discuss the matter further including how we might be able to minimise the tax charge which may apply to you family, please do not hesitate to contact us on 020 8952 2234.

Child Benefit Charge

The High Income Child Benefit charge applies to a taxpayer who has income over £50,000 in a tax year where either they or their partner, if they have one, are in receipt of Child Benefit for the year.

We set out below the main points of the charge and illustrate some of the practical issues.

Does this affect my family?

The High Income Child Benefit charge is payable by a taxpayer who has ‘adjusted net income’ (explained later) in excess of £50,000 where either they or their partner, if they have one, are in receipt of Child Benefit. Where there is a partner and both partners have adjusted net income in excess of £50,000 the charge only applies to the partner with the higher income.

Practical issues

Some couples with fluctuating income levels may find that they are caught by the charge or perhaps that the partner who usually has the highest income does not actually end up paying the charge as the following example illustrates.

Example

Nicola who receives Child Benefit is employed as a teacher and earns £52,000 a year. Her husband Alan is a self-employed solicitor and his accounting year end is 31 March. He is late in submitting his books and records to his accountant for the year ended 31 March 2017. His results for that year will form his taxable profit for 2016/17. Nicola and Alan do not have any other income other than their earned income but his profits are generally in excess of £60,000. On this basis Nicola assumes that Alan will be liable for the charge.

In January 2018 Alan’s accountant completes his tax return, files this in advance of the 31 January deadline and advises that his profit has reduced to £48,000 as he had experienced a number of bad debts.

As a result Nicola has the highest income for 2016/17 and is therefore responsible for paying the charge by 31 January 2018 and she will need to contact HMRC about this.

For couples who do not share their financial details there is a problem as it is difficult to accurately complete their tax return (or know if they need to contact HMRC to request one) if their own income is over £50,000 and Child Benefit is being claimed. Only the highest earning partner is liable so this will need to be determined.

Changes in circumstances

As the charge is by reference to weeks, the charge will only apply to those weeks of the tax year for which the partnership exists. If a couple breaks up, the partner with the highest income will only be liable for the period from 6 April to the week in which the break up occurs.

Conversely, if a couple come together and Child Benefit is already being paid, the partner with the highest income will only be liable to the charge for those weeks from the date the couple start living together until the end of the tax year.

So what is the adjusted net income of £50,000 made up of?

It can be seen that the rules revolve around ‘adjusted net income’, which is broadly:

• income (total income subject to income tax less specified deductions e.g. trading losses and payments made gross to pension schemes)

• reduced by grossed up Gift Aid donations to charity and pension contributions which have received tax relief at source.

In some cases it may be that an individual may want to donate more to charity or make additional pension contributions for example, to reduce or avoid the charge.

Inequity applies as household income is not taken into account.

Therefore, equalising income for those who have the flexibility to do so such as in family partnerships or family owner managed businesses is important.

Who is a partner for the purpose of the charge?

A person is a partner of another person at any time if any of the following conditions are met at that time. The persons are either:

• a man and a woman who are married to each other and not separated or

• a man and a woman who are not married to each other but are living together as husband and wife.

Similar rules apply to same sex couples.

The charge

An income tax charge will apply at a rate of 1% of the full Child Benefit award for each £100 of income between £50,000 and £60,000. The charge on taxpayers with income above £60,000 will be equal to the amount of Child Benefit paid.

Example for 2017/18

The Child Benefit for two children amounts to £1,788 per annum. The taxpayer’s adjusted net income is £55,000. The income tax charge will be £894. This is calculated as £1,788 x

50% (£55,000 – £50,000 = £5,000/£100 x 1%).

How does the administration operate?

In the self assessment system individuals are required to notify HMRC if they have a liability to income tax, capital gains tax and the High Income Child Benefit Charge by 6 October following the tax year. This requirement is amended to include situations where the person is liable to the Child Benefit charge.

In addition, the charge is included in PAYE regulations so that it can be collected through PAYE, using a reduced tax code. It is also included in the definition of tax liability, so that it could potentially affect payments on account and balancing payments.

So should you continue to claim Child Benefit?

It is important to appreciate that Child Benefit itself is not liable to tax and the amount that can be claimed is therefore unaffected by the charge. It can therefore continue to be paid in full to the claimant even if they or their partner have a liability to the charge.

On the other hand Child Benefit claimants are able to elect not to receive the Child Benefit to which they are entitled if they or their partner do not wish to pay the charge. However, this will not affect the credit available (for state pension purposes) to certain people who stay at home to look after children (provided that an initial claim for child benefit has been made when the child is born).

An election can be revoked if a person’s circumstances change.

But I don’t receive a tax return?

It may well be that you and/or your partner have not received a tax return before but this may need to change. You need to tell HMRC by 6 October following the end of the tax year if you think a charge may be due.

Guidance

HMRC have issued some guidance on the charge and the options available which can be found at https://www.gov.uk/child-beneift-tax-charge. This should be essential reading for many families.

How we can help

Pensions – Tax Reliefs

Author: Motty Korman

Pensions – Tax Reliefs

Does the High Income Child Benefit charge affect you….