Crystallisation of Retirement Benefits
- Most of the BCE relate to drawing retirement benefits. These include
- The designaton of assets from DC arrangement for income withdrawal
- The member becoming entitled to a scheme pension
- The member becoming entitled to a lifetime annuity purchased under a mp arrangement
- The member becoming entitled to a lump sum
- Prior to a day benefits could be taken any time after age 50 but had to be taken before 75
- There is no need to take all the benefits from an arrangement at one date
- No need to stop work to take benefits
- From A Day min pension age 55
- From 6 April 2001 the requirement to crystallise benefits by age 75 was removed. From this date there is no longer a requirement to take benefits by any particular date.
- Secured Income can be in the form of: SCHEME PENSION OR LIFETIME ANNUITY
- Unsecured income can be in the form of: Pension Fund withdrawal or Short Term Annuity
In addition there is also the alternatively secured pension (ASP)
From 6th April 2011 pension fund withdrawal and ASP ceased to be available and were replaced by a single new set of income drawdown rules. These rules only apply to who moved into income drawdown for the first time after 5 April 2011.
People already using income withdrawal or ASP before 6th April 2011 will be moved onto the new rules over a period of 5 years from 6 Apirl 2011 under transitional rules.
There is no limit to the amount of pension that can be taken under the simplified regime, nor is tehre any restriction on the rate of post retirement pension increases.
- A scheme pension is a pension paid to the member by, or on behalf of, a pension scheme It:
- Must be payable at least annually
- May not be guaranteed for more than ten years from the date the member first became entitled to a scheme pension or Lifetime annuity.
- Must not be reduced unless, generally:
- The reduction in the tate of scheme pension payable is being applied to all scheme pensions under the scheme
- It is a bridging pension that is being reduced or stopped at State retirement age by an amount of no more than the State retirement pension at that time.
- Ther pension is being paid on grounds on ill health and there ceases to be grounds to continue paying the pension
- May incorporate pension protection.
Availability of Scheme pensions
- DB schemes can only provide scheme pensions
- They can be bought from an insurance company or paid from the scheme funds.
- Where provided by an insurance company the scheme pension can be written in the name of the member or the trustees. If trustees name the trustees may arrange for insurance company to pay straight to member.
- DC scheme can offer a scheme pension but only where the memer had the chance to choose a lifetime annuity as an alternative.
- A liftetime annuity is subject to similar rules to a scheme pension. In particular a lifetime annuity:
- Must be paid by an insurance company and the member must have the opportunity to select the provider.
- May not be guaranteed for more than 10 years
- May be level or more increase each year. This may include having increases linked to an index such as RPI, an investment index or the performance of an Investment linked fund
There were two forms of unsecured pension:
- Income withdrawal
- Short Term annuity
In addition, once a person reached 75 and if they had not had their benefits secured using either a lifetime annuity or scheme pension, their benefits became an alternatively secured pension.
From 6 April 2011 new income drawdown rules were introduced for arrangements moving into income drawdown for the first time.
Alternatively Secured Pension
- ASP was introduced because some groups of people object to annuities on moral grounds.
- Reaching 75 was a BCE and afterwards no pension commencement lump sum was available. ASP was only available from age 75
- The maximum income had to be reviewed every year
- The max income was 70% of the basis amount calculated using tables produced by GAD and always using the rate for a person aged 75
- The min income was nil
- Rules were revised in Finance Act 2007
- Consciously in ASP : Max income still reviewed annually
- The max income is 90% of GAD
- The min income is 55% of GAD
ASP ceased to be available for arrangements being moved into income drawdown for the first time after 5th April 2011. Those in ASP before this date will progressively move to the new rules after 6 April 2011.
- Member draws income from fund to meet their needs
- Max annual income was 120% og GAD
- Min was nil
- Limit reviewed every 5 years
Income withdrawal ceased to be available for arrangements being moved into income drawdown for the first time after 5 April 2011. Those in income withdrawal before this date will progressively move to the new rules after 6 April 2011.
Income drawdown rules from 6 April 2011
- The max income allowed in a pension year is 100% of the basis amount. This is reffered to as capped drawdown.
- There is no minimum income required.
- New flexible drawdown option for those who can meet the minimum income requirement (MIR). This allows unlimited income to be taken, at any time.
- Reviews of the basis amounts are carried out at least every 3 years uo to age 75. Once over 75 limit is reviewed every year.
- The GAD tables are extended to cover ages beyond 75
- On death unused funds, which are funds reamining that are designated for drawdown, can be paid as a lump sum.
- Where a person can meet the MIR there is no limit to the amount of income that can be drawn each year.
- The usual amount of tax free lump sum can be taken and the remainder of the funds taken are taxed as income.
- Should the person be a non - UK resident when the fund is taken they will be subject to UK tax on it if they return to the UK within 5 years of making the withdrawal.
- The Minimum Income requirement is that a persion must be receiving a secure income of at least £20,000 in the tax year when they opt for flexible drawdown. The income that counts towards this limit must come from a combo of:
- State pensions
- Lifetime annuities
- Scheme pensions
- Secure income from overseas pension schemes
- Test only needs to be passed at time flexi drawdown is selected. It is not repeated.
- Consequence of flexible drawdown is that all pension savings provision must stop. No further contributions can be paid. In event of any further contributiions they will be fully subject to the annual allowance charge.
- People who at 5th April 2011 are already in income withdrawal or ASP will move to the new rules over a period of time.
- People in income withdrawal will keep the 120% of the basis amount limit until the earliest of:
- The start of a new reference period
- The start of the next pension year following a transfer of their drawdown fund or
- The state of the pension year after reaching age 75.
If further funds are designated for drawdown, or some funds designated for drawdown are used to buy an annuity, a review of income will be triggered, but on the 120% basis amount. The reference period will remain unaltered.
This means that someone who starts drawdown or who resets their five years reference period just before 6 April 2011 will note move to the new limits until nearlt 6 April 2016.
People who are in ASP on 5 April 2011 will have their first income review on the new rules from the start of their next pension year. Until then the basis amount last calculated will continue. However, they have been able to alter their income by taking up to 100% of the basis amount, or reducing the amount to zero from 6 April 2011.
Short Term Annuities
- After the member chooses to take any pension commencement lump sum they then use some of the funds designated for pension purposes to buy a temporary annuity. This annuity:
- Must be payable by an insurance company which the member must have the opportunity to select
- Must not be payable for more than five years and must cease before age 75
- Must be level or increase in the same ways as are available for lifetime annuities.
Pension Commencement Lump Sum
- 25% of total benefits
- The total value of benefits is usually calculated as described in chapter 2
- The Pensions Act 2004 made it possible to draw a tax free lump sum from protected rights.
- AVC's/FSAVC's are able to provide a tax free lump sum, provided the scheme rules have been amended to allow this.
AVC contributions and multiple arrangements within a scheme
The act also allows the pension commencement lump sum to be calculated as the aggregate value of all a persons arrangements within a scheme, rather than for each arrangement seperately. This allows people to amalgamate AVC's and other pension benefits within the same scheme and also to maximuse their cash sum up to the maxiumum allowable.
Subject to the scheme rules it allows people to take all their cash entitlement from their AVC.
PCLS - Transitional Rules
- Higher tax free cash sums are available for people who opt for transitional protection.
- A 25% cash payment will require a rule change for some pension schemes. As a result some scheme members may not have been able to access the extrac cash available under the new regime immediately.
Pre 2006 rights to take cash and defer pension
Occupational scheme members with a right to defer retirement will not be able to draw their tax free cash before A Day, defer their pension and then draw 25% of their remaining benefits as cash after A-day. They will only be allowed one cash sum entitlement.
Where benefits are taken in stages after a day all previously drawn benefits are revalued in line with the standard lifetime allowance first!
ill Health Benefits
- A member may draw benefits before the normal minimum pension age if:
- The scheme administrator has evidence from a registered medical practitioner that the member is, and will continue to be, incapable of carrying on their occupation because of physical or mental impairment, until they reach their state pension age
- the member has ceased to carry on their occupation
- Ill health payments can be suspended if the member regains their health
- It is possible for a member to commute all their uncrystallised arrangements for a lump sum if:
- They are under 75
- They have a life expectation of less than a year
- They have sufficient available LTA to cover the value of the benefits they are commuting.
Ill health benefits (2)
- The scheme admin must obtain proof from medical practitioner than the expectation of life is less than one year before making a payment.
- If not obtain first, then payment is unauthorised.
- Serious ill health commutation will be treated as a BCE event for the purposes of assessing whether the LTA has been breached.
- However, after testing against the LTA there is no income tax liability on serious ill health benefits.
- If benefits small enough they can be commuted for a lump sum.
- Two sets of rules that each allow small levels of benefits to be commuted on grounds of triviality.
- The first is member driven and in effect gives the member a twelve month window during which they can commute small benefits. Payments under this rule are known as trivial commutation lump sums.
- The other rule, introduced from December 2009, was to address instances where the above opportunity may have been exhausted, but a situation arose where a scheme had very small benefits to pay a member, buy for where it was not feasible or reasonable, to pay them as an income. This is known as the small lump sums provision.
Trivial commutaion lump sums
- From A day an individual could commute one of more of their pension arrangements at any time after their 60th birth, provided:
- all the benefits from the chosen scheme or annuities are commuted
- All commutation takes place within a commutation period of twelve months, starting from the date of the first trivial commutation payment.
- The commutation period ends before the individuals 75th birthday.
- The value of all the members pension rights does not exceed 1% of the standard liftetime allowance on the nominated date which can be any date within three months of the start of the commutation period. If no date is chosen, the nominated date will be taken as the first day of the commutation period.
Trivial commutation of benefits will be taxed as income. If the commutation relates to uncrystallised benefits, and the member has not drawn any benefits from the scheme, 25% of the payment will be tax free.
The 1& of the LTA restriction means thatn in 2011/12 trivial commutation is only available where the individuals pension rights were not worth more than £18,000.
Trivial Commutation Lump Sums (2)
- From 6th April 2011, the requirement that the commutation period had to end before the individuals 75th birthday was removed.
- The government has also announced that from 6 April 2012 the LTA will reduce to 1.5 million. The trivial commutation limit will cease to be linked to the LTA and will remain at £18,000
Small Lump Sums
- These provisions allow members to receive lump sums where a scheme has already purchased a lifetime annuity or schem pension for the member, or has transferred all the members rights to another registered pension scheme, and it is found that more benefits are payable to the member or the members twelve month window has passed, and there is a provision which allows an occupational pension scheme which still has benefits for the memeber, to pay these under this rule.
Trivial Commutation Lump Sums (3)
Transfer payment made
- Where a transfer has been made, the following conditions must be satisfied for a small lump sum payment to be made:
- There has been a transfer out of the scheme, for the member, to a registered pension scheme.
- After the transfer there was a "relevant accretion" which means there was a payment to the scheme for the member, or further rights in the scheme were identified for the member, but not because a further contribution was made to it for the member, or that there was a transfer into the scheme for the member.
- A payment is made by the scheme to the member which exstinguishes the members rights.
- The payment is not more than £2,000 and is not more than the value of the "relevant accretion"
- Payment is made by 1 Jun 2010, or six months after the relevant accretion occured.
Trivial Commutation Lump Sums (4)
Scheme pension or lifetime annuity bought
- Where a scheme pension or lifetime annuity has been paid the following conditions must be satisfied for a small lump sum payment to be made:
- The scheme has bought an annuity from an insurance company for the member
- If bought after A Day the member still has unused LTA
- After the scheme pension or Lifetime annuity was purchased there was a relevant accretion.
- A payment is made by the scheme, to the member which exstinguishes the members rights
- The payment is not more than £2,000 and is not more than the value of the relevant accretion.
- Payment is made by 1 June 2010 or six months after the relevant accretion occured.
Trivial Commutation Lump Sums (5)
Benefits arising in an occupational scheme
Where the benefits arise in an occupational scheme, the scheme can pay benefits as small lump sum and does not need to meet the conditions of the full test for trivial commutation. The conditions to be satisfied are:
The member is between age 60-74 inclusive
The member is at arms length from the employer running the scheme
There has not been a transfer out of the scheme for the member in the 3 years before the day the lump sum is paid.
A payment is made by the scheme together with all related schemes that does not have a total value of more than £2,000
The payment made to the member exstinguishes all their rights in the scheme and is made after 1 December 2009.
In all cases where a member receives a lump sum payment in the place of a pension income, the lump sum is taxable in the same way as trivial commutation lump sums.
Benefits payable on death after crystallisation
- The death benefits available after a member starts to receive their pension depend on the type of pension being paid. A lump sum may also be paid under DB scheme.
Scheme pension and Lifetime annuity death benefits
- There are two mutually exclusive benefits for scheme pensions and lifetime annuities: Guarantee periods and Pension/Annuity protection
Max of 10 years.
Guaranteed payments are taxable as income and cannot be commuted.
This form of death benefit is more commonly known as "capital protection".For deaths before 6 April 2011 the position is as folows:
The lump sum payment on death before 75 is he original pension cost, less gross income payments made, less a 35% tax charge
Benefits payable on death after crystallisation (2
- For members of DB schemes, death benefits will only be paid in the form of a pension protection lump sum if the member specifies that death benefits should not be treated as defined benefit lump sums. In practice this means that members of defined benefit schemes can avoid the 35% tax charge.
For deaths on or after 6 April 2011
- Where paid from crystallised funds and the members is under 75, the lump sum payment is taxed at 55%, unless paid as a charity lump sum death benefit. All lump sums paid after age 75, even from unused funds, will be taxed at 55%.
- Where a drawdown pension is being paid for funds crystallised to provide the drawdown pension, for deaths on, or after 6 April 2011, all remaining crystallised funds can be paid as a lump sum although some may be subject to tax, or can be used to provide benefits for dependants.
- For any remaining funds that have not been crystallised, on death before age 75 the remaining value of crystallised funds can be paid to a beneficiary. On death after 75 the lump sum is payable after tax at a rate of 55% is deducted. Alternatively, the funds may be paid as a charity lump sum death benefit and no tax is payable.
Defined benefit schemes must pay dependants pensions as scheme pensions
In a defined contribution scheme, dependants pensions may take any of the following forms:
- A lifetime annuity
- A scheme pension (provided option of lifetime annuity is also given)
- A drawdown pension
The definition of a dependant is the same as for death before benefit crystallisation.
Form of dependants pensions
Dependants pensions paid from a DB scheme must take the form of a scheme pension. If dependants benefits are paid from any other type of scheme they can be paid as:
Dependants Pensions (2)
- A lifetime annuity
- A drawdown pension
- A scheme pension, provided the member of the dependant has initially been given the option of a dependants annuity instead.
If the dependants pension is a drawdown pension, the maximum level that can be paid to a dependant is 100% of the basis amount from the pension year, with no min level. The drawdown year begins on the date the dependant first became entitled to a drawdown pension for the particular arrangement.
Characteristics of a dependants pension
- Normally payable for life or until the dependant ceases to be a dependant e.g. in the case of non dependant child.
- The pension may stop earlier if the dependant remarries.
- There are no restrictions on the size of a dependants pensions.
- May not be subject to any guarantee period
- Cannot have pension/annuity protection
- Cannot be surrendered or assigned, except under a pension sharing order
- Are non-commutable, other than on grounds of triviality.
Trivial Commutation of a dependants pension
Originally a dependant could commute a pension death benefit on grounds of triviality provided:
- The member died before age 75
- The payment is made before the day on which the member would have reached the age of 75
- The commutation extinguishes the dependants entitlement under the scheme to any pension death benefit and any lump sum death benefit in respect of the member.
If the amount of a lump sum payable exceeded 1% of the SLA on the date it was paid, the excess was an unauthorised payment.
From 6/4/11 the restriction on paying lump sums after age 75 was removed. This means that a trivial commutation lump sum can be paid at anytime.
In addition, where a member could have received a lump sum under the small lump sum rule but died before it was paid, the lump sum can be paid to a dependant.
Benefits Payable on death before crystallisation o
The simplified tax regime is generally more straightforward for death benefits than the previous one, and the change in the tax rules was expected to prompt a new demand for pension life cover.
The lump sum death benefits rules distinguish between DB and DC arrangements.
DB lump sum benefit
A DB scheme had to set the lump sum payable on death before age 75 as either a monetary amount or a multiple of salary. There is no requirement that the lump sum can only be paid before drawing pension benefits, so a defined benefit scheme could provide lump sum cover for a pensioner or until they reached 75. For members of a DB scheme, any lump sum payment before ge 75, and after their pension is in payment, was treated as a DB lump sum benefit.
From 6 April 2011 the age 75 restriction was removed which makes it permissable for schemes to pay DB lump sums after age 75. However, these are subject to tax at 55%.
Benefits Payable on death before crystallisation o
Uncrystallised funds lump sum death benefit
The lump sum death benefit represents the value of the uncrystallised funds in a money purchase arrangement paid out on death before age 75.
From 6 April 2011, these can now be paid after age 75, although they are subject to tax at 55%.
All stand alone pension life cover will be a defined benefits lump sum benefit.
Lump sum death benefits must be distributed within two years of the members death to avoid IHT.
Lifetime Allowance Test
The payment of a lump sum death benefit before any retirement benefits are paid, from any scheme, is a BCE and a lifetime allowance test must be carried out. The max TFC is therefore the remaining LTA.
If the lump sum death benefit exceeds the LTA, there will be 55% lifetime allowance charge on the excess, which will be payable by the recipient of the monies. This charge can be avoided by using the excess to provide a dependants pension.
- A person who was married to the member at the time of the members death
- A child of the member who is under age 23 at the date of the members death
- A child of the member who is aged 23 or over, but who, in the scheme administrators opinion, was dependant on the member because of their physical or mental impairment at the date of the members death
- A person who, at the date of the members death, was in the opinion of the scheme administrator to be:
- financially dependant on the member
- in a financial relationship of mutual dependance with the member
- dependant on the member because of their impairment
The dependants pension
All forms of dependants pension musy usually either be payable for life, or until the dependancy ceases. There is no restriction on the size of the pension, but it cannot be guaranteed or be subject to annuity pension protection. It cannot be assigned and it can only be commuted on grounds of triviality.
- Income payments are generally subject to income tax as earned income regardless of whether they are in the form of lifetime annuities, scheme pensions or drawdown pensions.
- Lump sims payable to the member or payable on death before crystallisation of retirement benefits are generally free of income and cgt, athough there could be a lifetime allowance charge.
- Lump sums:
- Payable under annuity pension protection
- Payable on death when the member is under age 75 and the lump sum arises from crystallised rights
- payable after the member has reached 75
- Are subject to a 55% tax charge. In the first instance, the liability to pay the 55% tax falls on the scheme administrator.
- Under DB schemes pension protection death benefits paid before a member reaches the age of 75 are treated as lump sum death benefits
- Contributions and pension/cash rights are generally ignored for IHT purposes, as are lump sum death benefits, provided distributed with 2 years.
- On death whilst in drawdown, the remaining funds can be used to provided benefits in the scheme to a dependant, or be passed to a charity as a charity lump sum death benefit.
Earmarking of pension benefits and offset will remain available after A day and are unnaffected by simplification, but pension credits following a sharing order after A day are affected. The rules for these are:
- Any pension credit created on or after A day will count against the former spouses LTA, and not against the members LTA.
- However, where a pension credit is paid in respect of a members pension that is already in payment and started after April 2006, the former spouse can elect that their lifetime allowance should be enhanced because the pension will already have been tested against the members LTA. The enhancement is calculated with the formula APC/SLA where:
APC - Annual pension creDit is the value of the pension credit when it was aquired.
SLA - Standard lifetime at the date the rights were aquired.
Transitional rules will apply to pension sharing orders thar are in existance on 5 April 2006. In calculating the value of a members lifetime allowance, the recipient of a pre A day pension credit had until 5 April 2009 to apply for enhanced lifetime allowance with the enhancement calculated according to the formula:
IAPC - (Indexed annual pension credit) is the value of the pension credit at the time it was acquired, increased in line with the RPI to April 2006.
SLA - is the standard lifetime allowance i.e. £1,500,000
For the member with a pension debit already in exsistance at A-Day, the value of the debit will be ignored i.e. only the unshared benefits are valued for the purpose of any lifetime allowance test.