Registered Pension Schemes
Since A-Day, pensions have operated under a scheme of registration. As such, for tax purposes there are broadly speaking two types of pension schemes: Registered Pension Schemes and Unregistered Pension Schemes.
Unregistered Pension Schemes can be further broken down into many different types of pension scheme and these will be dealt with elsewhere.
Points of Taxation for Registered Pension Schemes
The taxation of pensions can be divided into essentially three stages:
- Taking Benefits
Usually individuals will be concerned with stage three, so I will deal with that in the greatest detail, but it is worth briefly addressing the other two stages to understand how the full scheme of taxation works for registered pension schemes.
The contribution stage is the point at which contributions are made to a pension scheme. This is primarily governed by Part 4 of the Finance Act 2004 (“FA 2004“).
In short, what you need to know is:
- You (as an employee / member as opposed to your employer) can make unlimited contributions to a registered pension scheme in a tax year BUT there is a limit on the amount of contributions that will receive tax relief.
The limit is the greater of 3,600 pounds or your relevant UK earnings with a total cap of the annual allowance (currently 40,000 – see here).
- Your employer can make unlimited contributions to your pension scheme. They receive tax relief on these through deducting them from their profits as a business expense.
You are not taxed on these contributions as your own earnings. However, these contributions will count towards your annual allowance so if your employer contributes too much, you may be subject to taxation on the excess.
There are few tax charges to be concerned with as the member/employee during the investment stage. It is worth noting that there are generally exemptions for income and gains on the investments (see section 186 FA 2004).
Your greatest concern as a member of a pension schemes is going to be when can I take my benefits and how can I make sure to take them tax efficiently.
The registered pension scheme rules aim to encourage people to take their benefits between the minimum pension age and 75 years old.
But can I take my money out early?
If you want to take benefits before you turn 55, you can but they are treated as unauthorised payments unless you can satisfy the ill-health condition or you have a protected pension age. Unless you absolutely must drawdown early, I would suggest avoiding it as the unauthorised payment charges are higher than the traditional tax charges so it can be an expensive way to get access to your money.
So what can I do?
When you reach the normal minimum pension age (55), you can look into accessing your pension savings. To access them without suffering unauthorised payment charges, you will need to ensure that your payment of benefits complies with the pension rules. Your pension provider / financial adviser should be familiar with these.
What form can my benefits take then?
You can take your benefits in a variety of forms including: a lifetime annuity, a drawdown pension, a scheme pension, or an uncrystallised funds pension lump sum. The first three options are taxable and you can choose to take a tax-free pension commencement lump sum at the start. If you choose to take everything as a lump sum then part of it is taxable and part of it is not.
This is where it gets more complicated. The pension rules will differentiate between registered pension schemes on the basis of whether they provide benefits on a money purchase of a defined benefits basis.
If you have a money purchase arrangement, then the pension income can be provided in the following ways dependent upon the scheme rules:
- through the purchase of a lifetime annutiy contract from an insurance compnay;
- as a scheme pension;
- through the provision of a drawdown pension; or
- as an uncrystallised funds pension lump sum.
A defined benefits arrangement may only provide the member with a pension income as a scheme pension.
What is the most tax efficient way for me to do this?
For the most part, your pension income will be taxed as your income in the year in which it is received – this includes whether it is taken as a lump sum or as annual payments.
If possible, you can consider taking an uncrystallised pension lump sum provided you have sufficient available lifetime allowance. 25% of this lump sum is free of income tax and so that can be tax efficient. Other lump sums may be taxed differently and it is worth taking advice to see what options may be available to you given your circumstances.
Otherwise, what is important is ensuring that the payments are authorised so they don’t result in additional charges.
You mentioned 75, what happens at 75?
When you reach 75, any uncrystallised rights will crystallise for lifetime allowance purposes meaning that they may result in a tax charge.
The age 75 is also relevant due to the income tax consequences that follow on death depending on whether the individual dies either before or after they reach the age of 75. If they are over 75 when they die, there are income tax charges for the beneficiaries to be concerned with but there is not a tax charge if it is before the person reaches 75.
Do I need to be concerned with any of the other taxes?
Yes – you will want to be sure that you do not inadvertently find yourself with an inheritance tax charge. This is a relatively simple problem to avoid and in most instances, your financial adviser/pension provider will ensure that there is no inheritance tax charge, but it is something you will want to confirm with them.
Mary regularly advises on pensions tax issues that arise, on tax-efficient ways to take your pension, and on what steps you can take to ensure that you are making the best choices from a tax perspective. For more, please contact her here.