BeeHive > BeeLines > More complex explanations to help us understand simplification
More complex explanations to help us understand simplification
Right then, now where was I? Oh yeah! Pensions…
Uh, before I forget, have a happy new year and everything and I hope your Christmas break was good and stuff, but there’s no getting away from it I’m afraid, we’re back now and it’s real life again. Now, I don’t know what you were doing on the 23rd of December, but I notice that Her Majesty’s Revenue & Customs types were still chained to their desks and using the run up to the festivities to churn out ever more detailed explanations of how the highly and befuddlingly complex new tax rules will combine to produce a single, simple pensions environment from A-Day in April this year. In short, on the eve of Christmas Eve HMRC published its eighth Pensions Tax Simplification Newsletter and that’s what I’m bothering you with in this first BeeLine of 2006. I just know some of you will have missed it.
The Newsletter covered a number of issues as is usual, but the main thrust of it was to explain how life assurance will work alongside Enhanced Protection. That’s what I’ll try to explain here, but I’ve included a link to the newsletter at the end of this BeeLine so that those of you who are collecting the whole set can download your own copy.
As I’m sure you probably already know people who find that they have accumulated an excessive amount of pension savings by the 5th of April 2006 (the day before A-Day) will be taxed at 55% on the excess if they are not smart enough to protect themselves. Unless you’ve been on Mars or somewhere equally remote for the last few years you’ll know that the new tax laws coming into force on A-Day have defined what ‘excessive’ means in this context. Basically if your pension is valued at more than £1.5 million at 5th April 2006, then as far as the Government is concerned you’ve been overdoing it and you’re in line for a bit of retrospective taxation. But that doesn’t have to have "Ouch!" written all over it as the tax guys have been nice enough to give people a ‘get out of tax free card’ called ‘protection’. There are two types of ‘protection’ available; Primary Protection and Enhanced Protection, and believe it or not, you can have both together. (There are three types actually. The one I’ve missed out is called No Protection, but that’s only really on offer to people who don’t get proper financial advice in the run up to the drop-dead date of 5th April 2006. Horrible as that is it shouldn’t bother anyone reading the BeeHive I hope.) If you want to refresh your memory on the various ins and outs of ‘protection’ you can do that by chasing out these BeeLines here (but do try to keep up in future, please…):
Scheme Audits: part 1 - scheme benefits and contributions
Scheme Audits: parts 2 & 3 - administration and communication
Scheme Audits: parts 4, 5 & 6 - transitional protection
OK. Now I’ll try to make this explanation of how simplification will work in practice as simple as I can, but before I start I have to say that it’s one of the most complicated things I’ve attempted so far in the history of the BeeHive. Newsletter No.8 sets out to clarify the position of someone who goes for Enhanced Protection and then has the misfortune to die before they retire (or at least before they ‘crystallise’ their benefits, which is new pension speak for what you or I would call retirement).
The basic rule is that if someone gets granted ‘Enhanced Protection’ their pre A-Day pension benefits are protected from the new 55% tax as long as they or their employer don’t pay in a penny more towards their pension for the rest of their life. So, for example someone with pension assets at 5th April 2006 valued at £4 million, say, who applies for Enhanced Protection and gets it, stands to lose all that valuable protection if they’re daft enough to drop twenty quid into their AVC or Personal Pension pot at some point on or after A-Day. That’s not something that anyone in that position would be advised to do. It wouldn’t be a sound economic decision, put it that way.
That’s fair enough and we all know that, but the trouble with the life assurance thing seems to be that, depending on how the life assurance is set up in any particular scheme, it could sometimes blow the Enhanced Protection just as if someone had paid some money into the UK pension system. That has got "Ouch!" written all over it, by the way, as the person dying might kick themselves afterwards if they didn’t know about it.
To complicate things a bit as far as pension simplification is concerned there are three different types of pension scheme or arrangement; Defined Benefit, Cash Balance and something HMRC now refer to as ‘Other Money Purchase’. (You couldn’t make this up, could you?) Depending on which form of benefit becomes payable (and people can become entitled to a mix of types for the one death) Enhanced Protection can sometimes be blown and the 55% tax will kick in.
What someone going for Enhanced Protection needs to get their head round is whether under the terms of their pension arrangement the death benefits to be provided are calculated by reference to a pot of money. You know the sort of thing, someone with a Personal Pension getting the pension pot paid out as a death benefit is a good example. If you ask yourself that question and the answer is ‘no’ then the arrangement is a Defined Benefits arrangement. The trouble is, if the answer is ‘yes’ you then need to decide if the arrangement provides a ‘Cash Balance’ benefit, or if it’s a bog standard ‘Other Money Purchase’ arrangement and that’s not as easy as it sounds.
A Defined Benefit benefit is probably the easiest to spot as it is a promised benefit of some sort, say four times salary on death for instance. That’s quite common in occupational pension schemes. The difference between Cash Balance benefits and ‘Other Money Purchase’ benefits is a bit more obscure, though, and sometimes might only be possible to determine by looking through the scheme documentation or policy (or better still, checking with the scheme provider). The trick to spot is that a Cash Balance benefit is calculated by reference to a promised specified pot, which doesn’t necessarily mean it is actually there, whereas an ‘Other Money Purchase’ benefit arises in respect of a pot of real money that is actually there and the value of the pot determines the exact amount of the payout. To put that another way a Cash Benefit benefit could be described as a payment of £300,000, say, on death, whereas an ‘Other Money Purchase’ benefit would be described as a return of fund on death.
Those of you still reading and thinking ‘So what?’ at this stage will be surprised to hear that the basic rule seems to be that ‘Other Money Purchase’ death benefits will not cause Enhanced Protection to be lost, but Cash Balance or Defined Benefit lump sum death benefits may cause Enhanced Protection to be lost. So it’s pretty important.
Having explained it as well as I can thus far I’m now throwing the towel in and I recommend that anyone who is potentially affected by this, or knows someone who is, probably ought to get a copy of the HMRC Newsletter and work though the examples for themselves. There are links contained in that document to the various pages of the online Technical Manual that define the various types of pension arrangement and how this is meant to work in a dynamic environment where the Lifetime Allowance is itself increasing. The link to Newsletter No.8 is here:
HMRC Pensions Tax Simplification Newsletter No 8
That’s it for this one. I know it’s not the most readable (or understandable) BeeLine I ever wrote, but it’s an important point for a lot of people. All I can say is that we should thank our lucky stars the government guys set out to simplify pensions and not to complicate them. Goodness only knows where that could have ended up!
6 January 2006
This information is based on our understanding of the Finance Act 2004 and HMRC Pensions Tax Simplification Newsletter No 8.
Any research and analysis included has been provided by us for our own purposes and the results of it are being made available only incidentally.
