How have the pension income drawdown rules changed from 6 April 2011
Some important changes were made to the pension benefit rules from 6 April 2011.
In particular:
•Pensions and lump sums no longer have to be taken by age 75;
•New income drawdown rules have replaced the existing unsecured pension (USP) and alternatively secured pension (ASP) rules, which have been abolished;
•A new type of income drawdown, known as flexible drawdown, is available for those who meet the new minimum income requirement (MIR);
•Existing USP and ASP cases will be gradually moved fully onto the new basis under transitional rules;
•The death benefit rules, and aspects of their tax treatment, have changed.
Do pensions and lump sums have to be taken by age 75?
After 5 April 2011, benefits don't have to be taken from a registered pension scheme by age 75 - they can just be left in the scheme as unused funds until the member needs them. Where scheme rules allow, this gives members the flexibility to delay taking their pension or tax-free lump sum until after age 75 - potentially even continuing a phased retirement strategy into their 80s or beyond.
However, the benefits still have to be tested against the lifetime allowance by age 75 (as a benefit crystallisation event). So even though the member may not be taking anything from their fund, if those unused funds are greater than the remaining lifetime allowance, a lifetime allowance tax charge will have to be paid. Any lifetime allowance charge incurred at age 75 would be at the rate of 25%, with the residual excess fund retained in the scheme to provide taxable pension income.
This also means that lump sum death benefits paid after age 75, even from unused funds, will be subject to the 55% tax charge - unless it's a charity lump sum death benefit (which can be paid tax-free).
From 6 April 2011, the following lump sums can also be paid after 75:
•Trivial commutation lump sums;
•Trivial commutation lump sum death benefits;
•Winding up lump sums;
•Serious ill-health lump sums (but only from unused arrangements and subject to a 55% tax charge).
What are the new pension income drawdown rules from 6 April 2011?
On 6 April 2011, the unsecured pension (USP) and alternatively secured pension (ASP) rules were replaced by a new single set of income drawdown rules that are similar to the current USP rules. The key features of the new rules are as follows:
Income limits
•The highest income allowed in a pension year is 100% of the basis amount from the GAD tables at all ages (down from the 120% USP limit, but up from the 90% ASP limit).
•The lowest yearly income allowed is nil (the same as the USP rules, but significantly more flexible than the 55% minimum that had to be taken under the current ASP rules).
Those who meet the new minimum income requirement (MIR) may also have the option of flexible drawdown, which allows unlimited income to be taken at any time.
The GAD tables have been updated to reflect recent mortality improvements and extended to cover ages after 75.
Income reviews
•Until age 75, the income limit must be reviewed at least every three years.
•Once over 75, the limit must be reviewed every year.
Death benefits
•Lump sum death benefits are allowed from income drawdown funds at any age (a welcome relaxation for the over 75s).
•For deaths after 5 April 2011, any lump sum death benefit paid from an income drawdown fund (or after age 75 from unused funds) are taxed at 55% (up from the 35% that previously applied under USP). Lump sums paid on or after 6 April 2011 as a result of a death in USP before then will still be taxed at 35%.
Timing
•The new rules apply immediately to any arrangement moved into income drawdown for the first time after 5 April 2011.
•People in USP or ASP before 6 April 2011 will be moved fully onto the new rules over a period of up to 5 years under transitional rules.
What is pension flexible drawdown?
Flexible drawdown is perhaps the most radical aspect of the new income drawdown rules from 6 April 2011. Under flexible drawdown there's no limit on the amount of income that can be drawn each year - the individual can take their entire income drawdown fund out in one go if they really want to!
The usual tax free lump sum is allowed, but any other withdrawals taken by the individual will be taxed as income in the tax year they're paid. If an individual becomes non-UK resident whilst in flexible drawdown, any income drawn when non-resident will be subject to UK tax if they return to the UK within five tax years of taking it.
To opt for flexible drawdown, an individual must:
•meet the minimum income requirement (which is a safety net, so they won't fall back onto State benefits); and
•not make contributions to a money purchase pension scheme in that tax year - including employer and third party payments; and
•not be an active member of a final salary scheme at the time of making the declaration.
Protected rights
Protected rights funds can use the normal income drawdown basis but can't go into flexible drawdown.
When will the 2011 income drawdown rules apply to existing unsecured or alternatively secured pensions?
People already in unsecured pension (USP) or alternatively secured pension (ASP) before 6 April 2011 will be moved fully onto the new income drawdown rules over a period of up to 5 years.
Unsecured pension (USP) - income limits
Those in USP on 5 April 2011 will keep the 120% income limit until the earliest of:
•Next reference period: The start of their first new reference period (that is, when their five year review falls due or at any earlier interim annual review); or
•Drawdown transfer: The start of their next drawdown year after transferring their drawdown fund; or
•Age 75: The start of their next pension year after age 75.
New phasing, part annuitisation or pension sharing after 5 April 2011 will still trigger an income review. The limit will be calculated using the new GAD tables, but the maximum income will still be 120% of this revised amount. This review won't change the five year reference date or trigger a move to the new 100% income limit.
So someone who goes into USP before 6 April 2011, or resets their five year reference period by requesting an interim review on the anniversary of their drawdown year before 6 April 2011, may not move onto the lower 100% income limit and more frequent reviews until well after 2011.
Alternatively secured pension (ASP) - income limits
Those in ASP on 5 April 2011 will have their first income review using the new rules at the start of their next pension year.
•Until then, the basis amount calculated at their last income review will remain in force.
•However they can switch off their income, or increase it to 100% of their existing basis amount, immediately from 6 April 2011.
How have the pension death benefit rules changed from 6 April 2011?
From 6 April 2011, there are some significant changes to the pension death benefit rules:
•Lump sum death benefits are allowed at any age.
•For deaths after 5 April 2011, the tax charge on lump sum death benefits paid from crystallised rights is 55% (up from the current 35%).
•Tax-free charity lump sum death benefits are allowed in more circumstances.
•The scope for an IHT charge against pension rights has been narrowed.
Death benefits paid from 6 April 2011 relating to a death before then are still be covered by the old rules.
Death before age 75
On death after 5 April 2011 aged less than 75, any lump sum death benefit is:
•still tax free if paid from uncrystallised rights;
•but normally taxed at 55% if paid from crystallised rights (such as income drawdown funds or a value protected annuity). The only exception is for charity lump sum death benefits, which can be paid tax-free from crystallised rights.
Death on or after age 75
On death after 5 April 2011 aged 75 or over, it's okay to pay lump sum death benefits. This is a sea-change from the previous position on death in alternatively secured pension (ASP), where only a charity could legitimately have benefited from a lump sum on death.
•Any lump sum death benefit paid after 75 (including those from unused funds) is taxed at 55%.
Charity lump sum death benefits
Before 6 April 2011, a charity lump sum death benefit could be paid tax free to a nominated charity on death in ASP where there were no surviving dependants. For deaths after 5 April 2011, this option has been extended to cover death in drawdown before age 75.
To qualify as a tax free charity lump sum death benefit, all the following criteria must be met:
•The lump sum is paid from income drawdown funds; and
•There are no surviving dependants of the member to pay a pension to; and
•The deceased member (or dependant) had nominated a recipient charity (it's no longer possible for the scheme administrator to make a nomination).
Lump sums that don't meet these criteria can still be paid to charities, but they will be treated as normal lump sum death benefits - so if they come from crystallised rights the usual 55% tax charge would apply.
IHT
Before 6 April 2011, pension rights could create IHT liabilities - albeit only in fairly limited circumstances. Two significant changes were made from 6 April 2011 that make the risk of IHT charges even smaller:
•The abolition of the ASP rules mean that the IHT charges that previously applied on death in ASP don't apply for deaths after 5 April 2011.
•The ability for HMRC to levy IHT where they consider that someone has deprived their estate through an "omission to act" (for example, by delaying taking their pension) has been removed for omissions after 5 April 2011.
Any reference to legislation and tax is based on our understanding of United Kingdom law and HM Revenue & Customs practice at the date of production. These may be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.
