Human Resources
Pensions and Tax
Below is a general outline of the changes to the taxation of pensions that came into effect on 6 April 2006. It is not intended to be exhaustive and more information can be found in detailed guidance available in the downloads section or from your pensions administrator.
The main legislation which controls the taxation of pensions is the Finance Act 2004, which has been amended by the Finance Act 2005 and will be amended further by the Finance Act 2006. There are then numerous regulations relating to specific aspects; draft regulations are listed on the HMRC website.
The tax treatment of pensions changed significantly on 6 April 2006. In a number of respects the legislation is permissive. For example:
- there is no limit to the amount that an individual may pay in pension contributions; but there is a limit to the amount that may be paid free of tax
- there is no limit to the amount of pension benefits which may be paid to an individual; but payments in excess of a limit will be subject to a tax charge.
However, in other areas the legislation is restrictive. In particular, the payments that a pension scheme is authorised to make are set out by statute, and anything that falls outside the precise definition will be an 'unauthorised payment'.
New terminology introduced by the Finance Act 2004 includes:
The annual allowance – the amount by which the value of an individual’s pension benefits may increase in a tax year without the individual incurring a tax charge, set initially at £215,000 for 2005/06 and increasing as follows:
2007/08 - £225,000
2008/09 - £235,000
2009/10 - £245,000
2010/11 - £255,000
The lifetime allowance – the amount within which an individual’s total pension benefits will not be subject to an additional tax charge, set initially at £1.5m for 2006/07 and increasing as follows:
2007/08 - £1.6m
2008/09 - £1.65m
2009/10 - £1.75m
2010/11 - £1.8m
Tax relief on member contributions is a separate issue from the lifetime allowance. If pension benefits are paid above the lifetime allowance, arrangements must be made to pay any tax which is due. The tax charge is 25% on any excess pension payments and 55% on any excess lump sum.
A benefit crystallisation event – broadly, something which triggers the payment of pension benefits. As the tax legislation permits an individual to receive a pension whilst continuing to work for the same employer, a term has to be invented as “retirement” is not necessarily applicable.
It will be noted that the payment of a retirement lump sum and the payment of a retirement pension are separate benefit crystallisation events.
At each of these events, the amount of the lifetime allowance used must be calculated. For NPPS:
• A pension is valued at 20 times the annual pension payable for the first 12 months
• A lump sum is valued at the amount of the lump sum
• A transfer to a qualifying recognised overseas pension scheme is valued at the amount of the transfer payment.
This amount is then compared to the amount of the individual’s lifetime allowance remaining to see whether the lifetime allowance has been exceeded.
More information
HMRC have provided extensive guidance on the taxation of pensions in the Registered Pension Schemes Manual, which is accessed from the HMRC website (new window) and currently contains over 1,500 individual web pages. The Technical Pages give the most detailed guidance. A short version of the HMRC guidance is available on this website in the Downloads section.
