Pensions

Question 1

What is a pension scheme?

Answer 1

• is a saving plan for retirement that enjoys special tax privileges, but only if the scheme is registered with HM Revenue and Customs (HMRC)

Question 2

What is the investing in a pension scheme?

Answer 2

• is a long term investment and is very tax efficient

Question 3

What are the tax advantages of investing into a pension scheme?

Answer 3

• the individual obtains tax relief on the contributions made into the scheme
• where an employer contributes into the scheme, tax relief for the employer contributions is available without there being a taxable benefit for the employee
• pension scheme funds grow tax-free as the scheme is exempt from income tax and capital gains tax
• when taking the pension, some funds can be withdrawn as a tax-free lump sum

Question 4

What are the two main types of pension scheme?

Answer 4

• occupational pension schemes
• personal pension schemes

Question 5

What pension can have employed individual?

Answer 5

• join an occupational pension scheme provided by his, her or their employer
• choose not to join the employer’s scheme and set up a personal pension scheme
• contribute into both his, her or their employer’s occupational scheme and set up a personal pension scheme

Question 6

Occupational pension schemes?

Answer 6

• is a scheme set up by a specific employer for the benefit of its employees
• the employer may use an insurance company to provide and run a pension scheme or employees, or it may set up its own self-administered pension fund
• contributions into an occupational scheme may be made by both the employer and the employee

Question 7

What are the types of occupational pension schemes?

Answer 7

Defined benefit scheme:
- the benefits obtained when taking the pension are linked to the level of earnings of the employee during employment
Money purchase scheme
- the benefits obtained when taking the pension depend upon the performance of the investments held by the pension fund

Question 8

Who can establish personal pension scheme?

Answer 8

• the employed
• the self-employed
• those not working ( including children)

Question 9

Who can contribute into persona pension schemes?

Answer 9

• the individual
• any third party on behalf of the individual

Question 10

Overview of the tax relief rules for pension schemes?

Answer 10

• the amount of tax relief available for pension contributions is the same regardless of whether the scheme is an occupational or personal pension scheme

Question 11

When is a tax relief available for pension contributions?

Answer 11

• the pension scheme is a registered scheme and
• the individual is resident in the UK and aged under 75
• up to a maximum annual amount each year

Question 12

Tax relief is available on contributions up to the lower of:

Answer 12

• total gross pension contributions paid
• maximum annual amount = higher of:
  
  • £3,600
  • 100% of the individual’s ‘relevant earnings’ assessable to income tax in the tax year

Question 13

What includes relevant earnings? (tax relief)

Answer 13

• taxable trading profits
• employment income and profits from furnished holiday lettings
• no investment income

Question 14

The maximum annual amount applies to the total gross contributions made into all schemes where:

Answer 14

• an employee contributes to both an occupational and a personal pension scheme, or
• an individual contributes into more than one personal pension scheme

Question 15

What if an individual has no relevant earnings, can he still obtain tax relief?

Answer 15

yes, on gross contributions of up to £3,600 per annum

Question 16

How is given relief for basic rate tax relief?

Answer 16

• is automatically given by deduction at source when contributions are paid, as an individual makes contributions net of the basic rate of income tax (20%)
• contributions into a personal pension scheme benefit from basic rate tax relief, even if the taxpayer is paying tax at the starting rate, higher rate or not paying tax at all
• HMRC pay the 20% tax relief to the personal pension scheme

Question 17

How is given relief for higher and additional rate tax relief?

Answer 17

• basic rate relief of 20% is given at source
• further higher and additional rate relief is given by extending the basic and higher rate tax bands by the gross amount of pension contributions paid in the tax year
• an amount of income equal to the gross pension contributions is removed from the charge to higher rate tax and is taxed at the basic rate instead, and the same amount is removed from the charge to additional rate tax and is taxed at the higher rate instead
• the individual’s higher rate and additional rate thresholds are extended to £47,700 (£37,700 +£10,000) and £160,000 (£150,000+£10,000)

Question 18

Occupational pension scheme

Answer 18

• employees payments are made gross and tax is given at source by the employer through the PAYE system, as an allowable deduction against employment income
• the employer will deduct the pension contribution from the individual’s earned income, before calculating income tax under the PAYE system
• tax relief is therefore automatically given at source, at the employee’s highest rate of tax

Question 19

Contributions made by employers into pension schemes

Answer 19

• tax deductible in calculating the employer’s taxable trading profits, provided the contributions are paid for the purposes of the trade
• and exempt employment benefit for the employee
• added to the pension contributions paid by the employee on which tax relief is given to determine whether the annual allowance has been exceeded

Question 20

Employer contributions - trading deduction

Answer 20

• the deduction against the employer’s trading profits for pension contributions is given in the accounting period in which the contribution is actually paid

Question 21

Adjustment to profit computation - employer contributions

Answer 21

• add back any amount charged in the statement of profit or loss
• deduct the amount paid in the accounting period

Question 22

Annual allowance AA

Answer 22

• for a tax year is £40,000, but this can be increased by bringing forward any unused annual allowance from the previous three tax years
• an unused AA can only be carried forward if the individual was a member of a pension scheme for that tax year, otherwise it is lost
• the AA for the current year is used first, then the AA from earlier years, starting with the earliest tax year

Question 23

Calculation of annual allowance charge

Answer 23

• where the total of all contributions on which relief has been obtained exceeds the AA there is a tax charge on the excess
• the tax charge is calculated as if the excess is the individual’s top slice of income at non-savings rates

Question 24

Restriction of annual allowance - high income individuals

Answer 24

• the annual allowance is gradually reduced for individuals with high income
• the restriction applies to individuals with a ‘threshold income’ exceeding £200,000 and ‘adjusted income’ exceeding £240,000
• the restriction operates in a similar way to the reduction of the personal allowance for high earners
• the annual allowance is reduced by:
  (Adjusted income - £240,000) x 50%
• the minimum that the annual allowance can be reduced to is £4,000
• if the ‘adjusted income’ exceeds £240,000 the annual allowance for the tax year is reduced
• where the annual allowance has been reduced for a high income individual, it is the reduced annual allowance which is compared to actual contributions in a tax year when determining if there is any unused annual allowance to carry forward
• when an individual’s adjusted income is £312,000 or more the annual allowance is reduced to £4,000

Question 25

Calculation of adjusted income (annual allowance purpose)

Answer 25

Net income (from the income tax computation) x
Plus: Individual employee’s occupational pension contributions x
Employer’s contributions to any scheme for for that individual x

Question 26

What will happen once invested, funds in pension scheme?

Answer 26

• are accumulated and can grow in value, tax free
• exempt from income tax in respect of any income earned from the assets invested
• exempt from capital gains tax in respect of any capital disposals made by the trustees over the life of the scheme
• funds fall outside the death estate for inheritance tax purposes

Question 27

Accessing the pension fund ( individuals in defined benefit schemes - principally occupational pension schemes)

Answer 27

• the benefits on reaching pension age are linked to the level of earnings of the employee

Question 28

Accessing the pension fund (individuals in money purchase schemes - principally personal pension schemes)

Answer 28

• the benefits on pension age are dependent on the amount of funds accumulated in the pension fund
• individuals have flexibility in the way in which they can access the accumulated funds
• they can withdraw 25% of the fund as a tax-free lump sum
• the balance of the fund can be accessed in a variety of ways (including purchasing an annuity), to suit the individual’s circumstances, to provide income for the individual in their retirement
  -withdrawals from the balance of the fund are taxed as non-savings income in the tax year they are withdrawn at the normal rates of tax