CEMAP 1 Topic 10- Pension Products Flashcards
What tax reliefs and allowances are available?
UK residents under the age of 75 can receive income tax relief at their highest marginal
rate on annual contributions to occupational and private pension schemes, up to a maximum threshold.
There is a limit on the gross amount that can be saved into a pension each tax year. This is called the annual allowance. If the combined total of
contributions exceeds this figure, tax is charged on the excess. The annual allowance is tapered for higher earners, taking account of threshold income and adjusted income.
Threshold income is calculated through the following steps:
- Calculate total net income for the tax year.
- Deduct any gross pension contributions that benefited from relief at source (but excluding any employer contributions).
- Deduct any lump sum death benefits from registered pension schemes.
- Add any reduction of employed income for pension provision through salary sacrifice schemes made after 8 July 2015.
- Add any reduction of employed income for pension provision through flexible remuneration arrangements made after 8 July 2015.
Adjusted income is calculated through the following steps:
- Calculate total net income for the tax year.
- Add claims made for tax relief on pension savings paid before tax relief was given.
- Add pension savings made to pension schemes where tax relief was given.
- Add any tax relief claims on pension savings made to overseas pension schemes (for non‑domicile individuals).
- Add employer pension contributions.
- Deduct any lump sum death benefits received from registered pension schemes.
Two further allowances are important:
- Lifetime allowance – if the total value of an individual’s pension benefits exceeds the lifetime allowance at the point when benefits are taken, there is a lifetime allowance tax charge. The pension provider will deduct the
tax before benefits are issued. There are different tax rates charged depending on how the money is paid out, with lump sums attracting a higher charge than funds taken as income or withdrawals.
- Money purchase annual allowance (MPAA) – this applies where a pension scheme member draws benefits from their pension using flexi‑access drawdown income or takes an uncrystallised funds pension lump sum
(UFPLS).
In respect of contributions to personal pensions, tax relief is given at source at the basic rate with any higher‑/additional‑rate relief claimed via an
individual’s self‑assessment tax return. Marginal higher‑rate relief is given at source on contributions to occupational pensions as any pension contribution is deducted from gross, pre‑tax, income.
Within a pension fund there is no capital gains tax on gains and no income tax on savings or dividend income.
When and how can benefits be taken?
Benefits can generally be taken from normal minimum pension age, which is currently age 55 (expected to rise to 57 in 2028). When benefits are drawn the scheme member can usually take up to 25% of the fund as a tax‑free cash sum, referred to as a pension commencement lump sum (PCLS).
The rules regarding to taking the remainder depend on the type of scheme.
- Defined‑benefit scheme – the balance over and above any tax‑free cash must be used to provide an income, typically as a scheme pension direct from the pension fund.
- Defined‑contribution scheme – the balance once tax‑free cash has been taken can be used to provide income in the form of an annuity or flexible access drawdown (FAD).
An alternative is to take a UFPLS – Providers are not obliged to provide customers with the option of taking UFPLS, but customers have the option of switching providers should they wish to do this
Key Terms
ANNUAL ALLOWANCE
Maximum amount that can be contributed to a pension during a tax year without a tax charge being applied.
LIFETIME ALLOWANCE
The total amount that an individual may hold in tax‑privileged pension schemes at the point where the benefits are taken, without incurring a tax charge.
DEFINED‑BENEFIT SCHEME
A scheme in which the pension benefits the individual will receive are specified from the outset. Also referred to as a final salary scheme.
DEFINED‑CONTRIBUTION SCHEME
A scheme in which an agreed level of
contributions is paid but the benefits
that the individual ultimately receives depend on the performance of the investments into which the contributions are paid. Also referred to as a money‑purchase scheme.
PENSION COMMENCEMENT LUMP SUM
The sum (up to 25% of the individual’s pension fund) that may be taken at retirement tax‑free
Occupational schemes
Employees may be members of an occupational scheme. Occupational schemes fall into two main types, depending on how benefits are arranged:
- Defined benefit – the employee may receive a pension that is calculated as a percentage of final salary.
The longer the employee has been a member of the scheme, the higher the percentage.
Alternatively, the scheme may be a career average scheme within which pension benefits are based on a proportion of earnings averaged over the period an individual has been employed by a particular employer.
- Defined contribution – an agreed contribution is invested for each member. On retirement, the accumulated fund is used to purchase benefits. The level of benefits is not guaranteed by the employer and will depend on the size of the fund which, in turn, depends on how much is paid in and on investment performance.
Collective defined-contribution pension schemes
Demand for a third type of scheme, which can provide more predictability for scheme members than defined contribution, without the cost volatility for employers associated with defined benefit. The Pension Schemes Act 2021 provides a framework for the UK’s operation and regulation of collective money‑purchase schemes (AKA collective defined‑contribution pensions). The new collective
defined‑contribution (CDC) pension will see both the employer and employee pay into a joint fund, with pensions paid out from this shared pot. The benefits of the new scheme include that it offers predictable costs for the employer and is more resilient against economic shocks. The Royal Mail and Communication Workers Union will be the UK’s first CDC scheme.
Topping up defined-benefit schemes
As people are now living longer, employers are finding defined‑benefit schemes increasingly expensive to run. Many are reducing their commitment and transferring
responsibility for pension provision to individuals. Many people may therefore
wish to supplement their retirement income by contributing more to their occupational schemes, or contributing to private arrangements.
The following are tax‑efficient pension arrangements:
- additional voluntary contributions (AVCs);
- free‑standing additional voluntary contributions (FSAVCs);
- personal/stakeholder pension plans.
AVCs and FSAVCs are available to employees who are members of occupational schemes. Personal/stakeholder pensions are generally available to anyone under the age of 75.
Funds do not pay capital gains tax or income tax.
Additional voluntary contributions
AVCs are additional contributions to an occupational scheme. Sometimes, such contributions purchase additional years’ service in a final salary scheme.
However, most AVCs operate as money‑purchase arrangements and the employee will only have a limited choice of funds.
The employer will usually cover some or all of the administration and fund management costs. Contributions to AVCs are deducted from gross salary and the employee therefore receives full tax relief at the same time.
Free‑standing additional voluntary contributions
An individual might choose to contribute to
an FSAVCs money‑purchase fund provided by a separate pension provider.
FSAVCs are available from a range of financial institutions, including insurance companies, banks and building societies.
Contributions to FSAVCs are made from taxed income. Tax relief at the basic rate of 20 per cent is claimed by the pension provider and added to the individual’s pension fund. Higher‑ and additional‑rate taxpayers need to claim
additional relief separately through their income tax self‑assessment.
Until 2006, FSAVCs were attractive to employees who wished to keep their financial arrangements independent from their employer and because they offer a wider range of investment funds than AVCs. Their drawback
is that they tend to be more expensive than AVCs because the employer is not bearing the costs. Once personal/stakeholder pensions became available to all employees in April 2006, FSAVCs became much less popular
Workplace pensions
Workplace pensions and auto‑enrolment were introduced in 2012.
Under auto‑enrolment, employers must enrol ‘eligible’ workers in a qualifying workplace pension and contribute a specified minimum amount to the scheme.
Many existing occupational pensions already qualified as a suitable pension scheme for this purpose; those employers who did not have a scheme already could set one up, or enrol their employees in the National Employment Savings
Trust (Nest)
The criteria for auto‑enrolment are that the employee:
- is not already in a pension at work;
- is aged 22 or over;
- is under state pension age
- earns more than £10,000;
- works in the UK
An employee can choose to opt out of the scheme, but only after they have automatically been made a member.
Since April 2019 a minimum of 8 per cent of an employee’s earnings have to be paid into the scheme, made up of an employer contribution of 3 per cent, an employee contribution of 4 per cent and tax relief of 1 per cent
What is a personal pension?
