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Wednesday, 20 March 2013 09:43

Types of Pension

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Brief explanations of the different types of UK pensions are given below.

Basic state pension

Although an entitlement for most people, the amount received from the basic state pension will depend on the amount of national insurance contributions paid.

Full state pension allowance

For the year 2011/2012, the full pension allowance for a single person who has made sufficient contributions is £102.25 per week.

A married individual's state pension allowance is currently £61.20 per week if using their partner's national insurance contribution record. The married couple's pension allowance will be £163.45 per week in total (£102.25 plus £61.20).

If both partners have worked throughout their lives and have made sufficient national insurance payments individually, the separate single pension entitlements will apply. This means the total combined state pension allowance for a married couple or civil partnership rises from £161.45 to £204.50 per week.

Weekly state pension allowances (2011/2012)

Single person state pension allowance

£102.25

Married partner's state pension allowance

£61.20

Married couple's state pension allowance

£163.45

Both partners with full individual entitlement

£204.50

State Second Pension

On 6 April 2002, the State Second Pension (S2P), introduced by the Child Support, Pensions and Social Security Act 2000 replaced the State Earnings Related Pension Scheme (SERPS).

Not available for self-employed individuals, SERPS was set up in 1975 by the Social Security Pension Act 1975 and began in 1978. It is independent of basic state pension entitlement and it is based on a proportion of earnings during your working life.

S2P will initially start as an earnings-related scheme similar to SERPS but with three different accrual rates and the build up will vary for each tax year depending on the individual's earnings.

It is predicted however that at some point in the future, this will change to a flat-rate scheme to accrue uniformly over 40 years.
Personal and Stakeholder pensions
Personal pensions, introduced on 1 July 1988, originally aimed to give people who were not part of a company pension scheme their own portable pension, designed on a money purchase basis although since April 2001 certain individuals who are members of company pension schemes can also take out personal pensions.

Legislation for personal pensions and stakeholder pensions are identical (only the charges and product terms are set for stakeholder).


Annual pension allowance

Annual pension contributions have a new limit attracting full tax relief. This limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any contribution over the annual allowance will be subject to a tax charge.

Lifetime allowance

As well as an annual pension allowance charge, there is a possible lifetime allowance charge if total pension funds exceed the lifetime allowance when pension benefits are taken. The lifetime allowance for 2010/2011 is £1.8 million. Recent government proposals will see these allowances frozen until the end of tax year 2015/16.

The lifetime allowance charge is applied to the excess over the allowance. This can apply in two different ways or both depending on how the excess is taken. The individual charges are;

• 25% if taken as income, and
• 55% if taken as a lump sum

It is unlikely that there will be much difference because, if someone takes the excess as income, he will be charged income tax on top of this tax charge, more than likely at 40%.


Pension benefits
You can take pension benefits between ages 50 and 75. Normally these will be in the form of 25% of the fund as tax free cash, and the rest applied to produce an annual pension, although other alternatives are now available.


Level and bases of, and reliefs from taxation are subject to change.


Occupational pension schemes

Employers can set up an occupational pension scheme for their employees. An occupational pension scheme can be offered to both public and private employees.

Public sector occupational pension scheme
Public sector schemes typically offer pension accrual of 1/80th of final remuneration for each year of service up to a maximum of 40 years plus a tax free lump sum of up to 1.5 x final remuneration.

Private sector occupational pension scheme
Private sector schemes can be either final salary schemes known as defined benefit schemes or money purchase schemes known as defined contribution schemes.

Executive pension scheme

Many directors of small to medium sized family businesses make use of an executive pension scheme. Executive pension plans are similar to occupational pension schemes in that they are subject to occupational pension scheme rules.


Types of occupational pension scheme


Final salary schemes

Final salary occupational pensions schemes offer a guaranteed pension amount, usually based on salary and time served with an employer.

Typically accrual rates of 1/80th or 1/60th of pensionable salary for each year of pensionable service are found.

E.g. Fred Smith retires on a salary of £10,000pa after 20 years in a 1/60ths scheme. His pension is 20/60 x £10,000 = £3,333.

Money purchase scheme

With a Money Purchase occupational pension plan, the pension contributions are invested and the final pension is based on the investment performance of the fund. There is no guarantee.

Individual Contributions

Individuals can contribute as much as they want although there are limits on the amount of contributions that will receive the full benefits of tax relief.

Any contribution that is not paid by the employer is classed as a member contribution even if a third party has made the contribution. Tax relief is given according to the member's situation; i.e. make sure that tax relief at source applies if the member is a non- or starting rate taxpayer. An example of this is a grandparent paying a pension contribution for his/her grandchild.

Employer Contributions

Just like individual contributions, employer contributions are also unlimited. Full tax relief will be available without limit subject to the local inspector of taxes. However, there will be a tax charge on the member where total contributions are above the annual allowance.

Eligibility

Any member of a registered occupational pension scheme can make contributions to it. However, to be eligible to gain tax relief, the contribution must be made by an active scheme member who is also a relevant UK individual. To qualify as a relevant UK individual, the scheme member must meet one of the following criteria:

  • Have relevant UK earnings chargeable to income tax
  • for that tax year
  • Is resident in the UK at some point in that tax year
  • Was resident in the UK at some point during the five
  • tax years immediately before the tax year in question
  • and was also resident in the UK when he/she joined
  • the pension scheme
  • Has general earnings from overseas Crown
  • employment subject to UK tax
  • Is the spouse of an individual who has, for the tax year, general earnings from overseas Crown employment subject to UK tax

Pension Allowances

Annual Pension Allowance

Since A-Day, annual pension contributions have a new limit attracting full tax relief. This limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any contribution over the annual allowance will be subject to a tax charge. We will explain this in further detail later in this bulletin.

Lifetime Pension Allowance

As well as an annual allowance charge, there is a possible lifetime allowance charge if total pension funds exceed the lifetime allowance at when pension benefits are taken. The lifetime allowance for the 2010/2011 tax year is £1,800,000.

The lifetime allowance charge is applied to the excess over the allowance. This can apply in two different ways or both depending on how the excess is taken. The individual charges are;

  • 25% if taken as income, and
  • 55% if taken as a lump sum

it is unlikely that there will be much difference because, if someone takes the excess as income, he will be charged income tax on top of this tax charge, more than likely at 40%.

Additional Voluntary Contributions (AVCs)

It is now compulsory for companies to offer employees the opportunity to invest additional contributions into their occupational scheme where there is one, in order to boost retirement benefits.

Under existing revenue limits and since A- Day, if you are a member of an occupational pension scheme you can invest up to 100% of your total remuneration or up to a £255,000 in total.

Tax Reliefs & Contribution Limits

To receive full benefits of tax relief , pension contributions have to remain within a certain limit. Currently the limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any additional contribution over the annual allowance will be subject to a tax charge.

Levels and bases of, and reliefs from taxation are subject to change.

Free Standing Additional Voluntary Contributions (FSAVCs)

Free standing additional voluntary contribution schemes (FSAVCs) were introduced in 1987.

These are run by a pension provider rather than the trustees of the employee's pension scheme. The big advantage tends to be the wider choice of investment available.

FSAVCs tax relief and contribution limits 

To receive full benefits of tax relief , pension contributions have to remain within a certain limit. Currently the limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any contribution over the annual allowance will be subject to a tax charge.

Level and bases of, and reliefs from taxation are subject to change.

SIPP Pension plans

For many people a SIPP pension has become an attractive and Tax efficient method for long term saving.

Pension reform has widened the investment options available to the individual and has relaxed the rules which govern the purchase and sale of assets into a pension plan.

SIPP Pension Benefits

Another major change introduced from April 2006 is in the way individuals can take benefits or draw upon assets within a pension. When an individual wishes to retire, there is greater flexibility and choice when it comes to deriving an income.

Individuals now have the option of pension drawdown as well as the purchasing of an annuity - this gives greater control over the initial level of income derived and income flexibility during retirement.

A SIPP will allow regular and lump sum cash payments, and you will also be able to transfer other pension arrangements into the scheme. If you are employed, your employer can also pay into the plan. In addition SIPPS will allow investments from a wide range of sources including Commercial Property, shares and unit trusts.

Annual Allowance

Since A-Day, annual pension contributions have a new limit attracting full tax relief. This limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any contribution over the annual allowance will be subject to a tax charge. We will explain this in further detail later in this bulletin.

Lifetime Allowance

As well as an annual allowance charge, there is a possible lifetime allowance charge if total pension funds exceed the lifetime allowance at when pension benefits are taken. The lifetime allowance is currently £1.8 million (2010/2011 tax year).

State Earnings Related Pension Scheme (SERPS)

The State Second Pension (S2P) replaced SERPS with effect from 6 April 2002. Only those who have been employed between 1978 and April 2002 are entitled to SERPS subject to their National Insurance contribution record. Those who have always been self-employed are not.

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