Preparing for A-day: actions for trustees and employers

The new simplified tax regime for pensions starts on 6 April 2006 (A-day). We look at the issues that schemes should consider and review some of the modelling products available to assist with A-day pension planning.

Summary of key points

  • The new simplified taxation regime for pensions will take effect from 6 April 2006 (A-day) and employers and trustees need to ensure that they have reviewed their scheme benefits and set up the correct administration systems by that date.

  • As well as considering the position of high earners whose pensions may be affected by the new lifetime allowance, schemes need to review benefits such as the tax-free retirement lump sum and death-in-service lump sums.

  • Although much of the relevant information is still only available in draft form, administration systems have to be ready to meet the Revenue's reporting and filing requirements by A-day.

  • Companies need to decide their policies in respect of individuals whose benefits exceed the lifetime allowance and identify and communicate with those who may need to take advantage of the transitional arrangements under the new regime.

  • If schemes wish to help higher-paid employees ascertain their pension position, or make independent financial advice available, they may wish to consider the use of pension modelling programmes.

    When the Government announced three years ago that it was preparing to sweep away the different tax regimes relating to pensions and replace them with one simplified system (See Radical tax changes planned but compulsion put off ), the pensions industry was more or less united in welcoming the news. Now that the effective date for implementing the tax changes - 6 April 2006, known as "A-day" - is only a few months away, panic may be starting to set in.

    Although simple in concept, in reality the new tax system is complex, particularly in relation to the transitional arrangements. To compound the problem, although HM Revenue and Customs (HMRC) has published 43 sets of draft regulations and a number of draft forms, few have been laid before parliament. In addition, not all of the chapters of the Registered Pension Schemes Manual were available until very recently.

    Despite this general state of unreadiness, the introduction of the new simplified tax regime is not going to be delayed and employers and trustees need to be ready to operate the system with immediate effect from A-day. In this article, we examine some of the matters that trustees and employers should be considering in respect of the changes. In addition, we look at three of the pension modelling products available to schemes and advisers to assist higher-paid individuals, who may be affected by the limits under the new system, with their pension planning.

    New systems required

    At present there are eight different tax regimes applying to pensions, depending on matters such as when the scheme commenced, the type of benefits provided, whether schemes are occupational or personal and the date on which members joined. From A-day, there will be just one tax system applying to all types of scheme and all members (Complexity is price of tax simplification and Tax simplification: lump sums and death benefits examined ). Box 1 outlines the main features of the new regime.

    The Finance Act 2004 also provides for a new method of gaining tax-approved status. At present, in order to take advantage of the available tax concessions, pension arrangements generally seek discretionary approval from HMRC. From A-day, schemes must go through a registration process in order to gain the tax reliefs. Schemes that already have approved status will be treated as being registered automatically, although they still need to sign up to HMRC's new electronic filing system. Until recently, HMRC said that all reporting and tax payments had to be made electronically from A-day. However, it is now intending to allow paper returns for at least six months after A-day (see Pension tax system delay ).

    Schemes still need to familiarise themselves with the new processes and have their systems set up to meet HMRC's new reporting requirements as soon as possible. HMRC has published draft forms and draft regulations in respect of its information requirements on its website (www.hmrc.gov.uk/pensionschemes). It is also producing regular internet newsletters highlighting and explaining its new administration procedures (See Schemes drip-fed information about new tax regime ).

    The first quarterly accounting period under the new system ends on 30 June 2006 and schemes will have to submit "accounting for tax" (AFT) forms within 45 days of that date. Any tax due must also be paid within 45 days of the end of the accounting period. Thereafter, quarterly accounting dates will be 30 September, 31 December and 31 March. Schemes will also have to ensure that their pensioner payroll systems are changed so that the annual tax statement (P60) sent to pensioners shows the value of benefits that have crystallised before A-day.

    Design issues

    At present, most of the press focus on A-day planning has been on high net worth individuals whose benefits will be affected by the new limits or who have self-invested pension plans. However, those schemes that have no staff whose benefits are, or are likely to be, in excess of the lifetime allowance (LTA) still need to be reviewed to check that the design continues to fulfil the employer's intentions and that no unintended cost consequences arise from the new tax limits.

    The main benefits that employers and trustees may have to review as a result of the Finance Act 2004 are detailed below. Readers may also want to look at the Pensions Regulator's Briefing no.3 (covered in Schemes drip-fed information about new tax regime ).

    Contributions

    At present, employees' annual contributions to occupational schemes are restricted to 15% of earnings and maximum contributions to personal pensions are based on an age-related scale. Under the new regime, people will be able to contribute the greater of £3,600 or 100% of their earnings to pension schemes, subject to the annual limit (see box 1).

    However, schemes have the option as to whether to allow members to contribute up to these levels. In addition, where an employer pays matching contributions, it may have to amend the scheme rules to ensure that its liability is limited.

    Tax-free lump sums

    The present limits on the amounts of tax-free cash that may be paid from pension arrangements are complex. Some members may find that the new limit of 25% of the value of their benefits up to the LTA will give them a higher lump sum than that to which they are presently entitled.

    However, this change is not mandatory and some schemes may wish to maintain the tax-free lump-sum benefit at its existing level.

    Death benefits

    The current Revenue limit on tax-free, death-in-service lump-sum benefits of four times earnings will not apply from A-day and, instead, death-in-service benefits will simply be subject to the LTA. Some employers may take the opportunity to increase the amount of tax-free lump sum they pay on death in service while reducing the level of dependants' benefits.

    The rules relating to the payment of children's benefits are also changing and (although not a Finance Act 2004 change) pensions for surviving civil partners of the same sex are being introduced. Therefore trustees and employers may wish to completely restructure the benefits paid from a scheme on death.

    Additional matters

    Other matters for consideration include whether to continue to provide additional voluntary contribution (AVC) arrangements for future service, as these will no longer be compulsory. The Finance Act also allows employers to introduce flexible retirement, although again it is not mandatory, so organisations will need to decide on their policy in this area.

    The rules relating to the commutation of trivial pensions are also changing on A-day. Although the new rules increase the level of trivial pensions that may be commuted, they are more complex than the current rules. Some schemes may decide to commute as many small pensions as possible under the old rules before A-day to simplify administration.

    Transitional arrangements

    The majority of pension scheme members will be unaffected by the new limits on benefits and contributions. However, many organisations have a number of highly paid individuals the value of whose pensions will be greater than, or very close to, the LTA on A-day. In addition, some senior employees whose pensions are currently less than the LTA may believe that, if they are promoted after A-day, their pensions will exceed the limit.

    A large section of HMRC's guidance manual is devoted to the transitional arrangements. Box 2 provides a reminder of these provisions. Trustees and employers should already have taken steps towards deciding their policies in relation to higher-paid individuals, particularly those who choose enhanced protection and as a result may need to stop accruing pension.

    Organisations also need to determine how they will compensate employees whose benefits may be subject to extra tax at some time in the future. Some companies may decide not to compensate such employees if they choose to stop accruing pension. Others may offer additional remuneration or other benefits.

    This group of people will need information about their pension position as soon as possible. Although the registration for enhanced or primary protection can be made up to April 2009, the choice between the two routes may need to be made by A-day. This is because some actions (eg making any contributions to a defined-contribution arrangement) invalidate enhanced protection.

    Help is out there

    A number of organisations have produced pension modelling products to help individuals with their decisions. Some products may also be used by employers to determine an appropriate level of compensation that may be offered in lieu of pension where enhanced protection is chosen. Occupational Pensions has taken a look at three such products: BWiser, which is available from Barnett Waddingham; Pen-Tax2006, which has been produced by CheckleyFisher; and PensionMentor, which has been developed jointly by Lane Clark & Peacock and Anthony Hodges Consulting. Contact details are given in box 3.

    BWiser, Barnett Waddingham

    The BWiser modeller is available for stand-alone use by independent financial advisers (IFAs) or alternatively as part of Barnett Waddingham's advice service for executives. As well as setting out the individual's position at A-day, the modeller assesses the tax value of different retirement strategies to the individual. Such strategies may include investing money personally rather than in a pension arrangement.

    The process of using BWiser differs depending on whether it is being used by IFAs or companies. Financial advisers need to register online to use the product. There is an initial cost of about £900 plus VAT and IFAs then pay £180 plus VAT for each client, enabling them to produce up to six different scenarios for each client. The adviser is responsible for obtaining and inputting all the necessary data, setting the assumptions and output options, and providing the supplementary advice. The results can either be in the form of graphs produced electronically within a few seconds or, for an extra cost, an actuarial report can be prepared.

    Companies access BWiser by appointing Barnett Waddingham to provide individual advice to executives. The cost varies but typically would be between £2,000 and £3,000 plus VAT per executive depending on the level of service required (so £10,000 to £15,000 for five people). The incremental cost per person decreases if more executives are being advised. Where the system is purchased for a scheme, Barnett Waddingham inputs the data and produces reports using standard assumptions on matters such as inflation and investment returns for individual employees. The report will indicate the position of the individual at A-day and assess the impact of the LTA on future benefits. Following meetings with individual members to discuss the initial report, a final report is drawn up to assist the employee with pension options. Box 4 gives an example of the graphs produced by BWiser.

    The BWiser modeller is particularly useful where companies wish to assist their employees with wider aspects of financial planning rather than just pensions. It can also be used to determine rates of compensation that may be offered if employees stop accruing pension. However, the modeller produces sophisticated projections and so should not be used by individuals without the assistance of an adviser. The modeller is therefore only sold to IFAs or offered to companies who appoint Barnett Waddingham to advise their executives.

    Pen-Tax2006, CheckleyFisher

    The CheckleyFisher product, Pen-Tax2006, has also been developed for both IFAs and pension schemes. Unlike BWiser, the product operates in the same way for the two markets. Pen-Tax2006 users are licensed to access the product, which is available on a CD-ROM or for downloading from the firm's website. The exact cost of the basic modeller depends on the number of individuals it is used for; if the company or IFA wishes to produce models for five people, the cost would be £1,000 plus VAT. The cost per person reduces if the licensee wishes to use it for more people.

    Unlike the Barnett Waddingham product, the adviser or company inputs all the personal data, although CheckleyFisher can provide telephone or email backup. If the user wishes CheckleyFisher to provide greater input or produce the reports, the charging structure has to be negotiated. The input screens are detailed and require a reasonable pensions knowledge. The output appears on screen in one of two settings, standard or advanced. For most people, the former is likely to be adequate, but the latter produces up to 13 graphs. Box 5 provides an example of one of the main graphs that appears under both setups.

    As well as providing pension scheme members with information about their pension position, the system can be used to indicate the level of salary that would be required to put the member back into the pre-A-day position. Pen-Tax2006 also has a "goal-seeking" function whereby the desired end result can be specified at the outset; for example, those whose benefits are less than the LTA may wish to see how they could maximise the amount of their pension, and the variables can be changed to see how that result can be obtained. Like BWiser, the product is not really suitable for individuals to use without an adviser.

    PensionMentor, Lane Clark & Peacock and Anthony Hodges Consulting

    PensionMentor has been developed by Lane Clark & Peacock and Anthony Hodges Consulting in conjunction with six major pension funds. Unlike the Barnett Waddingham and CheckleyFisher programmes, PensionMentor has been designed as a standalone tool for use by scheme members to reduce the number of questions that need to be dealt with by the pensions manager, although it can be adapted for use by IFAs. It is not intended to be used by consultants advising on financial planning in the same way as the other two modellers and if members ascertain from using it that their benefits may be affected by the LTA, they may need to seek more detailed financial advice. Schemes can make it available to their members either on their intranet or on CD-ROM, although so far the latter option has proved to be more popular.

    PensionMentor is a communication tool as well as a basic pension modeller. Although users can go straight to the modeller, there are several screens explaining the new tax system. These are backed up by video clips of a live presenter describing the changes. This is useful for those who find they retain information better from videos. If it is being used by an occupational scheme, it can include a certain amount of scheme branding. The employer supplies scheme and member data which is loaded onto the programme. Each member's data is password protected and members can play around with the inputs to a certain extent, for example by changing contribution rate, retirement age, pensionable salary increase and investment return assumptions.

    Once the cost of the basic occupational scheme product of £20,000 plus VAT has been met, the only additional cost is that of the CDs. Lane Clark & Peacock has found that because of the low incremental cost some companies are giving the disks to nearly all of their staff. This raises employee awareness of the pension plan and, even if they do not need to consider protecting their benefits at A-day, enables individuals to model the effects of the LTA on their benefits, for example, of paying AVCs. However, unlike the other two products, PensionMentor is not designed for consultants to use for more sophisticated financial planning purposes. Nor, for obvious reasons, can it be used to determine appropriate rates of compensation if members cease to accrue pension having opted for enhanced protection. However, the advantage of PensionMentor is that individuals can work through it and see the big picture without the need for a pensions specialist to be present.

    A typical screen produced by PensionMentor is reproduced in box 6.

    Going forward

    In the next few months, employers, trustees, administrators and scheme managers will be focusing on ensuring that they have the correct systems to meet the Revenue's reporting requirements and on providing the necessary information to employees who may be affected by the transitional arrangements. Occupational Pensions has looked at three of the products currently available to help schemes. However, other firms of consultants will be providing similar services.

    Once A-day has arrived, the needs of new senior employees and others whose benefits approach the LTA at some time in the future need to be addressed. All three consultants we spoke to acknowledged that there will be a need for pension planning modellers to assist these people. Therefore, they are all intending to modify their products so that they can continue to be used in the future.

    Our research

    This feature is based on demonstrations by, and face-to-face interviews with, Andrew Roberts of Barnett Waddingham, Richard Nobbs of CheckleyFisher, and Tracey Scott and Mags Andersen of Lane Clark & Peacock. Further information for the article was drawn from a number of sources including: HMRC's Registered Pension Schemes Manual and pensions tax simplification newsletters; and client newsletters prepared by several firms of consultants and solicitors, including Aon Consulting, Freshfields Bruckhaus Deringer, Mercer HR Consulting and Punter Southall.

    Box 1: Key features of the tax simplification regime applying from 6 April 2006

  • The present system of discretionary Revenue approval will be replaced by a registration system.

  • An individual's total retirement benefits will be subject to a lifetime allowance (LTA), initially of £1.5 million. Figures for the first five years have been set and thereafter it will be subject to review, but is expected to be increased in line with prices.

  • Benefits paid in excess of the LTA will be taxed at 25%, or 55% if paid as a lump sum.

  • Defined pension benefits will be tested to check if they exceed the LTA by multiplying the amount of the pension by a factor of 20 regardless of age.

  • Schemes may pay a maximum tax-free lump sum of 25% of the value of the member's pension subject to a limit of 25% of the LTA.

  • Members may receive tax relief on contributions of the greater of 100% of earnings or £3,600. However, the amount of contributions plus the increase in the value of the member's pension in any year should not exceed the annual allowance, initially set at £215,000, which is expected to be increased in line with prices.

  • Members may have concurrent membership of different pension arrangements. However, their total contributions and benefits cannot exceed the annual allowance or the LTA, if tax is to be avoided.

  • The minimum age at which members may retire will be increased from 50 to 55 although, provided certain conditions are met, some members may retain the right to retire at a younger age.

  • Schemes will be permitted to introduce flexible retirement whereby older members will be able to continue working for the same employer while receiving a pension.

    Box 2: An outline of the transitional arrangements under the Finance Act 2004

    Pension scheme members who have accrued benefits immediately before A-day that exceed the lifetime allowance (LTA), or that are likely to exceed the LTA in the future, may be able to protect some or all of their benefits from tax charges under the transitional arrangements.

  • Primary protection

    This applies if the member's pension exceeds the LTA at A-day. If the member registers a right to primary protection, the protected pension will be expressed as a percentage of the LTA. For example, if the member's benefits are valued at £3 million on A-day (when the LTA is £1.5 million), the protected pension rights will be 200% of the LTA in force at the date of retirement.

  • Enhanced protection

    Individuals may apply for this if their benefits exceed the LTA at A-day, or if they believe that the value of the benefits may exceed the LTA at some time in the future. Subject to certain conditions, it permits the value of these pre-A-day benefits to be indexed in line with pay (or 5% pa, or the retail prices index if greater) or, if defined-contribution benefits, in line with investment returns, and the full amount of the benefit will be tax-protected.

  • Tax-free lump sums

    If the member is entitled to a tax-free lump sum under the scheme rules in force before A-day which is greater than 25% of the value of the total benefits, but less than 25% of the LTA, the lump sum may be protected with the agreement of the scheme administrator. This protection is not registered with HMRC.

    If the member's pre-A-day lump-sum rights exceed £375,000 and the member is registering for primary or enhanced protection, HMRC will provide a certificate showing the protected lump sum either as a monetary amount, if the member is registered for primary protection, or as a percentage of the value of the benefits if the member is registered for enhanced protection.

    Box 3: Contact details for pension modellers

    The contact details for the products referred to in this article are:

  • BWiser, Barnett Waddingham: Marcus Whitehead, Bob Chadwick or Andrew Roberts, tel: 01494 788100; email: bwiser@barnett-waddingham.co.uk; web: www.bwiser.co.uk .

  • Pen-Tax2006, CheckleyFisher: Richard Nobbs, tel: 020 7495 5639; email: richard@checkleyfisher.com; web: www.checkleyfisher.com .

  • PensionMentor, Lane Clark & Peacock and Anthony Hodges Consulting: Tracey Scott or Mary McGrath at Lane Clark & Peacock, tel: 020 7439 2266; email: enquiries@lcp.uk.com; web (demo available): www.lcp.uk.com/pm .

    Box 4: An example of output from BWiser

    BWiser example output

    Box 5: An example of output from Pen-Tax2006

    CheckleyFisher example output

    Box 6: A sample screen from PensionMentor

    PensionMentor example output