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For
self employed individuals or where an employer does
not have an occupational pension scheme they must
establish a private
pension scheme.
This also applies where an individual is not eligible
to join their employers pension scheme or wants
to make additional contributions independent of
the employer. A private pension will be a defined
contribution scheme |
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and usually offered to employees
as a group
personal pension (GPP) or since 6 April 2001
a group stakeholder pension also known as an insured
personal pension.
An insured personal pension is where
a life insurance company manages the assets and
where the Financial
Services Authority (FSA) must authorise the
fund managers. This arrangement will include private
managed funds (PMFs) but will not apply to
self invested pension arrangements such as self
invested personal pensions (SIPPs)
where the investment decisions are the responsibility
of the member.
For money
purchase schemes the fund value will determine
the pension income at retirement age and this
is dependent on contributions made and the investment
return. The contributions made will usually be
wholly by the scheme member although occasionally
an employer will make a percentage contribution.
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Plan contributions
The contributions to a personal
pension are limited by Inland Revenue maximums based on
the members age and ranging from 17.5% for individuals aged
35 or less up to 40.0% for individuals aged 61 or above, being
scaled between these limits.
The maximums imposed by the Inland
Revenue are in part due to the tax rebates given for contributions
made to exempt approved schemes, resulting in a difference
between gross
and net contributions. For a basic rate taxpayer there
will be a tax rebate of currently 22.0% on gross contributions
made. For a higher rate taxpayer a tax rebate of currently
40.0% is given although for a personal pension part of this
must be claimed through their self assessment. The scheme
member will be able to make regular
and single contributions to a personal pension and stakeholder
pensions during the tax year and this flexibility is particularly
beneficial to the self employed.
A stakeholder
pension limits the contributions to £3,600 per annum
irrespective of age or pensionable earnings. An individual
can also establish SIPPs that allow a wider investment choice.
As an occupational
pension scheme member, the individual can make private
payments to a free standing additional voluntary contribution
scheme (FSAVC)
that is separate from the employers occupational scheme but
they will still be limited to total contributions payments
of 15.0% of net
relevant earnings (NRE) as set by the Inland Revenue and
this includes all pension arrangements.
Contracting out
This is a personal pension plan that an individual can use
for contracting out of the state earnings related pension
scheme (SERPS).
This plan will build-up benefits where the pension income
at retirement will be dependent on the contributions made
and investment return.
An early leaver with a deferred
pension can use a buyout policy to transfer from an occupational
pension scheme. Under the Finance Act 1981, an employee can
take out a deferred annuity policy through an insurance company.
The annuity must match the guaranteed
minimum pension (GMP) if the occupational scheme is contracted
out of the SERPS.
Relief from previous years
Unlike a personal pension from 31 January 2002, retirement
annuity policies (RAPs)
can still be used for carry
back relief. This means an individual can make a contribution
in the immediately proceeding tax year and that contribution
will attract tax relief at the individuals marginal tax rate
in that tax year.
The total contribution cannot exceed NRE for the previous
year. The carry back contribution cannot exceed the unused
tax relief for that year, the maximum being based on the individuals
age as at the start of that tax year and their net relevant
earnings in that tax year.
As from 6 April 2001 the carry back relief
for a personal pension and stakeholder pensions will only
apply if contributions are received by 31 January of the current
tax year. Carry
forward relief in respect of personal pensions was abolished
from 6 April 2001. Carry forward can still apply to RAPs and
will allow members of these policies to make contributions
in excess of the normal maximum for their current tax year
while using any unused relief from previous tax years. There
are a number of conditions namely that;
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The RAP scheme member must use the
maximum contribution for the current tax year before using
carry forward; |
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The scheme member has net relevant
earnings in the carry forward tax year; any unused relief,
starting with the earliest year of the previous six years
can be carried forward; |
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The amount of unused relief for carry
forward is calculated using the maximum allowances and
percentage, based on the members age, of NRE for each
of the previous six years; |
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The tax relief is limited to the available
contributions up to the level of taxable earnings in the
current tax year. |
Protection benefits
The rules applying to personal pensions or retirement annuity
policies allow pension
linked term assurance to be incorporated within the premiums
paid into these schemes. There is a limit to the proportion
allocated to purchasing term assurance, however members can
claim tax relief at their highest rate on the premiums paid.
In the event of a critical illness or accident
of a personal pension scheme member, waiver
of premium benefit will allow a regular contribution by
the member or employer to continue to retirement age. Payments
from an income protection contact will not qualify as taxable
earnings so it would not be possible to continue paying into
a personal pension right through to retirement
age. Waiver of premium means the provider waives the regular
contributions, usually after a deferred period. Waiver of
premium benefit will not be available for policies started
from 6 April 2001 with the introduction of stakeholder pensions.
Investing contributions
A pension
fund represents a members pension rights accrued within
a money purchase scheme. This could be a personal pension
or an occupational
money purchase scheme. The pension fund value will depend
on the contributions made and investment return in contrast
to an employers occupational final
salary pension does not have an actual fund value as a
members retirement benefits are based on the years of service
and accrual
rate of the scheme.
The rate of growth in the pension fund value will be influenced
by the charges levied by the provider that includes both an
administration and a fund management charge. The charge is
expressed as an annual percentage, usually between 0.4% for
large investments in low risk funds to 1.0% for stakeholder
pensions and up to 1.75% for a portfolio of higher risk specialist
funds. These charges reduce the investment return as a reduction
in yield (RIY). In return for higher fund management charges
the investor is expecting extra growth in the fund that will
be greater than the extra charges levied thereby creating
a higher investment return net of charges in the long term.
An individual can invest via a SIPPs, this
being provided as an insured
personal pension or PMFs, the latter being midway between
the other two extremes. PMFs have similar investment restrictions
and advantages as SIPPs but operate as a normal insured personal
pension, having a fund link that is unique to the individual
or partners in a partnership. The life assurance company will
own the assets of the PMFs so these funds must satisfy various
regulations. This includes the private managed fund managers
being authorised by the FSA so technically the individual
or partners cannot personally manage the pension fund, as
is possible with a self invested personal pension scheme.
For a private pension scheme such as a personal
pension or if prior to 1 July 1988, retirement annuity
policies it is usually the practice to issue up to 1,000 separate
but identical pension arrangements within the same policy
and this is called segmentation.
This segmentation is used in phased retirement and the advantages
of this is that it; allows the individual to retire gradually
as relevant earnings from their work reduce; will allow the
fund to continue to grow in a tax free regime; allows the
annuity rate to improve as the member becomes older; and allows
the individual to retain any lump sun death benefit that would
be paid free of income tax and inheritance tax (IHT).
Delaying final retirement
A private pension will allow the scheme member to delay taking
a pension income in the form of an annuity, but allows part
of the pension fund to be taken as pension
withdrawals. Provisions introduced in the Finance Act
1995 allowed members of personal pensions to opt for withdrawals,
known as income
drawdown rather than acquiring a compulsory purchase annuity,
with the pension remaining invested with an insurance company
fund.
This allows the member to have more control
over their pension, but must still purchase a pension
annuity at the age of 75. When the scheme member takes
drawdown, commutation to a tax
free lump sum of 25.0% is possible and the balance of
the fund must be used for drawdown.
The withdrawal levels are subject to minima (being 35.0% of
the maxima) and maxima based on the Government Actuary's Department
(GAD)
tables on long-dated gilt yields that are reviewed every three
years. The tax free lump sum could also be used to buy a purchase
life annuity. There are annuity
taxation advantages for doing this which means that about
2/3rds of the income is a return of capital and free of tax
and 1/3rd is interest and taxed at saving rate of 20%.
Staggered vesting, also known as phased retirement, allows
the member to defer drawing all of their pension benefits
and spreading them over time, up to the age of 75 at which
time the balance of the fund must be taken as a compulsory
purchase annuity. However, the individual can exercise their
right to an open
market option where they can select the highest pension
income from the market.
Designed to give the member more control
over income at retirement age, phased
retirement allows segments of the pension fund to be drawn
when required. A personal pension plan will consist of up
to 1,000 identical but separate segments. Each time the member
draws on a segment, a tax free lump sum of 25.0% can be taken
and the balance used to purchase a compulsory
purchase annuity. The remaining the fund value will remain
invested with the provider.
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