With stakeholder and the introduction of the new defined contribution (DC) tax regime on the horizon...
With stakeholder and the introduction of the new defined contribution (DC) tax regime on the horizon from April 2001, IFAs have their work cut out to keep abreast of all the changes. In particular, many IFAs will find themselves advising on the interaction of existing arrangements with the new ones.
One aspect of this will be the impact of new developments on Section 226 retirement annuities (S226). Although the new DC regime will apply to all personal pensions (PP), stakeholder pensions and, potentially, to occupational DC schemes, the tax treatment of S226 contracts remains unchanged. From April, IFAs may find themselves advising clients on the merits of incrementing contributions within the S226 or paying additional contributions to a new DC regime contract, be it PP or stakeholder. For simplicity in this article, PP and stakeholder will be jointly referred to as PP.
So, what are the issues that need to be considered? Some of the existing areas need to be dealt before going on to look at those to be introduced in April 2001.
The big issue here is whether the individual is paying all contributions into an S226 or if part is being paid towards a PP. Where all contributions are going into an S226, these will be subject to the S226 contribution limits.
However, if an increment is directed towards a PP, then the maximum total contribution will be subject to the PP contribution limits and hence the earnings cap. Provided the total contribution does not breach this maximum, part of it can still go to an S226, subject to the S226 limit. Table 1 shows the contribution limits.
The earnings cap is an important factor to consider in any decision. PP contribution limits are subject to the earnings cap whereas S226 contributions are not. For a PP investor, earnings above £91,800 (for the 2000/01 tax year) are excluded when determining the maximum contribution. It is therefore likely that many high earners will benefit by incrementing through their S226 policy. Table 1 also shows the earnings levels for the current tax year.
The key difference between S226 and PP is the age from which benefits can be taken. Under an S226, this is usually age 60, while a PP gives access to benefits from age 50. Importantly, a PP also gives access to the flexibility of income drawdown, an increasingly attractive alternative. If the individual decides to transfer to another provider to draw benefits, the transfer can either be to another existing S226 or to a PP (and hence into the PP regime). Before transferring, IFAs are advised to check if the S226 offers a guaranteed annuity option.
Many investors want to have access to the maximum tax-free cash possible and therefore this is a key consideration. Under a PP, up to 25% of the non-protected rights fund can be taken as tax-free cash. Under an S226, however, this depends on current annuity rates at the point of vesting. The tax-free cash under an S226 must not exceed three times the amount of the single life, level, yearly-in-arrears annuity that could be purchased with the balance of the fund after taking tax-free cash.
Where the client has, say, £100,000 in a PP fund, the maximum tax-free cash would be £25,000. Under an S226, this would vary with age and according to whether the client was male or female, as demonstrated in table 2. The table also shows the age above which investors would receive more tax-free cash if vesting under the S226 regime.
Until fairly recently, the treatment of pensions in bankruptcy varied according to the type of pension vehicle. The intention of the Welfare Reform and Pensions Act was to removes all forms of pension from the reach of creditors with effect from April 2001.
This was brought forward, so that for bankrupts after 29 May 2000 the pension, whatever the arrangement, does not form part of the bankrupt's estate and is therefore safe from creditors.
One exception to this is where the individual has deliberately paid large amounts into the pension to keep assets beyond the reach of creditors.
This will not be tolerated and such excess funding will be unwound. Additionally, if the bankrupt is not discharged when benefits come into payment, the trustee in bankruptcy may access the tax-free cash or ongoing pension by obtaining an income payments order.
Death benefits are another important consideration. PPs usually offer full return of fund on death. Some S226s, unit-linked policies for example, will offer full return of fund. However, with-profits contracts may only offer a return of contributions, usually with interest.
Additional life cover can be set up under either vehicle. Under an S226 this must be through a separate term assurance contract, while PPs currently allow life cover to be integrated into the pension contract. However, PPs set up after April 2001 can have no more than 10% of the total contribution going towards purchasing life cover. This makes it likely that life cover will be arranged separately from the PP. There is no change for S226 term assurance.
An important area to watch is that any S226 policy is written under trust, as otherwise the death benefits are likely to be paid to the estate, which could have possible inheritance tax implications.
Tax on contributions
Under the new DC regime, the tax treatment of contributions made by individuals (as opposed to employers) to any pension arrangement is changing. This affects new and existing PPs and occupational money purchase schemes that have opted for the new regime, but not S226s.
Under a S226, contributions will continue to be paid gross, with tax relief being rec
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