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Pension Simplification

From 6 April 2006, a single regime for all pension types (including personal pensions, Stakeholder and executive schemes) came into effect and replaced the eight previous tax regimes that ran concurrently.
Pension simplification has introduced two important new controls:
  • The pension lifetime allowance
  • The pension annual allowance
The other main change is to allow all schemes to offer a tax free cash of up to 25%, to allow employees the opportunity to continue working for their employer while taking benefits from their occupational pension scheme. Also, pensions schemes are to be allowed to invest in many more types of investments, (although the move to allow residential property to be held as a pension scheme asset was blocked in November 2005); effectively anything that is not explicity prohibited or disallowed for the purposes of gaining tax relief under the new rules is allowed.
The main aspects of the new changes are highlighted below:

Lifetime allowance

A lifetime allowance is the maximum amount of pension savings that can benefit from tax relief and was initially set at £1.5 million. This figure was set to rise incrementally over time, but circumstances have affected this, and as you can see, it is actually now lower in the 2023/24 tax-year in it was in 2006:
£1.6 million
£1.65 million
£1.75 million
£1.8 million
£1.8 million
£1.5 million
£1.5 million
£1.25 million
In November 2009 it was announced that the lifetime allowance would be frozen for five years and reviewed again in the 2015/16 tax-year. This was further reduced to £1.5 million in the 2012/13 tax-year and there has been a further reduction to £1.25 million in the 2014/15 tax-year. Therefore, individuals who already have a fund valued at £1.5 million could face a significant tax charge if there fund grows in value and they wish to take benefits from the plan or scheme unless they apply for Fixed Protection and cease all future pension contributions.
There was a lifetime allowance charge of 25% on pension funds that exceed the lifetime allowance. Funds that exceed the lifetime allowance could be taken as a lump sum and in this case the lifetime allowance charge would be at 55%. Excess funds taken as taxable income will be subject to an additional excess tax rate of 25%. To value the capital value of a defined contribution scheme a valuation factor of 20:1 will be used. Pensions in payment will be valued using a factor of 25:1. Therefore, an individual who received a pension of £60,000 in the 2006/7 tax year had already used up their lifetime allowance.

Annual allowance

The annual allowance was initially set at £215,000 and this figure will rose until 2010 when the figure was £255,000 for payments to defined contribution schemes or as accrued benefits within a defined benefit scheme. The limit will not apply in the actual year of retirement.
In line with the freezing and reduction of the lifetime allowance, the annual allowance has been gradually reduced to £60,000 and could reduce even further. In reality, this will affect very few people, with the exception of very high earners. Instead of the complex system of capping tax relief at the highest rate for such individuals, it was decided it was much simpler to reduce the annual allowance.
For those with no income, the maximum level of contribution of £3,600 (gross) per annum.

Minimum pension age

From 2010, the minimum retirement age rose from 50 to 55. If you are in an occupation where there is an existing contractual right to retire before 55 (and these rights were documented before 10 December 2003), you will be able to retain this right. The rules also protect people who currently have pensions with low retirement ages (such as sporting professionals) to preserve this retirement age for their existing pensions. However, when benefits are taken below the minimum pension age, a lower lifetime allowance applies.
Under the new rules you will be able to carry on working for your employer and still take the benefits from your pension scheme.

Income Drawdown (now referred to as 'Unsecured Income')

The section below has now been superceded. Please refer to the section below regarding the 2011 and 2015 changes
There was no major changes for those who currently hold income drawdown plans (a.k.a pension fund withdrawal); however, the good news is that the changes have made this pension arrangement more flexible. The current withdrawal amounts are limited by tables produced by the Government Actuaries Department. The old limits allowed a maximum income of 100% of a single life annuity and the minimum was 35% of the maximum.
Pension simplification has replaced this by allowing a minimum income withdrawal of £0 and a maximum of 150% of a single life annuity each year (previoulsy this was 120% but was revised upward with effect from 27 March 2014). This income amount is to be reviewed every 3 years (and on an annual basis after age 75).
Pension fund withdrawal will be known as unsecured income. After age 75 the compulsion to purchase an annuity will has been removed, but there are restrictions on the amount of income that can be withdrawn from a fund and serious tax repercussions upon death.
In the emergency budget on 22 June 2010, transitional rules were put in place to raise the maximum age for taking benefits from 75 to 77. This has now been abolished altogether, and there is no upper age limit.(Although age 85 is the upper limit for calculating GAD limits)
The new rules offered three different ways to provide income during retirement.
  • Unsecured Income
  • Secured Income
  • Alternatively Secured Income

Unsecured Income

This is similar to pension fund withdrawal, as it exists at present, which allows you to keep your pension fund invested without purchasing an annuity and drawing income from your pension fund, with a few important changes.
  • The minimum income that can be drawn is reduced to zero per annum.
  • The maximum income is 150% of a level single life annuity that can be purchased on the open market, (based on Financial Services Authority comparative tables up to 3 months before pension date).
  • The income must be reviewed at least every 3 years. The maximum income at review is determined in the same way as the initial maximum income.
  • Term annuities of up to 5 years duration can be used to provide unsecured income up to age 77, but the income generated must be taken into account when measuring against the maximum income allowed.
The lump sum death benefit is similar to the current income drawdown death benefit i.e. a full return of fund is permitted, subject to a 35% tax charge. Unsecured income cannot continue after age 77 when the basis of payment must switch to Alternatively Secured Income (ASI) or secured income.

Alternatively Secured Income (ASI)

ASI was also similar to pension fund withdrawal and is available from any age after 50 (rising to 55 in 2010) or from age 77 when unsecured income must stop. The key features of ASI were:
  • A minimum annual income of £1 must be paid.
  • The maximum income is 70% of a level single life annuity that can be purchased on the open market at age 75, or earlier (based on Financial Services Authority comparative tables).
  • The maximum income is reviewed annually using annuity rates from Financial Services Authority tables up to 60 days before the review date.
  • Upon death, any funds returned to the members estate are liable to an Inheritance Charge if it takes the member over the Nil-Rate band.

Secured Income

If income is not secured on the ASI basis by age 77, then it must be secured either by:
  • A promise from a pension scheme e.g. a defined benefit scheme (Final Salary Scheme), or
  • An annuity purchased from an insurance company.
On the whole, it is felt that these changes will further increase the flexibility of pension fund withdrawal arrangements.


From April 2011, there is now one form of income withdrawal which is known as 'Drawdown Pension'. The main points are:
  • The compulsion to purchase an annuity at age 75 has been dropped. There is no upper age restriction.
  • The maximum GAD level has dropped from 120 % to 100%. However, this was raised back to 120% on 26 March 2013 and 150% from 27 March 2014. The minimum GAD still remains at 0%
  • Review periods have reduced from 5 years to 3 years, then annually after age 75
  • Any lump sum passed on at death will be taxed at the rate of 55%; This was previously taxed at the rate of 35%
  • There is an additional option of taking Flexible Drawdown where you can take unlimited income, as long as you have sufficient alternative pension income (around £20,000 per annum). This amount was lowered to £12,000 with effect from 27 March 2014. See Drawdown Pension for more details.

2015 Update

From April 2015, existing drawdown plans can operate under the pre April 2015 rules, but for plans taken out after April 2015 (or existing plans that transfer into Flexi-Access Drawdown after that date), the major difference is that there upper limits to the amount that can be taken as taxable income. If required, the value of the remaining fund can be taken as income.
The Pension Commencement Lump Sum (PCLS) remains the same, which means that up to 25% of the fund can be withdrawn as a tax-free lump sum at the outset.
The ability to take the entirety of the remaining fund as cash does not mean that it is tax-free. All further income that is taken is taxable at your highest marginal rate, just as it was previously. Therefore, care should be taken when taking large amounts of income from a fund in any one tax year, or when taking the entire fund as cash, as a basic-rate taxpayer could end up paying higher-rate tax on the amount withdrawn, which could be far less tax-efficient than taking a regular income from the fund.
Money Purchase Annual Allowance
If you are considering using Flexi-Access Drawdown and making further pension contribution, you will be subject to the Money Purchase Annual Allowance (MPAA), which is currently £10,000.
This measure is used to prevent individuals taking large sums of money from a pension plans in order to fund further pension savings that would receive additional tax-relief. Effectively it limits the ability to continually recycle pension funds in order to generate additional tax relief.
See our Our Flexi-Access Drawdown Calculator to calculate the effects of using Flexi-Access Withdrawal.
If you are considering encashing an entire pension pot, you can use our Flexi-Access Drawdown Tax Calculator to work out the potential tax consequences.

Protecting your existing pension funds.

On the whole, only a very small proportion of individuals have been negatively affected by the maximum lifetime limit. These are individuals with funds close to or over £1.5 million. However, there may be many members of occupational pension schemes who have an entitlement to a tax-free lump sum that is greater than 25% of the fund value. Lump Sums have been automatically protected in most instances.
There are two elements to transitional protection ; for the total fund value against the Lifetime Allowance, and the maximum tax-free cash. This protection produces pre A day planning opportunities.
Please Note: People had until April 2009 to retrospectively claim protection of their pre 06/04/2006 pension funds. It is now too late to apply for protection.
Lifetime Allowance - Primary protection
Those who have pre A-day rights over £1.5 million will have their rights indexed in parallel with the indexation in the Lifetime Allowance.
Lifetime Allowance - Enhanced protection
If you cease to contribute to or be an active member of any pension schemes prior to A-day then pre A-day funds will be exempt from the Lifetime Allowance. Can be revoked in favour of Primary protection.
Lifetime Allowance - Fixed protection
Having already dropped from £1.8 million to £1.5 million, and now down to £1.25 million in the 2014/15 tax-year, it is possible to apply for Fixed Protection in order to retain a lifetime allowance of £1.5 million. This will increase in line with the lifetime allowance should it increase in the future. Fixed Protection is not available if the individual already holds Primary Protection or Enhanced Protection.
Once protection is in place, no further pension contributions can be made, or else it will void the protection, and potentially trigger a tax charge.
Protection against the Lifetime Allowance is portable so funds can be transferred.
Tax free cash - where Primary protection applies tax free cash entitlement at A-day will be indexed in parallel with the indexation in the Lifetime Allowance.
Tax free cash - where Enhanced protection applies pre A-day entitlement is expressed as a percentage of the fund value. It is this percentage that is used to calculate the tax free cash at retirement.
Tax free cash - where neither Primary nor Enhanced protection applies the tax free cash entitlement at A-day is indexed in parallel with the indexation in the Lifetime Allowance. Plus tax-free cash can be paid up to 25% of the fund value for contributions paid post A-day. Any protection is lost if benefits are transferred to another pension scheme (unless as part of a bulk transfer).

Self-Invested Personal Pensions (SIPPs)

One of the most talked about effect of the changes was in relation to SIPPs, largely because of the proposal of residential property as an allowable investment - a move that was subsequently blocked.
Overall, SIPPs operate under the same rules as outlined above. The only differences is what they can invest in. Previously, there was a permitted range of investments. Now, anything can be invested in that is not specifically excluded (usually these are either assets that can depreciate in value - and are therefore not 'assets' - indeed they are 'liabilities' in the true sense of the word, or assets in which the member is likely to derive personal benefit from). Assets that are excluded are:
  • Residential Property
  • Vintage Cars
  • Works of Art
  • Fine Wines
'Indirect Investment' in these assets are also blocked. For example, if a SIPP held 100% of the shares of a company that invested in residential properties, this would be viewed as if the SIPP had bought the properties directly. However, if the SIPP owned shares in a company where residential property only constituted a proportion of the company's assets, then this may not be prohibited.
There are other investments that could be considered questionable, so it would be wise to refer these to your local HMRC inspector for an opinion before any action is taken
PLEASE NOTE: If any of these prohibited investments are purchased via a pension scheme, an additional tax charge of up to 70% of the value of the investment can be levied. This will make investing in such assets an extremely undesirable option. It is the opinion of HMRC that they wish to block investment into assets which would probably be for the members direct benefit, rather than the benefit of the pension fund.
The other main changes relates to the amount that a SIPP can borrow when purchasing a Commerical Property. Before 06/04/2006, the old rules allowed a SIPP to borrow up to 75% of the market value of the property - the post 06/04/2006 rules will only allow for a maximum borrowing of 50% of the value of the PENSION FUND. This has significantly lessened the scope for borrowing, and SIPP plans will need a greater amount of initial funding before Commercial Property purchase becomes a viable option.

Other Significant Changes

Above are listed the main changes that took effect from April 2006. However, there are other important changes that have been overlooked by many commentators who have focussed mainly on the Lifetime Allowance and changes to the tax-free lump sum.

Death benefits

Death benefits from a scheme can be in the form of a lump sum or a pension payable to one or more dependants. These benefits will vary depending if death is before or after vesting. If death is before vesting a lump sum would be tested against the lifetime allowance but a dependant's pension would not be tested against the lifetime allowance.
If death occurred after vesting there would be the protection afforded by a value protection annuity or term certain annuities or the guaranteed period of up to 10 years from a standard annuity. For income drawdown before the age of 77 a return of the capital sum less 35% tax and for income withdrawal after 77 by means of the alternatively secured income there would be no return of capital. However, from April 2011, this has been replaced by a charge of 55% upon lump sums due to the removal of the need to purchase an annuity.

Trivial pensions

The proposed changes to trivial pensions aim to increase the number of options available where an individual has a smaller fund by taking this as a lump sum. There are a number of conditions that the individual must comply with as follows:
  • The sum of all your pension rights does not exceed £30,000.
  • You are aged 60 or over. (Whilst it is currently possible to take pension benefits from age 55, it is not possible to commute pension funds under triviality rules until age 60.)
  • You can only commute the pension(s) between the age of 60 and 75. Whilst it is now possible to defer purchasing an annuity beyond the age of 75, it is not possible to commute a pension after the age of 75.

'Recycling' of Tax-Free Lump Sums

This refers to the practise of taking a tax-free lump sum from a pension scheme, using it to pay a single premium into another pension scheme in order to benefit from additional tax-relief on the contribution. This could be potentially repeated a number of times, gaining further tax relief on each occasion
Whilst this has occured to some extent in the past (i.e. recycling unwanted income from pension fund withdrawal plans, where an income had to be taken, the new pension rules make it easier to take a tax-free lump sum but defer taking the main pension benefits until a later date. It is believed that the potential for abuse of this facility would only be increased, so a limit of 1% of the lifetime allowance (currently £10,731) has been imposed as an upper limit for 'recycling' purposes.
From April 2011, when the lifetime allowance was frozen, the trivial limit still remains at £18,000; thus breaking the link between triviality and the lifetime allowance. This was raised to £30,000 as of 27 March 2014.
  • The member must take the trivial pensions within a 12 month period;
  • The capital value of pensions already in payment is taken into account when calculating the overall limit
  • Pensions alredy in payment are valued at £25 capital for every £1 per annum gross pension;
  • The fund to be used for the trivial pension must be commuted in it's entirety;
  • Pensions in payment may also be commuted but will be taxed in full as earned income.

Retirement Annuity Contracts

The post 06/04/2006 rules brought significant changes to Retirement Annuity Contracts (otherwise known as S226 pensions). One of the main changes is the level of tax-free cash entitlement. This was directly related to the value of the annuity available from a policy and varied with age. From 6 April 2006, the level will be 25% of the fund value, falling into line with other pensions. After 31 January 2007 it was no longer be able to pay contributions by using unused tax relief from previous years, which could have had the effect of restrict contributions for some high earners. Effectively, Retirement Annutities are now treated exactly the same as personal pensions.

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