At the moment, some pension schemes are set up to provide a pension which replaces all, or part, of the additional State pension (also called the State Second Pension). This includes some company, stakeholder and personal pension schemes. When you join one of these pension schemes, you are said to be ‘contracted out’ of the additional State pension.

There are two ways of contracting out, based on how the benefits are to be calculated. Some company schemes, generally money purchase or defined contribution schemes, along with personal and stakeholder pensions, contract out on a defined contribution basis. Other company schemes, normally defined benefits schemes, are contracted out on a salary- related basis. Currently individuals who are members of a contracted out scheme pay lower National Insurance contributions and/or receive some National Insurance rebates into their pension scheme.

The Government are planning to end contracting out of the additional State pension on a defined contribution basis from 6^th April 2012. The planned changes mean that you will no longer be able to use a pension contracted out on a defined contribution (money purchase) basis in place of the additional State pension. Instead you will automatically be brought back into the additional State pension and, depending on your earnings; you may begin to build up entitlement to the additional State pension from this time. In most cases you will earn entitlement to the additional State pension.
There may be some cases in which you won’t, for example if you stop working or earn less than the Lower Earnings Limit.

The National Insurance rebates an individual and, where applicable, their employer currently get if they are contracted out are intended, when invested in the contracted- out scheme, to provide benefits broadly the same as those given up in the additional State pension. However, benefits from defined contribution schemes can vary depending on investment returns and annuity rates. This means it is difficult for individuals to predict with any degree of certainty whether they would be better off in the additional State pension or contracted out. To help simplify the pensions system and decisions about retirement savings, the Government has, therefore, decided to abolish contracting out on a defined contribution basis.

From 6^th April 2012, instead of receiving rebates of your National Insurance contributions you may begin to build up entitlement to the additional State pension. For every year that you pay National Insurance on earnings over £5,044 a year (based on 2010/11 earnings) you will get around an extra £1.60 a week on your State pension when you come to claim it. People earning above £14,000 per annum (based on 2010/11 earnings) will also be entitled to an extra earnings- related payment but the earnings- related payment will be gradually withdrawn so that by 2030, additional State pension will be made up of the flat- rate amount only.

If you require any further information on the ‘Abolition of contracting out on a defined contribution basis’ please do not hesitate to contact our office on 01634 281145.

The evidence suggests that delaying may not be the best course. It is possible that rates might improve in the next year or two, but the full benefit of any increase may not be passed on to investors because annuity providers are having to
accommodate ever-rising levels of life expectancy and the fragility of the bond market in which annuity funds are invested.

Also, delaying means missing out on immediate income payments, which may not be recouped even if annuity rates do rise. Those who delay are often disappointed.

When buying an annuity, the most important message is to shop around, not only between annuity providers but also between different types of annuity. The value of the income from a level annuity will quickly erode with inflation so, if a lengthy retirement period is anticipated, it may be wise to include provision for annual increases, or to opt for an annuity whose value is linked to share values, though this will depress the value of the immediate payments.

The most significant development in the annuity market in recent years has been the rise in popularity of annuities which reflect the state of individual investors’ health. These “enhanced” annuities can offer markedly improved levels of income.

If there is a need to supplement pension income, the first port of call should be ISAs, the income from which is tax free, and in this respect equity income funds currently offer significantly higher yields than most corporate bond funds, and certainly much more attractive rates than cash deposits. Some fixed term structured products, whose returns depend on the level of stock markets at a future date, are also attractive, though great attention needs to be paid to the small print. At
times like these, the return of capital is more important than the return on capital.

Those with larger pension funds are better placed to play a waiting game and may well prefer to keep their pension plans in place and draw an income from the investments under an income drawdown arrangement.

Retirees who can demonstrate that their guaranteed pension income from sources other than their drawdown plan exceeds £20,000 a year are particularly well placed, because there is no limit on the amount they can withdraw. The Government considers that having this level of income removes the risk of the investor having to turn to the state for support if the investments in their drawdown fund become worthless.

For other drawdown investors, however, withdrawal levels are restricted by the Government and have recently been reduced, causing retirees to look to other potential sources of income.

Some may consider dipping into capital to supplement their income, but this should be a last resort, as also should the equity release schemes which enable householders to cash in on the value of their homes. Maintaining a capital buffer as protection against unforeseen future financial demands should always be a long term financial objective.

“If the parents of a student starting university this year had put aside £50 a month from birth, they would have accumulated more than £20,000 in savings. Most importantly, they would have helped to demonstrate the value of financial planning and responsibility.”

He added that there are many options open to parents looking to save a regular sum for the long term. Many friendly societies offer tax-exempt savings plans, and from November it will be possible to open a Junior ISA to help fund a child’s education.

The latest figures from the Office for National statistics show inflation stood at 4.2% in June, after falling from 4.5% in May. In the Bank’s Augusts’ inflation report, published last week, the Monetary Policy committee (MPC) says inflation is likely to rise in
the coming months before falling back in 2012 and 2013.

It says: “There is a good chance that inflation will reach 5% later this year, boosted by utility price rises, and reflecting the continuing impact from past increases in VAT and in oil and other import prices.”

The bank cut its growth forecast from 1.8% to around 1.5%, due to the euro zone debt crisis and the threat to US economic growth.

John Charcol senior technical manager Ray Boulger, says: “It looks like base rate will not go up until 2013 here. Bearing in mind the MPC has got 2 remits- to keep inflation to target and the other to facilitate employment in the general economic scenario- and the bank obviously feels it is able to keep base rate where it is and achieve this.”

Capital Economics senior UK economist Vicky Redwood says: “The MPC’s growth forecasts still look optimistic to us, particularly in light of the further market volatility seen since the committee signed off the report last week. Accordingly, we still think that keeping interest rates low will not be enough to generate a strong recovery and more quantitative easing will be necessary.”

Data showed that 45% of over 60s cannot afford to retire, while 1/3 want or need to work after the age of 65 to boost retirement savings. More than half, 56% of the age group said they enjoyed working.

Dominic Grinstead, managing director of MetLife UK, said: “The whole concept of retirement is changing rapidly and that is reflected in the number of people aged 60 and over who are carrying on working.

“The past decade has seen a doubling of the number of over 65s who work and clearly the numbers will continue to increase as the abolition of the default retirement age takes effect. Many are keen to carry on working, but many have to keep on working. They need retirement income solutions which can enable them to maximise income while retaining flexibility. “

However the survey identified a split between those who want to work full-time or part-time, with 40% preferring to stay in their current job but on a part-time basis, compared with 28% who want to stay full time in their current job and another 11% who would prefer to move to a new full-time or part-time post.

The poll also found that women were more likely to be unable to afford to retire than men, with 50% of women stating that they cannot afford to stop work, compared with 42% of men.

About 10% of over 60s said their employer had asked them to keep working.

Pension sharing is usually the better remedy in respect of pension rights as it gives the transferee spouse their own separate pension fund. Attachment of pension income can only come into effect when the spouse with pension rights starts to draw them, which they may never do, if they die before reaching retirement age.
If there are substantial assets so that a clean break order can be made, the first consideration is whether it is feasible to divide each class of assets in the same percentage.

Pension sharing orders divide a member spouse’s pension fund(s) in percentages by reference to their cash equivalent transfer value (CETV). That percentage represents a pension credit to the transferee and a pension debit for the transferor. It is a simple exercise if the fund is a money purchase one, as its value on any given day is defined by the value of its underlying investments. With a defined benefit (DB) scheme the CETV will be governed by complex calculations that take into account the member’s salary, age, years of service and the funding of the scheme.

A spouse due to receive a percentage of a CETV of a DB scheme will want to know whether they can take the pension credit in the form of rights in the transferor spouse’s scheme (an internal transfer) or by receiving a payment to another scheme they are already a member of, or will set up. In the majority of cases an external transfer will be the only possibility. Internal transfers more frequently occur where rights in an unfunded public service scheme arise, subject to that scheme being open to new members.  A transferee of a pension credit should take advice from a suitably qualified IFA as to what their newly acquired pension pot will provide them with on retirement and at what age. 55 is the minimum age at which benefits can be taken in most schemes, though benefits will be less the earlier they are drawn. Many public service schemes do not permit ex-spouses to draw benefits as early as age 55.

Where a spouse has a pension pot with a CETV worth around £1.5m, it will be most important to ascertain whether he or she has primary and/or enhanced protection under the 2006 regulations or, if they were not applicable, is aware of the need to apply for fixed protection before April 5, 2012 to avoid the special tax charge for having a fund that exceeds the lifetime allowance.

It is important to remember the basis of valuation for the lifetime allowance is quite different in the case of a DB scheme from the CETV valuation.
The tax rules relating to the annual allowance for pension contributions and the lifetime allowance for the value of an individual’s pension fund have become exceedingly complex. Where one spouse has a very substantial pension fund, pension sharing on divorce can offer constructive tax planning opportunities. It is by no means always practical or tax effective to divide each asset class in the same proportions. Even when the parties cannot settle financial issues on divorce, the presiding judge may still leave some discretion to the spouses and their advisers to work out the precise division of the different classes of assets.
If the spouses do not want pension rights shared, the issue of an offsetting payment by the member spouse to the other spouse will arise.

Pension attachment orders can be made in respect of pensions prior to their payment or when they are in payment, in respect of lump sum commutations on retirement or lump sum death benefits. They are more likely to be useful when a clean break cannot be effected and a continuation of periodical payments to one spouse after the paying spouse’s retirement is contemplated. The court has no control of when the spouse with pension rights will retire. Attachment orders cannot be made in respect of rights being shared. Where a spouse has more than one scheme, attaching a death in service lump sum of the scheme that is not being shared maybe useful to the spouse caring for the children as it insures for the loss of periodical payments for them on the paying spouse’s premature death.

KEY POINTS

• Pension sharing allows the transferee spouse their own separate pension fund and is usually the preferred option
• Pension attachment orders are useful when spouses are unable to make
  a clean break and there are continued periodical payments.
• Even if spouses are I unable to settle all financial matters upon divorcing, the judge may use their discretion in allowing the parties to divide pension asset classes as they see fit

Gerry Brown, the technical manager of Prudential, said the dearth of EBT’s announced in the Finance Bill on 31 March, means that employees, beneficiaries or trustees of EBTs should come clean and bring their affairs up to date. He said “EBTs have been used around since the late 1980s and have been used extensively by high earning employees. Many footballers, in particular are believed to have used them.

“The Government has gradually tightened the tax rules applicable to their use and the Finance Bill 2011 contains provisions intended to finally kill them off as tax planning arrangements”.

Mr Brown added that HMRC is offering employers who have used EBTs and similar arrangements an opportunity to resolve any outstanding tax liabilities without recourse to litigation.

Employers, trustees or beneficiaries willing to reach a final settlement with HMRC can do so; however they will have to pay any unpaid tax charges as well as interest on the sum.

Mr Brown said, “The precise tax treatment of EBTs has not been always clear and HMRC is now offering to sweep up all tax issues in one go. Sponsoring companies and beneficiaries should seek specialist tax advice as soon as possible.

“It could be that a company underpaid corporation tax or an employee received a benefit that triggered a tax charge but did not report it. What HMRC would like to do is take an EBT, look at the various tax aspects and determine where there is a liability”.

EBTs are used to minimise the income tax and national insurance charges on remuneration to employees and directors and may also generate a claim for corporation tax deductions for payments into the trust. However, in George Osborne’s Finance Bill, legislation was introduced to confirm that such arrangements or schemes do not work.

The Treasury says 6million children will be eligible for junior Isa’s, which will replace child trust funds, when they launch on November 1^st. It expects a further 800,000 to become eligible each year. Children will be able to have 1 cash and 1 stocks and shares junior Isa at a time. Funds in junior Isa’s will be locked in until the child is 18 when the accounts automatically become adult Isa’s.

The Treasury says if a parent contributes the maximum amount over 18 years, a child could see resulting funds of up to £80,000. Those who already have a child trust fund will not be eligible to pay into junior Isa’s but the Government will increase the child trust fund contribution limit from £1,200 to £3,000 in line with junior Isa’s.

For further information, please contact our office in Chatham, Kent on 01634 281145.

The reduced rate of IHT, which will be discounted from 40% to 36%, is designed to encourage charitable giving and will apply from April 6, 2012.

Estates valued at £325,000 or more incur an IHT charge. Independent consultant Colin Jelley calculates that, under the current rules, if an estate valued at £425,000 made a £10,000 charitable gift, the estate, if taxed at 40% would pass £379,000 to the family. Under the new rules, the family receives £382,600, an additional £3,600.

On the same basis, families would receive £385,000 where no charitable gift was given. Osborne said in his budget speech no beneficiaries would be better off under plans. Jelley says: “I think the move will certainly improve charitable giving because the costs to the family will be substantially less as a result of the changes than they would otherwise have been.”

But Contact Law will writing and probate solicitor Haroon Rashid does not feel the Budget discount move will trigger more charitable gifts. Rashid says, “For those people who take their social responsibilities seriously, the move will be welcomed. However the problem is, will a 10% inheritance tax relief actually encourage people who are not keen charitable givers to leave money to charities in their wills?”