The implementation of pensions tax simplification in 2006 is set to have a significant impact on the life assurance market. Wojciech Dochan explains
Pension tax simplification is one of the hot topics currently occupying the minds of the UK financial services industry. The Government intends to replace the eight fiscal regimes that presently apply to Inland Revenue approved pensions with just one, and its radical proposals will be published this year in the Finance Act and supporting regulations.
A Green Paper published in December 2002 originally set 6 April 2005 as the date for its implementation. However, this has been put back to 6 April 2006, much to the relief of providers, financial advisers and, it is suspected civil servants, who will now have more time to prepare for the changes to come.
Most of the coverage given to the proposals has focused almost exclusively on the implications of the new single tax regime for the various ways of building up pension provision over the years leading up to retirement and drawing an income later on. The different ways of handling the tax planning challenges set by high earners, who have accrued substantial pension rights already, have also attracted plenty of attention.
Annual allowance
In comparison, coverage of the issues arising from the coming changes for temporary life assurance - especially in terms of marketing opportunities and product design - has been virtually non-existent. This leaves the question: with the time of implementation now finalised, what exactly will happen in terms of individual policies?
With just a single tax regime, there will no longer be separate rules for occupational schemes and personal and stakeholder pensions. The maximum lump sum death benefit per individual will simply be equal to the lifetime allowance, which will be set at £1.5 million in the 2006/07 tax year and then rise by annual stages to £1.8 million in 2009/10 when it will be reviewed. Part of this may be taken up by the value of an individual's accumulated pension fund with the balance provided as the lump sum benefit from pension term assurance. Any amount that exceeds the lifetime allowance would be taxable on the recipients at the rate of 55%.
Survivors' pensions on an individual's death before taking their pension will be allowed as well as or as an alternative to a lump sum. However, for tax reasons most people will probably choose cash unless they are forced to take a pension. For example, by contracting-out of requirements or the rules of the particular scheme to which they belong, lump sum benefits paid under trust should be free from Inheritance Tax (IHT).
Revolution
In terms of the limits that are to apply to contributions, there is to be an annual allowance, part of which may be used for investment for future pension provision and part applied as premiums for term life assurance. This will be set at £215,000 in the 2006/07 tax year and then rise each year to 2010/11 when it will be reviewed.
Within this annual limit any person, and if they are employed, their employer, can contribute up to £3,600 or 100% of their earnings, whichever is higher, and obtain the full tax advantages available. For the individual this means income tax relief at the rate of 22% or, if they pay tax at the higher rate, 40%. Low earners and even those who do not earn at all may contribute up to £3,600 gross a year with basic rate tax relief deducted at source - £2,808 net. For an employer, the premiums should be tax relievable as a business expense. Any payments above the annual limit will be taxable on the individual at the rate of 40%.
The coming of pension tax simplification is likely to trigger a revolution in the individual as well as the group term life assurance fields, but this means there will be opportunities for advisers within their individual client banks. There will be nothing to prevent pension scheme members from applying for separate 'concurrent' pension term assurance policies of their own.
If there is an existing group life arrangement, these can be used to top up the cover that it provides. In many ways the policies will be similar to the old Section 226A/Section 637 contracts that were popular in the years leading up to the changes made to the maximum premium rules with the introduction of stakeholder pensions in April 2001. However, the market for this new generation of policies will be much larger. Instead of being restricted to the self-employed - an important and growing market - and those in non-pensionable employment, they will be available to virtually all adults under the age of 75.
Even those with no earnings will be able to pay premiums of £3,600 gross/£2,808 net a year, if they are not paying, or having someone else pay into a pension for them. What is more, the lump sum benefit, payable under trust, should be IHT free. This should provide plenty of scope for meeting the protection needs of the great bulk of the population in a highly tax-efficient way. The marketing message is indeed compelling as the two case studies show.
The 6 April 2006 deadline may seem a long way off, but it is drawing closer by the day, and it always pays to be well prepared.
Wojciech Dochan is head of product development at BUPA
Case studies
l John Brown's employer provides a group personal pension arrangement for its workforce. In 2006/07, John is on a salary of £30,000 and is a member of the scheme into which he pays a contribution of 8% of his earnings, which works out at £200 each month.
His employer makes matching payments of the same amount. Should John die in service, the trustees would pay his dependants the current value of his accumulated pension fund. There is no additional term life assurance cover.
On his financial adviser's recommendation, John, who is married with a mortgage and young children, applies for a pension term assurance policy which will run to his expected retirement age of 65.
In April 2006, the value of John's personal pension is £80,000. He has no other pension entitlement. This means that the maximum level of term life assurance cover that the new tax rules allow is £1.42 million (the lifetime allowance of £1.5 million less £80,000).
The amount of cover recommended is, however, well below this at £460,000. This should be enough to protect John's £100,000 mortgage with a further lump sum of 12 times his current salary to secure his family's lifestyle if he should die before he plans to retire.
The gross monthly premium is £60, which, as John is a basic rate taxpayer, nets down after 22% tax relief to £46.80. The gross pension contributions (employee's and employer's) and life assurance premiums, which total £5,520 ([£200 + £200 +£60] x 12) for the 2006/07 tax year, are well within the annual limit of John's £30,000 salary.
Should he die during the policy term, the lump sum assured would be paid promptly under trust outside his estate so that there should be no IHT to pay.
l Carol Green, is a partner in a firm of solicitors. She has a self-invested personal pension valued in April 2006 at £700,000 and estimates that her share of the partnership profits for the new tax year should comfortably exceed £80,000.
Carol intends to pay a further £40,000 into her pension, and, on her financial adviser's recommendation, decides to apply for pension term assurance cover of £500,000. The policy is to run until her planned retirement age of 60.
Carol chooses to pay a yearly premium of £350 gross, which, as she is a higher rate taxpayer, nets down after 40% tax relief to just £210. Like John Brown, her accumulated pension fund, life assurance sum assured, pension contributions and term assurance premiums come well within the lifetime allowance and annual limits set by the new tax rules.
Again her policy is written under trust so that the proceeds should be payable free from IHT. The fiscal advantages of the coming new generation of pension term assurance products will provide an enticing sales and marketing message, and in this article I have only given a broad outline of what is to come. The leading protection insurers will almost certainly launch a number of different permutations, designed to meet a wide variety of specific client needs.
The coming changes may lead to a surge in switching activity as those with existing non-pension cover are urged to move over to that of the tax advantaged kind. We may also see some unbundling of flexible menu-based packages as policyholders look for the greater fiscal benefits that may be available outside.
COVER notes
• In April 2006, the Government intends to replace the eight fiscal regimes that presently apply to Inland Revenue approved pensions with just one.
• The maximum lump sum death benefit per individual will simply be equal to the lifetime allowance, which will be set at £1.5 million in the 2006/07 tax year and then rise by annual stages to £1.8 million in 2009/10 when it will be reviewed.
• The coming of pension tax simplification is likely to trigger a revolution in the individual as well as the group term life assurance fields, but this means there will be opportunities for advisers within their individual client banks.
