If one spouse has a substantial pension pot that is in danger of breaching the cap — and therefore being subject to big tax charges — can they transfer or gift part of the pot to their spouse whose pension pot is much smaller?
Christine Ross, client director at Handelsbanken Wealth Management, says it is not possible for one spouse to transfer or gift part of their own pension savings to their spouse. At the risk of being indelicate, the only exception to this rule is in the case of divorce, when a pension sharing order can be made.
There have been attempts within small group pension schemes to shift value from one family member to another or to reallocate growth disproportionately to each member’s fund value to avoid breaching the lifetime allowance. In such cases HM Revenue & Customs reserves the right to tax any transfer of value, which could be treated as an unauthorised payment and taxed at 55 per cent.
The lifetime allowance limits the amount of pension savings that can be accumulated and an additional tax charge is applied on any value above this level. It was introduced in 2006 at £1.5m and rose to a peak of £1.8m in 2011-12 before it was gradually cut back.
The current limit is £1.055m, which increases each year in line with inflation. An increasing number of individuals are being affected by the lifetime allowance and are having to decide whether to cease pension contributions to avoid an excess charge.
Members of an employer’s pension scheme who are close to the lifetime allowance should ask whether a cash alternative option is available. If so this could be used to fund other tax efficient savings such as Isas. Careful thought should be given before deciding to leave an employer’s pension scheme and the employee should first establish whether any associated benefits such as life insurance could be lost.
The cash allowance would be taxable and when added to salary could result in a higher rate of tax, the loss of child benefit or the tapered loss of the personal income tax allowance for those with income over £100,000.
If the spouse with the larger pension is aged 55 or over they can use some of their pension commencement lump sum (tax-free cash) or taxable pension income to fund a contribution for their spouse, subject to 100 per cent of that spouse’s earnings or the £40,000 annual allowance, whichever is lower. Even if their spouse has no earnings, a gross contribution of £3,600 a year can still be made. There are rules around recycling of pension tax free cash but this does not extend to making a contribution on behalf of another.
Where a substantial pension fund has been accumulated, only some of this may be needed to fund spending in retirement. In this case, accessing funds up to the lifetime allowance could be the best strategy to help mitigate the lifetime allowance charge. There will eventually be a charge at age 75 (or on death if earlier) but until then the scheme member will have the benefit of tax-free investment returns on the balance of the fund. Funds that remain in the pension can be left for nominated beneficiaries free of inheritance tax.
Martin Jenkins, partner at Irwin Mitchell, says pension rights cannot generally be gifted or transferred to a spouse. Some pension plans allow benefit options which will permit some reallocation of benefit between partners but it is all very limited. Even where it is permitted it will not solve a tax allowance problem.
Of course, pension reallocation does take place on divorce and dissolution of a civil partnership. In these circumstances, legislation provides for a transfer of pension rights between spouses, typically via a pension sharing order.
Pressure is now growing for a change in legislation on this point and it is easy to understand why. In decades past pensions were permitted to grow, if not quite tax free, at least in a tax advantaged environment. Broad cross party support for this policy persisted until the 2000s. Cracks began to appear, however, after successive Conservative and then Labour governments introduced some tax charges. Major changes came in April 2006, with the implementation of annual and lifetime allowances on pensions saving.
At first, the full impact of these changes was perhaps not fully appreciated. The first lifetime allowance was as high as £1.8m with an annual allowance of £215,000. Successive governments have significantly limited these so now the lifetime allowance is just slightly above £1m and the annual allowance can be as little as £10,000 a year depending on earning levels. The tax restrictions now are really starting to bite.
Some employers have reacted to the problem by agreeing with staff that salary and earnings should be restructured. In most cases, this means that some pay is made non-pensionable. Legally, such arrangements are generally permitted but this is not a universal solution.
The principal problem is that existing legislation which restricted the transfer of pension rights (outside divorce) was not changed at the time that the tax limits were first imposed. This was a missed opportunity that is now long overdue a revisit. There are some measures which a couple can undertake to ameliorate the problem by ensuring that the spouse who is not earning maximises the tax-free allowance.
A new “marriage allowance” plan might help further to allow a proportion of unused allowance to be transferred from one partner to another. A partner can also pay a certain amount to his or her partner’s pension.
Change is needed on the portability of pension rights. In the meantime, the advice is to check the rules of your own pension plan, maximise tax allowances on income and pension contributions and watch for further developments in this area.
The opinions in this column are intended for general information purposes only and should not be used as a substitute for professional advice. The Financial Times Ltd and the authors are not responsible for any direct or indirect result arising from any reliance placed on replies, including any loss, and exclude liability to the full extent.
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Our next question
I understand that a married individual may take 25 per cent of their pension pot tax free. Can such an individual who is about to be divorced ask their pension fund to release such funds to them without advising their spouse in writing that they are doing so? What requirement is there on the pension provider to inform the spouse that a portion of the pension is to be released and is the pension fund required seek the spouse’s approval for such a distribution?
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