Contact: Chief Pensions Officer [email protected] ; 01962-847506

1 Introduction

1.1 Currently, all pension schemes operate under several tax regimes which have developed over many years. These place limitations on the amount of tax relief available to scheme members' pension contributions and on benefits.

1.2 From 6 April 2006 a new tax regime will apply to registered pension schemes. It enables members to get more tax relief on their contributions to encourage saving for retirement. There will be no limit on benefits, but extra tax will apply if a person's benefits are valued for tax purpose at over £1.5 million.

1.3 The current limits are written into the Local Government Pension Scheme (LGPS) and will continue to apply unless they are removed. The Office of the Deputy Prime Minister (ODPM) is consulting LGPS interests about removing the current limits to take advantage of the new flexibilities from 6 April 2006, but without adding to employers' costs. This report sets out the key changes and the County Council's proposed response for the Panel's consideration.

1 Contributions

2.1 Currently, scheme members' contributions, plus any additional voluntary contributions (AVCs) being paid, are limited to 15% of pay in a tax year and attract income tax relief at source.

2.2 From 6 April 2006, this limit will be raised to 100% of salary, but must not exceed £215,000 in a tax year. This limit is the new tax-free annual allowance and goes up each year. A tax charge becomes payable where the amount of the benefits which an individual accrues in any tax year exceeds this amount.

2.3 This greatly increases the scope for individuals to pay extra contributions to buy extra benefits in the LGPS. Currently only 554 out of 46,000 are doing so and about 6 new contracts start each month, although many others do enquire. This is due to the fact that individuals meet the full cost of buying extra benefits without any corresponding contribution from the employer. Whilst the individual should meet the full cost, they are treated as fully paid if ill health retirement occurs. ODPM asks if limits on buying added years should be kept.

2.4 Considering the relatively low take-up rate of 1.2% this seems unnecessary. This would enable individuals to invest more money in the LGPS if they wish.

3. Additional voluntary contributions (AVCs)

3.1 The current requirement on all schemes to offer an AVC facility, Zurich and Equitable Life for the Hampshire Fund currently, will be removed, because individuals will be allowed to contribute to personal pensions, which are similar to AVC plans, whilst contributing to the LGPS at the same time.

3.2 835 individuals are paying AVCs and about 14 start each month. ODPM proposes to protect their right to pay AVCs, but to let each employer decide whether or not they wish to offer the same facility to contributors who wish to start paying AVCs when the amendments to the LGPS come into force.

3.3 This would simplify administration but restrict choice for employees later on. In particular, AVCs can be paid solely for extra life cover, so as to double the LGPS death grant from two years' pay to four years' pay, under current rules.

4. Service

4.1 LGPS benefits are based on the scheme member's length of service and level of salary. Currently the LGPS contains limitations on each of these factors.

4.2 From 6 April 2006 these limitations can be removed. Whilst allowing this, ODPM is concerned that their removal should not give rise to windfall profits for scheme members, as these would add to employers' costs in the long run.

4.3 ODPM proposes to remove the limit on length of service to encourage people to work longer, save more for retirement and to discourage age discrimination.

4.4 This will also remove an anomaly, whereby some employees are required to contribute for parts of their careers without accruing more benefits, unless the employer grants a contribution holiday. The power to do that will be removed.

4.5 ODPM suggests that those employees currently affected could continue with their contribution holidays or make the necessary contributions, with interest, to count the service and accrue benefits. Either solution would be acceptable.

5. Salary

5.1 Currently, a person who entered LGPS after May 1989 has their salary "capped" for LGPS purposes. The earnings cap is £105,600 in 2005/06. Their contributions and benefits are based on this level, even if they earn more.

5.2 Removing the earnings cap would enable the person to pay more and also get more benefits, based on their length of service, including the "capped" service. This would give the person a windfall gain at the expense of the pension fund.

5.3 Whilst only two people are affected, one windfall gain could be substantial.

5.4 ODPM has suggested four options for dealing with this. Three would not allow the pension fund's costs to be increased overall. The fourth would do so, but only if the person concerned made additional contributions to cover that, as certified by the fund's actuary. Any of these solutions would be acceptable.

6. Retirement benefits

6.1 LGPS currently pays a standard package of benefits of a tax-free lump sum, a pension and a widow's or widower's pension. Pensions are also paid to deceased scheme members' children, until their full-time education or training ends. The benefits taken can be altered at the member's option, within limits.

6.2 The standard package and its value will not alter, so neither will employers' costs, but from 6 April 2006 it will be possible for members to receive lump sum payments almost 92% larger than now, in exchange for smaller pensions. The conversion factors in use will still be decided by the Government Actuary.

6.3 From 6 April 2006, pensions for children who are not disabled cease at age 23.

6.4 Flexible retirement will allow members to draw their benefits without retiring completely. However, LGPS already requires a person's pension to be abated whilst they work in local government, so that their combined rates of pension and pay do not exceed their rate of pay before retirement, and will still do so.

7. Taxation

7.1 PAYE applies to pensions, but retirement lump sums are not taxed currently.

7.2 From 6 April 2006 an additional charge to tax will arise when benefits worth more than the tax-free lifetime allowance of £1.5 million are paid to an individual taxpayer. The scheme and taxpayer will be jointly liable for this.

7.3 ODPM have proposed that benefits should be reduced to defray this charge.

7.4 An LGPS contributor with 40 years' service would need to earn over £134,000 to incur this charge. Five contributors have been warned that, potentially, they stand to incur the lifetime allowance charge, which is, effectively, a 55% tax on the value of their benefits in excess of the tax-free lifetime allowance

7.5 Where an individual's benefit accrual in a tax year before retirement exceeds the tax-free annual allowance for that year the excess will get taxed at 40%. This effectively removes the preferential tax treatment for any excess benefits. In October 2004 ODPM asked if employers should be allowed to pay this tax if it were caused by awarding extra service to an employee after 6 April 2006, but they have not repeated it. This does not apply to awards made before then.

Recommendation

That on behalf of the County Council, the Panel welcomes ODPM's proposals for adopting new tax regime limitations in the LGPS which allow contributors more flexibility to save more for retirement by paying extra contributions and buying extra benefits, provided that these do not increase the employers' costs.

Section 100 D - Local Government Act 1972 - background documents

The following documents discuss facts or matters on which this report, or an important part of it, is based and have been relied upon to a material extent in the preparation of this report.

NB the list excludes:

1. Published works.

2. Documents which disclose exempt or confidential information as defined in the Act.

None