Mercer Limited is authorised and regulated by the Financial Services Authority Registered in England No Registered Office: 1 Tower Place West, Tower Place, London EC3R 5BU Shropshire County Pension Fund Introduction to UK taxation / National Insurance and pension reforms 2010/2011 April 2011 Matt Hawkins Tel

1 Mercer Contents/Agenda What has come in 2010 and what’s in store for 2011?2 Outline of new pension tax regime3 How pensions used to work1 4Further considerations

2 Mercer How pensions used to work Employee contributionsEmployer contributions Pension Fund Build up mostly free of tax  Tax deductible at the employee’s marginal rate  Corporation tax & NI deductible  No imputed tax charge on employee  Tax-free cash sum  Taxed pension Limits on benefits and employee contributions

3 Mercer Pension limits and allowances since ‘A-day’ – April 2006  No benefit limits  “Allowances” determine favourable tax treatment – but don’t breach them!  Annual contribution/benefit allowance (“Annual Allowance”) Risen from £215,000 in 2006/07 to £255,000 in 2010/11  Cumulative “Lifetime Allowance” for pension Risen from £1.5m in 2006/07 to £1.8m in 2010/11  From 6 April 2010, minimum age 55 for early retirement  Up to 25% tax-free cash

4 Mercer Lifetime Allowance Valuing benefits at retirement  Defined benefit plans – Comparison with Lifetime Allowance at ‘crystallisation’ date Gross pension £20: £1 per annum Lump sum £1: £1 – Example: Pension received=£60,000 per annum Lump sum=£375,000 Value=[£60,000 x 20] + £375,000 = £1,575,000 One factor for all ages, types of pension increase (up to RPI or 5%) and dependant’s benefits  Defined contribution plans (AVC’s, Personal Pension arrangement) – Value of Fund at crystallisation date

5 Mercer Lifetime Allowance (LTA) – expected scenario pre April 2009 Budget 2006 £1.5m Up to 25% tax free cash max £450k in 2010 Remainder as pension (taxed) 25% Lifetime Allowance charge on excess Cash or pension (taxed) 2010 £1.8m Retirement Retail Prices Index increases expected originally } 55% “marginal” rate of tax

What’s coming? Major changes to tax/NI introduced/proposed via Budget 2009/ Finance Act 2009 / Budget April 2010

7 Mercer April 2010 tax changes APRIL 2010 NI Contributions increase MARCH 2010 Introduction of new top rate of income tax of 50% for incomes > £150,000 p.a. Rapid elimination of personal tax allowance for incomes > £100,000 p.a. Extra 1% National Insurance contributions (NICs) payable by employer and employees – retained by the new Coalition Government

8 Mercer 2010 changes – removal of the Personal Allowance

Outline of the new pension tax regime – originally announced via the Coalition Government’s emergency Budget in June 2010 and detail revised on 14 th October 2010

10 Mercer Annual Allowance – how will the calculations work No plans to increase this AA threshold – at present Annual Allowance (AA) – restricted to £50,000 Valuation of annual DB pension accruals:  ‘real’ increase in accrued pension (over CPI) over the year, multiplied by  a flat factor of 16, irrespective of the member’s age Valuation of annual AVC pension savings  total employee contributions Pension value in excess of AA would normally incur a tax charge at employee’s marginal rate Members’ contributions will enjoy full tax relief

11 Mercer Annual Allowance – how will the calculations work – LGPS example Real increase in pension = £55,000 – [£50,000 x (1.025)]= £3,750pa Real increase in lump sum = £130,000 – [£120,000 x (1.025)]= £7,000 Deemed value of pension savings = (£3,750 x 16) + £7,000 = £67,000 So (ignoring mitigation techniques), excess of value of pension accrual over AA= £67,000 - £50,000 = £17,000 Accrued pension at end of year = £55,000 pa Accrued pension at beginning of year = £50,000 pa Accrued additional lump sum at end of year= £130,000 Accrued additional lump sum at beginning of year= £120,000 CPI inflation = 2.5% pa Annual pension tax due (for 40% taxpayer) = 40% of £17,000 = £6,800

12 Mercer Generic LGPS Examples Case 1Case 2Case3 Salary at beginning of year£40,000£100,000£150,000 Sevice at beginning of year Pre-2008 service at beginning of year Salary at end of year£46,000£110,000£160,000 Service at end of year Pre 2008 service at end of year Inflation over year2.5% Pension accrued at beginning of year£20,500£26,250£48,750 Lump sum accrued at beginning of year£55,500£63,750£123,750 Pension accrued at end of year£24,342£30,708£54,667 Lump sum accrued at end of year£63,825£70,125£132,000 Value of ‘pension savings’£60,204£65,615£80,323 Excess over annual allowance of £50,000£10,204£15,615£30,323 Tax charge if 20% tax rate£2,041-- Tax charge if 40% tax rate£4,082£6,246£12,129 Tax charge if 50% tax rate-£7,807£15,161

13 Mercer Annual Allowance – what’s exempt? Death and ‘severe’ ill- health benefits Revaluation of deferred pensions is exempt

14 Mercer Annual Allowance – but what gets caught? Increases to accrued benefits due to salary increases, e.g. on promotion Augmentations to benefits on redundancy But no penal charges will arise on early retirement

15 Mercer Possible mitigation techniques – carry forward of unused AA Ability to carry forward the previous three years’ unused Annual Allowance to offset excess pension savings Special transitional rules will apply for , , and – based on an assumed AA of £50,000

16 Mercer Members whose benefits exceed the Annual Allowance (of £50,000) in a tax year can request the scheme to pay the additional tax, and have their benefits reduced in the scheme. The main points are: -Scheme pays will be available if the benefits built up in one scheme exceed the Annual Allowance and the Annual Allowance charge exceeds £2,000; - It will be compulsory for schemes to offer scheme pays for members that exceed the Annual Allowance outright in that scheme; and - Schemes will have flexibility on how they implement scheme pays, as long as it 'fair to all members'. Employer could phase in pensionable salary increases following salary increases/ promotions Possible mitigation techniques – Scheme Pays

17 Mercer Proposed changes to the Lifetime Allowance Government will reduce the Lifetime Allowance (LTA) to £1.5m on 6 April 2012 Maximum tax free cash lump sum will also fall to £375,000 DB pensions will still be valued for LTA purposes at 20:1 but will this remain on early retirement? AVC benefits valued at “face value” LTA charge will remain at 55% if taken as cash or 25% if taken a pension (with the pension then taxed in the normal way)

18 Mercer 2006 £1.5m Up to 25% tax free cash - max £375k from 2012 Pension (taxed) 25% Lifetime Allowance charge on excess pension (taxed) 2010 £1.8m Retirement Potential for 62½% tax Lifetime Allowance Excess – penal taxation applies Total HMRC value of retirement benefits Proposed changes to the Lifetime Allowance – from 2012? £1.5m (frozen indefinitely?)

19 Mercer Special transitional protection will apply to any member who wishes to elect for the existing LTA of £1.8m. Any member seeking this new form of ‘Fixed Protection’ will need to elect for and obtain the Fixed Protection certificate before 6 April Details of the election process with HMRC are not yet known. Proposed changes to the Lifetime Allowance - Fixed Protection Members with Fixed Protection will also be able to retain a maximum tax free cash opportunity of £450,000. Any member seeking Fixed Protection would need to opt out of all registered pension provision completely before 6 April Any contribution or benefit accrual by or on behalf of such a member after 5 April 2012 will result in the Fixed Protection election being lost.

20 Mercer Schemes need to provide information on the value of pension accruals (if > AA) within 6 months after the end of the tax year If requested by the member, by the later of 3 months of the request or 6 months after the end of the tax year Employers must provide information on pensionable pay and benefits by 3 months after the end of the tax year Special concessions apply in the first year – deadlines are extended by a year to 6 July 2013 or 6 October 2013 Other aspects – Information Requirements

Further considerations

22 Mercer Issues for impacted employees to consider High level - Should I stay in the registered plan beyond April 2011? – there may be an annual allowance charge to worry about – however, for many, there may be no AA charge, and – the opportunity to utilise any unused AA carry forward may be available – and you can always reduce AVCs – but don’t forget about the Lifetime Allowance – for older members on substantial salaries, should early retirement be pursued before 6/4/12 to get the £450k tax free cash? Should pension contributions actually be boosted next year? – tax relief for member’s contributions will be available at the highest marginal rate – can utilise unused AA carried forward - particularly in 2011/12, perhaps due to anti - forestalling

23 Mercer Issues for impacted employees to consider  The opt out vs stay in the pension plan dilemma – on opt out, you avoid the AA charge – and perhaps encounter a lower LTA charge (if any) – but what would you get in return? – pension contributions attract full marginal tax relief (while the AA is not exceeded) while the post retirement tax rate could be lower and there is tax free cash!  New form of Fixed Protection under the LTA – opt out before 6 April 2012 to keep the £1.8m LTA  Should you allow for the LTA/AA to increase in the future?  The current defined benefit Pension Plan is unlikely to remain in its current format for long. Lord Hutton proposals for the reform of LGPS in March 2011

Appendices

25 Mercer Anti-forestalling rules introduced Transitional period - until 5 April 2011 Intended to stop high earners paying too much into pensions before 2011 These apply to employees: whose ‘relevant income’ is £130,000 or more and who increase their normal ongoing regular pension savings on a money purchase basis** (the ‘Protected Pension Input Amount’), and whose annual total pension savings exceed £20,000 (or rarely up to £30,000) If all three conditions above are met, a ‘special annual allowance’ test will apply “Relevant income” for anti-forestalling period is broadly total income (from all sources) less charitable donation deductions. ** Normal ongoing regular pension savings would include your DB pension accrual and any AVCs, paid at least quarterly, where AVCs started before 22 April 2009, if relevant income is above £150,000, or before 9 December 2009 where relevant income is between £130,000 and £150,000

26 Mercer Illustration of carry forward calculation for AA purposes Estimated Accrued Pensions: £32,000 as at 5 April 2008 £36,000 as at 5 April 2009 £40,000 as at 5 April 2010 £44,000 as at 5 April 2011 Inflation - Consumer Price Index: For the 2008/09 tax year 1.80% For the 2009/10 tax year 5.20% For the 2010/11 tax year 1.10% Pension Input Amount: 2008/09 - [(36,000 – 32,000 * 1.018) * 16] + (100,000 – 96,000 * 1.018) = £57,056 Carry forward = /10 - [(40,000 – 36,000 * 1.052) * 16] + (104,000 – 100,000 * 1.052) = £32,848 Carry forward = £17, /11 - [(44,000 – 40,000 * 1.011) * 16] + (108,000 – 104,000 * 1.011) = £59,816 Excess £9,816 The calculation below assumes no AVC payments have been made. Adjusted Unused Annual Allowance available to carry forward to 2011/12: 2008/09 -nil 2009/10 - £17,152 - £9,816 = £7, /11 - nil Estimated Additional Lump Sums: £96,000 as at 5 April 2008 £100,000 as at 5 April 2009 £104,000 as at 5 April 2010 £108,000 as at 5 April 2011

27 Mercer Carry forward of unused Annual Allowance – further example Suppose value of pension accrual in = £75,000 So Annual Allowance for = 50, ,000 = £95,000 There is an excess of AA over value of pension savings Hence tax due in = Nil Residual AA carried forward to = £95,000 - £75,000 = £20,000 YearValue of ‘pension savings’ AAUnused AA 2011 – 12£30,000£50,000£20, – 13£35,000£50,000£15, £40,000£50,000£10,000 Unused AA£45,000

28 Mercer Carry forward of unused Annual Allowance – different example BUT, unused annual allowance can only be carried forward if it hasn’t been used up in a subsequent year Suppose value of pension accrual in = £75,000 So the unused annual allowance for is reduced to zero in as it has been used up in the year. Annual Allowance for = 50, ,000 = £60,000 There is an excess in the value of pension savings over the AA. Hence tax is due in at the marginal rate of income tax on £15,000, i.e. between £6,000 and £7,500, and there is no residual AA to carry forward YearValue of ‘pension savings’ AANotional Unused AA Adjusted unused AA 2011 – 12£30,000£50,000£20,000£ – 13£40,000£50,000£10, £70,000£50,000£0 Unused AA£10,000

29 Mercer  Answer depends on whether you would pay AA or LTA charge on the pension. If marginal tax rate is 50% before retirement and 40% after: Approximate value of £100 invested in pension vs cash under different scenarios (noting that there is scope to build up £50,000 of pension savings tax efficiently each year) Tax-effectiveness of pension saving If you pay £100 into pension fund just before retirement, how does net pension compare with cash cost? Notes Assumes member’s marginal tax rate is 50% before retirement and 40% after retirement No allowance for NI contributions Assumes that 25% of pension could be taken as tax-free cash sum (if LTA doesn’t apply )

30 Mercer  Answer depends on whether you would pay AA or LTA charge on the pension. If marginal tax rate is 40% before retirement and 40% after: Approximate value of £100 invested in pension vs cash under different scenarios (noting that there is scope to build up £50,000 of pension savings tax efficiently each year) Tax-effectiveness of pension saving If you pay £100 into pension fund just before retirement, how does net pension compare with cash cost? Notes Assumes member’s marginal tax rate is 40% before retirement and 40% after retirement No allowance for NI contributions Assumes that 25% of pension could be taken as tax-free cash sum (if LTA doesn’t apply )

Mercer Limited is authorised and regulated by the Financial Services Authority Registered in England No Registered Office: 1 Tower Place West, Tower Place, London EC3R 5BU