Pensions Bulletin 2014/43 - Taxation of Pensions Bill special
Pensions & benefits Policy & regulation
Taxation of Pensions Bill special
The Government this week introduced the Taxation of Pensions Bill to the House of Commons, a key piece of the jigsaw to give effect to the planned flexibilities announced in the March Budget. The intention is for the Bill to pass speedily through Parliament and to be given Royal Assent before the end of 2014 – ready to apply for members drawing benefits from 6 April 2015.
The Bill was accompanied by Explanatory Notes; and HM Revenue & Customs also published an updated tax information and impact note entitled “Pension Flexibility 2015”.
Publication of the Bill was heralded by huge press coverage. But most of the commentary related to a flexibility which was already announced in August (see UFPLS below), when draft clauses/guidance were published for consultation (see Pensions Bulletin 2014/32). A case of old news re-spun.
However, the Bill does contain several new points of detail and clarification since the consultation draft. And the Bill is of such importance that it is in any case worth taking stock of the main provisions, which we do in this Bulletin highlighting some of these changes. Some of these (particularly in our second two articles) impact immediate projects.
See our website for comments (including for example our quarterly updates, videos and guides) on some of the big picture implications for all types of pension provision.
As a reminder: here “money purchase” includes both traditional defined contribution arrangements and cash balance. And as the flexibility changes in tax law are written at an “arrangement” level, not scheme level, they apply to, for example, money purchase AVCs held in a pension scheme where the main benefits are final salary.
The main elements of the new money purchase regime – news but not much “new” news
The new ways of taking money purchase benefits
To recap, as announced before there will be two new ways that individuals can access their money purchase (“MP”) funds once they reach an appropriate age (their Normal Minimum Pension Age (NMPA) in the scheme involved – typically 55 but lower for some for historical reasons), or earlier if in ill health.
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The member can designate some or all of their MP fund to be for “flexi-access drawdown” (“FADD”). They can then draw sums from this as and when, either as cash instalments, or to buy an annuity (either short term or lifetime), or to buy a scheme pension. Each amount they receive is taxed as pension income at their appropriate marginal income tax rate(s) for earned income. At the time they designate funds to FADD, they can also take a tax-free “pension commencement lump sum” (PCLS) from other funds in the same scheme (typically of a maximum of 25% of the total of the tax free sum taken and funds designated – but potentially more or less given the complex way PCLS rules can work)
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The member can draw a sum from their uncrystallised funds, called an “uncrystallised funds pension lump sums” (UFPLS). An UFPLS will be 25% tax-free, with the balance taxed as pension income
In either case, the FADD designation or the UFPLS can be equal to some or all of their uncrystallised MP funds in the scheme.
Other ways of drawing from uncrystallised MP funds remain available, including buying a lifetime annuity or scheme pension (both of which can be in conjunction with a PCLS), or drawing the whole scheme benefit as a “small lump sum” if the conditions are satisfied (see our later article in this Bulletin on the latter).
It is important to remember that these are what tax law permits. What route a member can actually use (and how flexibly) for MP funds in a scheme will depend on what the scheme offers.
Comment
The Bill provisions are mostly the same as in the August draft. The UFPLS is broadly the same as designating funds to FADD together with a “25% PCLS” and immediately accessing all the FADD funds – so the UFPLS is effectively a streamlined and simplified version allowing no subtle variations. But there will be times, even when the trustees’ aim is to offer simple one-off cash out of all the MP fund, that UFPLS will not do the best job (the “2006 Protections” article below gives an example).
Permissive scheme rules override
The Bill includes an override giving scheme trustees and managers the power to utilise certain of the new flexible MP payments – among them UFPLSs, instalments from FADD, and (newly) PCLSs alongside FADD designations.
Comment
This is a continued reassurance that schemes are not being compelled by law to offer flexibilities. But it is a surprise that it is (still) drafted giving no say to the entity that will ultimately pick up any additional admin costs of operating new flexibilities – typically the employer. Where the trustees and employer are in agreement about offering flexibilities, the provision will save schemes having to make rule changes. The structure is more problematic if the trustees choose to take no regard of the employer’s wishes, particularly if there is no power in the rules to make charges. Given the large amount of press coverage already, and the likelihood of that continuing, will some trustees feel pressured into providing access to increased flexibility even if their employer would prefer not to?
Trustees and managers will (with or without the employer) in any case need to consider what flexibilities they want to offer and with what constraints; what other rule changes they might still need to make (eg to make sure they can pay “small lump sums”) and whether they need to try to prevent any unintended changes.
New flexibilities permitted in the design of lifetime annuity products
Some restrictions will be lifted on the shape of “lifetime annuities”, with a view to enabling creative new products. A lifetime annuity on offer from 6 April 2015 can still only be from an insurance company and must be payable at least for life, but can now be set up:
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With a guarantee period of more than ten years; and
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To decrease in payment (although the new draft confirms that such a product has implications for the £10K MPAA measure as per below)
“Anti-abuse” measures – the £10,000 Money Purchase Annual Allowance et al …
Alongside the new flexibilities, there are measures to “ensure that individuals do not exploit the new system to gain unintended tax advantages”. The key measure is the new £10,000 annual allowance for money purchase savings (the “£10K MPAA”), which applies – in parallel to the “normal” Annual Allowance – after an individual has first accessed their savings “flexibly”.
Accessing savings flexibly (ie the trigger putting an individual into the £10K MPAA parallel regime) includes:
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Receiving a payment from funds that have been designated into a FADD
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Receiving a UFPLS
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Some other points relating to those already in drawdown, and those with Primary Protection certificates with “£375K+ lump sum protection”
and (newly added):
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Buying a lifetime annuity that can reduce “other than in prescribed circumstances” (the “circumstances” not yet being clear); and
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Receiving a payment from a “scheme pension” set up from MP funds on or after 6 April 2015 from a scheme with (broadly) fewer than 11 other pensioners
As in earlier drafts, the measure is not triggered by an individual designating funds into FADD, receiving a PCLS at the same time as the FADD is designated, or if a fund is paid out as a “small lump sum”.
Once triggered, the £10K MPAA regime acts as a check in all future tax years on what counts as new MP savings for the individual across all schemes. If that is within £10,000 no special action is required; if over £10,000, there will be an Annual Allowance charge that the individual needs to identify and pay. The “normal” £40,000 Annual Allowance also applies as before, with measures to avoid double taxation where both types of Annual Allowance are exceeded. The 10K MPAA has some of the same features as the normal Annual Allowance (using Pension Input Periods) and some that are different (no carry-forward, the member cannot use Scheme Pays if only the 10K MPAA bites).
The August draft included extra complexity in applying this £10K MPAA where an individual has “hybrid arrangements” (ie where the benefit promise is to the better of a DB and MP benefit) because of Government worries that these could potentially be used as artificial structures to circumvent the £10K MPAA. We are pleased to see that, in the Bill, these provisions now only apply for hybrid arrangements set up on or after 15 October 2015 – a relief to the many schemes set up with contracted out protected rights or reference scheme underpins.
The “Recycling” anti-abuse measures continue to operate too, but now to be triggered at £7,500 rather than 1% of the Lifetime Allowance.
… and new obligations on pension schemes to help deliver the £10KMPAA
The Bill gives first sight of the new information obligations added to the burden of pension scheme administrators. HMRC’s brief description is that new reporting requirements for scheme administrators and individuals are being “introduced to ensure that where an individual has flexibly accessed their pension savings” [ie has triggered being in the £10K MPAA regime]:
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[All] schemes of which they are a member are aware of this
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The individual gets the right information to declare on their self-assessment tax return and calculate the annual allowance charge due; and
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HMRC is provided with sufficient information to ensure the right amount of tax is paid“
In practice this means a lot of (post event) information exchange between members and their schemes (including any scheme the member has rights in now or in the future) and HMRC; and Annual Allowance Pensions Savings Statements to be issued much more widely than before (including exact figures of both defined benefit and money purchase savings).
Comment
Fundamentally it is the individual’s responsibility to spot and pay Annual Allowance charge where it is due – but we suspect that these provisions are so complex that individuals will not do this in many cases. But there is no doubt that schemes will shoulder a significant extra burden (and risk of error or misinformation), importantly even where it was not the scheme in which the original trigger event happened. HMRC are due to publish more guidance, which we await with interest.
And finally, death
The Bill drafting introduces some of the changes announced in September on the tax charges applying from 2015/16 to MP pension funds passed on at death – ie the amounts designated to but not yet taken from a drawdown fund and MP funds not yet crystallised at all.
Individuals will be able to nominate any beneficiary for such funds to be passed to when they die.
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If the individual dies before reaching age 75, the beneficiary will pay no tax on it, whether it is taken as a single lump sum, or accessed through drawdown
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If the individual dies at or over the age of 75, the beneficiary will be able to access the pension funds flexibly, at any age, and pay tax at their marginal rate(s) of income tax. There are no restrictions on how much of the pension fund the beneficiary can withdraw at any one time. There will also be an option to receive the pension as a one-off lump sum payment – and the longer term intention is that this too would be subject to the recipient’s marginal rate of tax, but while the Government engages with stakeholders in order to put such a regime in place for 2016/17 a flat 45% tax will apply instead
The Lifetime Allowance “still applies”.
This system will replace the current 55% tax charge that applies for some death payouts as well as apparently removing income tax charges for some other payouts and widening the range of allowable beneficiaries.
Comment
The Bill includes some of the changes announced to apply for 2015/16 – but not all. We understand more drafting changes are to come. We look forward to seeing the remaining drafting as soon as possible to be sure of the Government’s intentions.
See our Pensions Bulletin 2014/40 for more comments on this very significant decision by the Government on the design of the “new MP world”.
Changes on how to cash out small(ish) benefits
The following are the changes to the toolkit available to cash out small pensions if the current wording in the Taxation of Pensions Bill stands. The provisions are similar in principle to the August draft but with some improvements in response to the points raised in consultation. The changes now are all to take effect (broadly) for payments made on or after 6 April 2015:
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An easement to the age at which a scheme can pay a member a trivial commutation lump sum (“TCLS” – with its £30,000 limit tested across all the schemes of a member) and small lump sums (“SLS” – with its £10,000 per scheme limit). The age condition is reducing from 60 to NMPA (so usually age 55 but earlier for those with historic “protected pension ages” – see article below). And such payments can be made even earlier if the member satisfies the tax law “ill-health condition” (broadly if there is medical evidence that the individual cannot do their current job any more on health grounds)
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An easement to the facility to pay one-off cash to a dependant to extinguish the benefits otherwise in payment following the death of a member (the “trivial commutation lump sum death benefit”). The cash can now be up to £30,000 (per scheme) rather than £18,000 (the Bill draft also helpfully eliminates an age condition that currently applies where the member died before 2011)
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A tightening of the use of TCLS – in future TCLS can be paid to a member only in respect of (and extinguishing all) the member’s defined benefit in a scheme. If the member also has a DC benefit in the scheme it can be left standing (but is included in the £30,000 test). All the other conditions for TCLS – testing against all schemes’ benefits, 12 month window, special valuation calculations – continue to apply (and experience shows this to be onerous to manage if a member has benefits in more than one scheme)
Comment
The first two of these changes will be very welcome by the many schemes now considering using the increased limits to allow pensioners an alternative to a very small monthly payment.
It is interesting that the SLS is being kept as a feature of the MP world – presumably to give a way to avoid cash-out of small scheme benefits triggering the £10K MPAA. Trustees that want to allow full cash-out options will generally want to label these SLS (where the conditions are met and where the scheme rules allow SLSs), rather than say UFPLS.
No change to two 2006 protections despite lobbying
Some long-standing members of some pension schemes can, under tax law, be allowed to take benefits at an age lower than 55 or take more than 25% of their benefits as a tax-free retirement lump sum. This arises from the protections in tax law reflecting the provisions in a scheme’s rules before A-Day (6 April 2006) as read through “Finance Act 2004 spectacles”. However, focussing on two – “protected pension ages” and “scheme specific protected lump sums” – there are several ways that these can be lost, including in particular if the member transfers all benefits from the 2006 scheme:
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To another scheme, on an individual basis – unless at the same time and to the same scheme (or to personal pensions with the same provider) as another member; or
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To a buyout policy if the transferring scheme is not winding up
“Transfer buddies” are not always easy to find. These restrictions mean that it can be difficult for members to take an individual transfer to a new scheme without losing these protections – something many members may want to do in future to access the new Budget flexibilities if their current scheme will not offer these.
As part of a temporary patch tiding members over to the post 2015 regime, the Government changed the law to lift these requirements for members who transfer before 6 April 2015 provided that they draw or designate their transferred benefits in the new scheme by 5 October 2015.
Unfortunately the Government has resisted strong lobbying to include changes in the Bill so as to make longer-term and wider easements.
Comment
2006 protections are complex and we can see why HMRC would balk at a whole new raft of schemes inheriting members with these. But it now seems that a member may indeed have to choose between having the benefit of their 2006 protection and (if having to involve a transfer) access to the new flexibilities. This is likely to add pressure to trustees of schemes with affected members to offer at least some new flexibilities (perhaps just a 100% cash-out option? but to do this will have to use the “FADD+PCLS” toolkit, rather than the UFPLS which only allows 25% tax free – see the first article in this Bulletin.
Of course members want to move to a scheme more suitable for any number of reasons. And the restriction can also be a stumbling block to scheme reconstructions/“tidy-ups”. But it seems the Government’s mind is made up.
Schemes with members in the limited group that can benefit from the temporary window noted above may want to highlight it to the group.
What next?
The above is an outline of some of the key points in the Bill. Although the Bill covers other areas, such as transitional features for those already in an (old style) drawdown and international aspects, some key parts of the 2015 regime jigsaw are still to emerge.
We are expecting the Pension Schemes Bill to bring in changes to widen an individual’s statutory rights to take a transfer from a scheme; and details as to what financial advice an individual must prove he has taken before trustees can allow a transfer out of a DB arrangement to a DC one.
The framework of the guidance guarantee (see Pensions Bulletin 2014/35) is also being finalised (a government webpage has been set up ready to be populated).
On the tax side, among other things, we wait to hear how schemes/providers will be required to deduct tax from payments they make, and – where the deduction does not match the actual tax due – how any adjustments (both up and down) will be made.
Plenty for the Government to do (and explain) – and as soon as possible – so that decisions, communications and implementation systems can be set up by employers, trustees and product providers, ready for individuals who may be drawing benefits as early as 6 April 2015; less than six months away.
This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you.
