Pensions Bulletin 2015/12 - Budget Special

This Budget special summarises and comments on new announcements made in today’s Budget which are of potential relevance to pension schemes and their members.

Is a second-hand annuity market on its way?

As promised on Sunday, the Chancellor of the Exchequer has now published a call for evidence on proposals to extend the DC pension freedoms to around five million people who have already bought an annuity and who may now wish to revisit that decision. Annuity contracts held by occupational pension schemes are not within scope of this reform.

The Government intends to legislate in a future Finance Bill so that, from April 2016, the unauthorised payment tax charges of 55%-70%, which currently apply on assigning annuity income, will be removed. This will take away one crucial block to individuals selling the income they receive from their annuity.

The Government intends that the individual assigns to a third party, it having set its face, for the time being at least, against permitting insurance companies to buy back the annuities they have issued.

The proceeds can either be paid as cash, invested in a flexible drawdown product or a flexible annuity (the last two of which might be provided by the third party). Income tax will be charged at the annuity holder’s marginal rate on the proceeds, but only when received in the annuitant’s hands. So, for example, if it is invested in a flexible drawdown product, it is the amount subsequently drawn down that will be taxed; not the amount invested. Other examples of the tax treatment are given in the call for evidence.

The £10,000 money purchase annual allowance will apply to those assigning their annuity.

The Government believes that, for most people, retaining their annuity will be the right choice and that making a decision whether to sell and at what price will be difficult. So, to ensure people are in a position to make an informed decision, the Government will be working with the Financial Conduct Authority to introduce appropriate guidance and other consumer protection measures. This may include an extension of Pension Wise.

The Government expects that obtaining the right to annuity payments could be attractive to a broad range of institutional investors including insurance companies and pension schemes and is consulting over who should be permitted to purchase the annuity income. It is likely to exclude retail investors owing to the complexity and difficulty in determining a fair price.

The call for evidence invites views on some of the practical issues which are presented by the proposal. How would an annuity provider know when a member had died? What fees would it be reasonable for annuity providers to charge and how should fees be regulated? How should mortality and selection risk be managed – should buyers underwrite or aggregate when pricing?

Comment

So what seemed to start a little while ago as kite flying (see Pensions Bulletin 2015/02) has become Government policy. Whilst a fascinating development it is only right that this proposal is now explored properly through consultation. There are clear challenges involved in setting up a viable market for second hand annuities and the risk to the consumer is high. But if the Government decides to proceed and a secondary market does develop, the income streams may become attractive to trustees of pension schemes as a way to protect themselves from rising life expectancies – if the price is right.

Lifetime Allowance to reduce again?

The Chancellor has announced that legislation will be introduced in a future Finance Bill to reduce the Lifetime Allowance (LTA) from its current £1.25m level to £1m from 6 April 2016. Transitional protections for those with large pension savings are promised (as for previous drops in the LTA) but details are still to come. The legislation is also to provide that the LTA will be increased annually in line with the Consumer Prices Index (CPI) from April 2018.

Government projections suggest that the measure will bring in government revenue of £1,860m over the four years 2016/17 to 2019/20.

Comment

A possible reduction in the LTA was trailed only in the last days before the Budget. It mimics one of Labour’s election promises (see Pensions Bulletin 2015/10), so it seems likely to happen regardless of the General Election result. In his speech, Mr Osborne potentially took further wind out of the sails of Labour’s election plans by rejecting further cuts to the Annual Allowance on the grounds that this would penalise “moderately-paid, long-serving public servants, including police officers, teachers and nurses”. The reason Mr Osborne gave for the cut was not to fund particular other measures, but because “… the gross cost of tax relief has continued to rise through this Parliament, up almost £4 billion”.

It does seem likely that some savers have made as high contributions to their personal pension as they can, worrying about the spectre of future tax relief measures. But the £4bn seems to reflect ONS statistics that are footnoted as having a “particularly wide margin of error”. Does the statistic unreasonably include the relief on contributions employers are having to put into defined benefit pension schemes to fund deficits from the build-up of liabilities including long gone pensioners and deferred pensioners?

Long-term inflation-proofing of the LTA is a logical step to enable long term pension planning – but only if savers can believe it will be upheld by future governments. And the overnight 20% drop in the LTA will bring significantly more savers into having an LTA charge on some of their pension when they draw it – the extra 25% tax charge on top of the income tax already due when drawing a pension.

With more people in the LTA net and with a scheme’s active and deferred members potentially having any of nine types of LTA protections, operating a pension scheme is about to get yet more complicated.

Annuity payment flexibility following death to go ahead as planned

The Government has confirmed that the Finance Bill will contain its proposals (see Pensions Bulletin 2015/09) to amend the existing pension tax rules around who can receive payments from an annuity on the death of a member and to allow payments of these annuities to be tax-free on the death of an individual before 75.

The end of undated gilts, but more long-dated gilts to be issued

The Government has announced plans to redeem all remaining undated gilts, which have a value of £382 million.

The good news for pension schemes is that long-dated fixed interest gilts will form a higher proportion of the Government gilts issue in 2015/16, with anticipated issuance of £37.4 billion (28.0% of total issuance), up from the £33.1 billion (25.8% of total issuance) anticipated for 2014/15 in last year’s Budget. A planned total of £31.4 billion of index-linked gilts (23.5% of total issuance) will be issued, compared to £31.0 billion (24.1% of total issuance) planned at the 2014 Budget.

Comment

Pension schemes will be hoping that additional long-dated gilts issuance might increase yields, and scheme funding levels, slightly. Any increase as a result of this issuance change is likely to be small, but in these times of very low yields any good news is welcome.

A new personal savings allowance

Legislation will be introduced in a future Finance Bill to apply a new Personal Savings Allowance to interest earned on savings, such as bank and building society interest. The changes from 6 April 2016 will mean that:

• For basic rate taxpayers, the first £1,000 of interest will be tax free; and
• For higher rate taxpayers, the first £500 of interest will be tax free

Additional rate taxpayers will not be entitled to this allowance.

When this new rule comes in, banks and building societies will stop automatically taking 20% in income tax from the interest earned on savings.

Comment

For an individual with an average DC pot of less than £40,000 at retirement, this new allowance may facilitate it being cashed in and deposited at a regular bank account, to earn tax-free interest until it runs out.

This new allowance is likely to blur the line between an old-style cash ISA and a non-ISA savings account, especially when considered together with the new ISA flexibility to withdraw and replace money within the annual ISA subscription limit.

Details of this policy remain to be seen.

Further increases to the personal tax allowance and basic rate limit

Legislation will be introduced in the Finance Bill 2015 that will:

• Increase the income tax personal allowance from £10,600 in 2015/16 to £10,800 in 2016/17 and £11,000 in 2017/18; and
• Increase the basic rate limit from £31,785 in 2015/16 to £31,900 in 2016/17 and £32,300 in 2017/18, so that most higher rate tax payers will get the full benefit of the above increases to the personal tax allowance

Taken together they will increase the level of income after which taxpayers begin to pay the 40% higher rate of tax from £42,385 in 2015/16 to £42,700 in 2016/17 and £43,300 in 2017/18. This follows on from the accelerated increases announced in the Autumn Statement last year (see Pensions Bulletin 2014/50).

Also, from 2016/17, there will be one income tax personal allowance regardless of an individual’s date of birth (currently a higher allowance can be set for those born before 6 April 1938).

The national insurance upper earnings and upper profits limits will also increase to stay in line with the higher rate threshold.

Comment

Whilst there is no automatic link, it had been thought that last year’s jump in the personal tax allowance (from £10,000 in 2014/15 to £10,600 in 2015/16) might result in a corresponding increase to the “earnings trigger” for the employer duty to auto-enrol certain jobholders into workplace pension schemes, with the result that more low-paid employees would be taken out of the scope of auto-enrolment. However, this has not happened and the trigger has been kept at the 2014/15 level of £10,000 for now, though what will happen with the further rises due over the next couple of years remains to be seen.

NI shake-up for self-employed

The Government has announced plans to abolish Class 2 national insurance contributions, which are paid by the self-employed earning over £5,885 pa, in the next Parliament. The Government will also consult on changes to Class 4 contributions, which are paid by the self-employed who earn over £7,956 pa, later in the year.

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.