Pensions Bulletin 2015/30 - Summer Budget Special

This Budget special summarises and comments on new announcements made in Wednesday’s Budget which are of potential relevance to pension schemes and their members. The Summer Finance Bill will be published on 15 July 2015 and the Act is expected to receive Royal Assent in the autumn.

Would reforming pensions tax relief encourage saving into pensions?

In his Budget speech, the Chancellor of the Exchequer launched a consultation intended to gather views on whether the current pensions taxation system (based on the principle that tax should be deferred until benefits are taken) continues to be the best way to encourage saving into pensions – or whether there is now a case for reform to strengthen the incentive to save.

The consultation document says that this review is prompted by the challenges generated by increased longevity and changes in the nature of pension provision – most notably the shift from DB to DC provision. But perhaps more tellingly, it also says that there is the desire to ensure that the significant cost of the present system of tax relief (as set out in official statistics), is justified as the best incentive to encourage pension saving. This desire is despite the various measures to restrict tax relief introduced in recent years (such as the reductions to the lifetime and annual allowances).

The Government believes that any system of pension tax put in place should be simple and transparent, allow individuals to take personal responsibility for ensuring they have adequate savings for retirement, build on the early success of auto-enrolment and be sustainable. The Government also acknowledges the possibility that the conclusion of this consultation may be that maintaining the current system is the most effective method of achieving these aims.

The consultation poses eight questions, ranging from the fundamental – “Do respondents believe that a simpler system is likely to result in greater engagement with pension saving” – to the complex – “Should the Government consider differential treatment for defined benefit and defined contribution pensions?” - and invites contributions from all interested parties.

Consultation closes on 30 September 2015 following which the Government intends to publish a summary of responses, including the detail on how it intends to proceed. No indication has been given of when we can expect this document.

Comment

Although the consultation document itself is quite lightweight, this belies its significance and true purpose. By putting this subject formally on the agenda, the Government is challenging those who wish to defend the status quo to explain their reasons, and those who for some time have been lobbying for an alternative structure, to put forward their proposals and rationale. Whilst it is good that the Government is consulting in an apparently open and neutral way, the prize, should it take forward a new form of pension taxation, is more likely than not that it will show a significant improvement in government finances, albeit at the expense of a worsening many years hence. And getting on for thirty years after Nigel Lawson sought to tackle the “much loved but anomalous tax free cash sum”, the current occupant of No. 11 could achieve the same result, but by far more radical means.

The annual allowance tapers away to £10,000 for high earners

As expected, the Government is to restrict pension tax relief for high earners by introducing a tapered reduction in the amount of the annual allowance for individuals with income (including the value of any pension contributions) of over £150,000 and who have an income (excluding pension contributions) in excess of £110,000.

To facilitate this taper, legislation will also be introduced to align pension input periods with the tax year as well as transitional rules to protect savers who might otherwise be affected by this alignment.

For further details of this important development, whose principal effects will be felt by high earners, see our News Alert. Six case studies are also set out on our website.

Comment

Yet further complexity is added to the pension tax system at the top end in order to more than pay for inheritance tax relief on substantial estates in a less than straightforward manner. The annual allowance taper is expected to raise £4bn over the period running up to and including 2020/21, although interestingly, in 2015/16 it is expected to cost money as those who can take advantage of the transitional rules.

Lifetime allowance reduction to £1m going ahead

The Government has confirmed that it will reduce the lifetime allowance from £1.25m to £1m from 6 April 2016. Transitional protection for pension rights already over £1m will be introduced alongside this reduction to ensure the change is not retrospective. The lifetime allowance will be indexed annually in line with the CPI from 6 April 2018.

Comment

This measure is not new – it being announced in the March 2015 Budget. We still await details of how the two forms of transitional protection –individual and fixed - are to work.

Taxation of DC lump sum death benefits switched to the recipient’s marginal rate

As a result of the Taxation of Pensions Act 2014, from 6 April 2015 lump sum death benefits paid from a DC registered pension scheme or non-UK pension scheme are taxed at 45% where the owner of the pension rights dies aged 75 or over. They are also taxed at 45% in some limited circumstances if the deceased was aged under 75.

This tax rate was intended to be an interim measure, pending consultation with stakeholders (see Pensions Bulletin 2014/47). The Government has now confirmed that the Summer Finance Bill will contain measures that subject such lump sum death benefits to the recipient’s marginal rate of income tax where the lump sum is paid directly from the pension scheme to an individual who is the ultimate beneficiary.

The new approach will have effect in relation to lump sums paid from 6 April 2016.

Comment

The net effect of this will be a reduction in tax for most recipients, albeit at the price of some extra complexity for the scheme administrator. But it does make sense to align the treatment of those lump sums that are taxed with that of pension income.

Growth of salary sacrifice schemes being monitored

The Red Book states that salary sacrifice arrangements, which can allow some employees and employers to reduce the income tax and national insurance that they pay on remuneration, are becoming increasingly popular and the cost to the taxpayer is rising. Therefore the Government will actively monitor the growth of these schemes and their effect on tax receipts.

Comment

It is not clear what message to take from this statement. Such arrangements are perfectly valid and HMRC has said as much in the recent past, setting out guidance to assist those who wish to set up them up to ensure that they do deliver the desired benefits. But maybe just like pension tax relief, if the official statistics show that the published cost to the Exchequer is getting too high, they will be restricted in scope. At least the Chancellor has chosen at this Budget not to announce any changes that might have impacted salary sacrifice arrangements as these currently benefit large numbers of employees in workplace pension schemes.

Further increase given to future income tax thresholds

The Chancellor announced further increases in both the personal tax allowance and the higher rate tax threshold from the 2016/17 tax year above those announced in the March Budget (see Pensions Bulletin 2015/12):

• The income tax personal allowance will rise from £10,600 in 2015/16 to £11,000 in 2016/17 (it was due to increase to £10,800) and then to £11,200 in 2017/18 (compared to an announced £11,000)
• The higher rate tax threshold will increase from £42,385 in 2015/16 to £43,000 in 2016/17 (it was going to be £42,700) and then to £43,600 in 2017/18 (it was due to increase to £43,300). The Upper Earnings Limit for national insurance contributions will increase to remain aligned with the higher rate threshold

The Government will also legislate that, once the personal allowance reaches £12,500, it will be uprated in line with the National Minimum Wage going forward to ensure anyone on it working 30 hours per week or less will not pay income tax.

Comment

It would seem likely that the disconnect between the earnings trigger for auto-enrolment purposes (currently standing at £10,000 pa) and the income tax personal allowance will further widen over the coming years. Those impacted may be disadvantaged unless they are auto-enrolled into a scheme that operates the relief at source method.

Corporation tax rate to be cut by 2%

Following the reduction in corporation tax to 20% from April 2015 announced in the March 2013 Budget (see Pensions Bulletin 2013/12), it is now to fall further – to 19% in 2017 and 18% in 2020. Government forecasts expect the move to reduce the accumulated amount of corporation tax paid by £6.6 billion by the end of 2020/21.

Comment

As for previous cuts in corporation tax, employers might benefit from bringing forward contributions to registered pension schemes whilst the tax relief available is higher. Care should be taken, as a company triggering the spreading of relief rules might undo any tax gains made.

Dividend taxation overhauled

The Government is to abolish the 10% dividend tax credit from April 2016 and introduce a new dividend tax allowance of £5,000 a year. Tax on dividend income (above the new allowance) will increase from 0% to 7.5% for basic rate taxpayers, from 25% to 32.5% for higher rate taxpayers and from 30.56% to 38.1% for additional rate taxpayers.

Registered pension schemes and ISAs will not be impacted by this reform.

The Government is trying to reduce the incentive for people to be remunerated through dividends rather than normal pay – there are currently tax advantages to doing so. The change is not intended to increase tax for ordinary investors with modest dividend income – indeed those who receive dividends less than £5,000 may find that they are better off. However, those who receive considerable amounts as dividends through their companies, in lieu of normal pay, will pay significantly more tax (as will those running large but unsheltered share portfolios). By the end of 2020/21 the Government is forecasting that it will have raised nearly £9bn through this measure.

Comment

Nothing to worry about for pension schemes, but 18 years on the Chancellor still felt the impact of Gordon Brown’s abolition of Advanced Corporation Tax on pension schemes worthy of a mention in his Budget Speech as he proceeded elsewhere to dismantle other aspects of the former Chancellor’s legacy.

Pension Wise extended to those who have reached 50

Seemingly with immediate effect, people aged 50 and above will be able to access the Pension Wise guidance (see Pensions Bulletin 2015/03) which is currently restricted to those aged 55 and above. There will also be a marketing campaign to publicise the service.

Comment

It clearly makes sense for people who are approaching the age when they may avail themselves of the new pension flexibilities to be able to access the Pension Wise guidance. Hopefully the resources of the Pension Wise providers will not be over-stretched.

Exercising flexibility – consultation confirmed (again)

Following its previous announcement (see Pensions Bulletin 2015/26), the Government has stated, once more, that it will be consulting “on options aimed at making the process for transferring pensions from one scheme to another quicker and smoother, including in relation to any excessive early exit penalties”. Somewhat amusingly, the Red Book states that the Government will consult “before the summer”.

If there is evidence of excessive exit penalties the Government will consider imposing a legislative cap on them for those aged 55 or over.

Comment

There had been some expectation that the consultation would be unveiled in the Budget papers but we will now have to wait a little longer. Given the stated willingness to legislate and the suggested quite wide ambit it may be that we eventually get changes to transfer value legislation beyond a cap on exit penalties.

Launch of secondary annuity market put back a year

Something else which might have materialised on Budget Day was the Government’s response to its March 2015 consultation on facilitating a market in the income from annuities (see Pensions Bulletin 2015/27). Instead, the Government’s plans will now be set out in the autumn. Moreover, the Government agrees with respondents that implementation should be delayed until 2017 instead of 2016 as previously targeted as it was becoming obvious that this was not realistic given the challenges involved in getting a functioning market off the ground.

Comment

A delay is welcome news. There was a danger that this proposal could have been rushed with potentially disastrous consequences. There was no need to rush as a General Election is not due any time soon.

Pass on £1 million to your kids, tax-free

Apparently paid for by the restriction on the annual allowance for high earners, the Budget proposes an extra amount that can be paid tax-free to direct descendants on death in respect of a main residence.

The additional amount applies to deaths after 5 April 2017 and will start at £100,000, increasing to £175,000 by 2020/21, after which it will increase in line with the CPI. This new amount is in addition to the current nil-rate inheritance tax limit of £325,000, which will now be frozen until 2020/21. Like that limit, the additional amount can be added to a spouse or civil partner’s limit on the first death, so by 2020/21 it will be possible for the last surviving member of a couple to pass on a total of:

2 x (£325,000 + £175,000) = £1 million of assets tax-free.

The extra amount is in respect of property which is or has been a main residence of the deceased, but (subject to a technical consultation) can include other assets if the person has downsized or ceases to own a home on or after 8 July 2015.

Those with estates worth more than £2 million will see the additional nil-rate band tapered away by £1 for every £2 the estate is over £2 million.

Comment

This is a complex bolt on to the inheritance tax laws that will benefit larger estates. Although the gain of the additional amount is partially countered by the extended freeze to the £325,000 limit, it is forecast to cost the Treasury around £2.5 billion over the period running up to and including 2020/21. Coupled with the new tax rules for DC pensions on death, those inheriting a sizeable (though not excessive) sum will find themselves better off.

Government to legislate for a “tax lock”

The Government will legislate to set a ceiling for the main rates of income tax, the standard and reduced rates of VAT, and employer and employee (Class 1) NIC rates, ensuring that they cannot rise above their 2015/16 levels. The tax lock will also ensure that the NICs Upper Earnings Limit cannot rise above the income tax higher rate threshold and will prevent the relevant statutory provisions being used to remove any items from the zero rate of VAT and reduced rate of VAT for the duration of this Parliament.

Unfunded EFRBS in Treasury cross-hairs

The Red Book states that “the government will consult on tackling the use of unfunded employer-financed retirement benefits schemes (EFRBS) to obtain a tax advantage in relation to remuneration”.

EFRBS are pension arrangements outside of the tax privileged registered pension scheme framework. Unfunded EFRBS are sometimes used to top up the pension benefits of senior executives.

Comment

It looks likely that as a consequence of their use in aggressive tax planning unfunded EFRBS will be subject to anti-avoidance provisions. But we must await the consultation for details.

Equitable Life Payments Scheme draws to a close

The Government has announced that the Equitable Life Payments Scheme, which began making payments in 2011, will close to new claims on 31 December 2015. A further effort will be made to trace remaining policy holders due £50 or more, with profit annuitants will continue to receive annual payments under the Scheme for their lifetimes and eligible policyholders in receipt of Pension Credit will see their lump sum payment doubled, with payments made in early 2016.

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.