Yesterday, the Chancellor of the Exchequer delivered the Summer Budget. The Budget confirmed measures, already announced in the Conservative party manifesto, to reduce the amount that high earners (those with income over £150k) can contribute to their pensions tax-free. The Government has also launched a Green Paper in which it has invited suggestions as to how the pensions tax-relief regime can be changed. The changes, it considers, are necessary because the population is living longer, and to reflect the changing shape of UK pensions. The Green paper floats the idea that pensions be taxed like ISAs, so that contributions into the scheme are taxed but any growth on the contributions and the benefits when they are paid out is not. In this briefing, we provide a summary of the pensions measures announced in the Budget yesterday.

Reducing annual allowance for high earners

The annual allowance (the maximum amount that can be contributed to a pension scheme on a tax free basis) is £40k at the moment. Those with DC pots who have taken their benefits flexibly, however, under the Budget 2014 flexibility measures, are subject to the "New Money Purchase allowance" rules. Under these rules, they have a smaller annual allowance of £10k for any further DC savings they make and an adjusted allowance of £30k for any further DB savings made.

Changes for high earners

From 6 April 2016, high earners with income of over £150,000 (including the value of pension contributions) will have a smaller annual allowance. The reduction in the annual allowance will be applied on a tapered basis, so that the allowance will be reduced by £1 for every £2 that the income exceeds £150,000, up to a maximum reduction of £30,000. This will mean that those earning £210,000 and over can contribute only £10,000 to their pension tax-free.

The adding back of pensions contributions prevents individuals using salary sacrifice to 'duck' the 150K threshold. Employer contributions are also included and for defined benefit (DB) and cash balance schemes, these will be valued using the existing annual allowance methodology.   A threshold of £110k will exist below which individuals will not be subject to the tapered annual allowance, whatever the level of pension contribution but any salary sacrifice arrangement made from 9 July will be taken into account when assessing if the threshold is exceeded.

Those who are subject to the New Money Purchase annual allowance rules will also be subject to the tapering rules.

Carry forward relief will be available but will be based on the unused tapered allowance.

Alignment of pension input period with the tax year

In order to facilitate the tapered reduction in the annual allowance for high earners, legislation will be introduced to align the pension input period (PIP) with the tax year.

All PIPs open on 8 July 2015 will end on that date. The next PIP will run from 9 July 2015 to 5 April 2016. After 5 April 2016, all PIPs will be aligned with the tax year. Transitional provisions will apply. The Government will in due course consider if PIPs can be scrapped altogether.

These changes will be effective from 8 July 2015.

Reforms to pensions tax relief: the Green paper

The Government has issued a Green paper consulting on whether and how to undertake a wider reform to pensions tax relief. The reforms are being considered to reflect the changing shape of UK pensions and to reflect the fact that people are living longer. The Government is therefore consulting on "whether there is a case for reforming pensions tax relief to strengthen incentives to save, offering savers greater simplicity and transparency, or whether it would be best to keep the current system".

The Green Paper does not make any firm proposals but sets out why reforms may be needed and invites ideas. The consultation runs until 30 September 2015.

Treat pensions like an ISA

A key idea floated is to treat pensions like an ISA. The current structure of the system is described as “Exempt-Exempt-Taxed” (EET), in other words:

  • Exempt: Pension contributions by individuals and employers are exempt from income tax, and employer contributions are also exempt from National Insurance contributions (NICs) (although total contributions are subject to both an annual allowance and a lifetime allowance).
  • Exempt: No personal tax is charged on investment growth from pension contributions while in accumulation, subject to the lifetime allowance.
  • Taxed: a pension when it is paid out is taxed as income.

The paper floats the idea that the EET system is changed to a TEE system, so that like an ISA, pension contributions are taxed upfront, the investment growth is exempt from tax and the benefits when they are paid out are tax free.

Principles for reform

Any reform, the Paper states, should follow certain principles. The reform should:

  • be simple and transparent.
  • allow individuals to take personal responsibility for ensuring they have adequate savings for retirement. They should encourage people to save enough during their working lives to meet their aspirations for a sufficient standard of living in retirement.
  • build on the early success of auto-enrolment in encouraging people to save more.
  • be sustainable in terms of overall costs.

The paper acknowledges that there is a need to proceed gradually and accepts that, after consultation, the consensus may be that no change is needed.

Other changes

Lifetime allowance changes

As already announced in the March Budget this year, the Government will reduce the Lifetime Allowance for pension contributions from £1.25 million to £1 million from 6 April 2016. Transitional protection for pension rights already over £1 million will be introduced alongside this reduction to ensure the change is not retrospective. From April 2018, the Lifetime Allowance will be indexed annually in line with CPI.

Exit penalties on transfers

The Government will consult before the summer 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. If there is evidence of such penalties, the Government will consider imposing a legislative cap on these charges for those aged 55 or over. For more on these proposals, click here.

Death benefits: Under the changes to the taxation of death benefits introduced recently, if a member dies after the age of 75, the beneficiary can take the whole pot as a lump sum, but this is taxed at 45%; if the fund is passed on as drawdown to a beneficiary, the beneficiary is taxed at the marginal rate on any withdrawals (for our summary of the changes to death benefits, click here). The Government will, as it promised at the time these changes were announced, replace the 45% tax rate on lump sums with the marginal rate.

Secondary annuities market

The proposals to allow a secondary market for annuities (as announced in the March Budget this year) that would allow individuals to buy and sell their annuities will be delayed until 2017. Further plans for introducing these measures will be issued in the autumn.

Unfunded employer funded retirement benefit schemes

The Government will consult on "tackling the use of unfunded EFRBS to obtain a tax advantage in relation to remuneration".  (EFRBS are often used to compensate individuals affected by the lifetime and annual allowances).

Pension Wise: The Pension Wise service, the free pensions guidance service for DC members, is to be extended to those aged 50 and above.

Comment

The Green paper asks if the Government should consider differential treatment for DB and DC schemes. The concept of treating pensions like an ISA has a certain appeal in relation to DC schemes (which are more akin to savings) but is more difficult to apply in respect of DB schemes. It is difficult to see how a level playing field could be maintained between DB and DC.  The concept of moving from EET to TEE may involve complex transitional arrangements too and there is a risk that it could introduce more complexity to the pensions tax relief system.