The tax framework for the new secondary annuities market is taking shape. Here we look at the latest consultation from HMRC.
On 20 April 2016 HMRC published a consultation document setting out its proposed draft tax framework for the secondary annuities market. It will be of interest to anyone involved in the product design of pension annuities. Operators of personal pensions holding annuities and providers of drawdown pensions should also monitor the changes and prepare to amend their scheme documents as necessary.
The consultation is open for comments until 15 June 2016.
The story so far
The Government's call for evidence on 18 March 2015 and the reply in the following December set out a proposal to increase the flexibility allowed for pension annuity holders.
The intention is that the annuitant will be permitted to assign rights to installment payments to a third party in exchange for a lump sum. The issuing insurer will be permitted to buy back the annuity: larger annuities will only be capable of purchase indirectly through the open market although purchase of lower value annuities will be allowed directly from the annuitant. Direct purchase by retail investors, assignments of annuities held by occupational pension scheme trustees and partial assignments will not be permitted.
Which annuities are affected?
The changes cover lifetime annuities (but not short-term annuities) from registered pension schemes and deferred annuities which are treated as registered schemes. However, most annuities from pre-A Day approved schemes that have wound up are covered by the changes. Questions remain about annuities from 'old code' schemes, annuities held by people resident outside the UK and annuities purchased with funds from relevant non-UK schemes.
An annuitant will be the member, a beneficiary receiving a pension death benefit or a personal representative where the annuity continues after death.
HMRC's draft tax framework
The new consultation document adds a layer of depth by setting out the tax treatment of the proceeds of assignment or surrender. The changes are permissive and there will be no obligation on an insurer to alter its product design.
The new rules will apply if the annuitant is over the age of 55, or has a lower protected pension age or has retired through ill health. The annuitant will be given three options:
- to receive the proceeds of assignment or surrender as a lump sum taxable as income under PAYE
- to invest the proceeds in his flexi-access drawdown fund
- to purchase a flexible annuity.
Individuals with deferred annuities under the age of 55 will be permitted to buy a new deferred flexible annuity or an uncrystallised money purchase fund.
One interesting development is that proceeds may be used to buy separate member and dependants' annuities, the latter starting on the death of the member. Furthermore, the proceeds of single life annuities will be allowed to purchase joint life annuities.
Restrictions will be added to prevent assignment to a person with links to the annuitant, such as a connected person or an employer.
Taxation of proceeds
The treatment of a purchase of flexi-access drawdown or flexible annuity will be similar to the transfer of annuities. On taking a lump sum, however, the annuitant will receive a P45 from the insurer and the lump sum will be treated as pension income at his marginal rate. Exemptions from income tax for survivor pensions on the death of the member under age 75 will be extended to the proceeds of assignment or surrender.
The purchaser will be obliged to operate PAYE on the lump sum it pays. Following assignment, the annuity instalments paid to the purchaser will no longer be treated as pension income but will instead be taxed as savings income in the form of a purchased life annuity1 unless otherwise taxed or if no tax is payable.
The insurer will however, be required to continue treating the annuity as pensions business and not Basic Life Assurance and General Annuity Business. Furthermore, it may no longer be required to operate PAYE but may be required in some cases to deduct income tax at the basic rate2, depending on the nature of the buyer. The insurer will find therefore that its book of pensions business will over time be taxed under a combination of up to three procedures:
- PAYE (if there has been no assignment)
- under the basic rate only
- not taxed at all.
Provided all conditions are fulfilled, the payments under each option will be authorised.
Annual allowance and the lifetime allowance
Annuitants who flexibly access an annuity will become subject to the money purchase annual allowance. Small annuities purchased before 6 April 2016 will be exempt.
A benefit crystallisation event (BCE) will be triggered when an individual over normal minimum pension age surrenders or assigns a deferred annuity which is not yet in payment. No BCE will be triggered though, by the purchase of a new deferred flexible annuity or by the payment into an uncrystallised fund.
A lump sum paid directly to the annuitant will not only be subject to income tax but will also form part of his estate upon death.
The new IHT rules will apply to any proceeds invested into a flexi-access drawdown fund, meaning that unused flexi-access drawdown funds on death before age 75 can be passed to a beneficiary who is an individual free of IHT (but not income tax).
Purchasers of annuities which operate PAYE on lump sums will be required to notify HMRC.
Insurers will also be required to tell annuitants about the potential tax liability where PAYE has not been applied.
We see again that a complex layer of detail lies beneath what seems to be a straightforward high level proposal. Annuitants and their advisers should take the tax implications of a transaction into account when assessing the suitability of an assignment.
Insurers will need to think carefully whether the additional proposed flexibility will be a feature that is desirable in their product range and if so, make the appropriate changes in their annuity documentation. Personal pension schemes that hold lifetime annuities will also need to review their documents and bring them up to date.
The consultation raises a number of questions and interested parties are invited to reply or comment on the consultation. The closing date for comments is 15 June 2016.