Hot on the heels of the implementation of the “pensions freedoms”, the Chancellor announced yet more change for pension schemes in the Summer Budget. Whilst the restriction of the annual allowance for high earners had been well trailed, the possibility of a radical overhaul for pensions tax relief came somewhat out of the blue. This Business Insight looks at the Chancellor’s announcements.
Reform of tax relief
The Government wishes to ensure that the “right incentives are in place to encourage saving into pensions in the longer term”. To that end the Government has issued a consultation paper looking at whether or not there is a case for reforming pensions tax relief.
Currently pensions are subject to the EET system. This means that pension contributions are exempt from tax (have the benefit of tax relief), pensions investments are exempt from tax but that pension benefits are taxed at the member’s marginal rate.
The Government is interested in the ways in which the current system might be changed from the fundamental reform of a move to a TEE (taxed, exempt, exempt) system like ISAs with a Government top-up on pension contributions to less radical options such as retaining EET but altering the lifetime and annual allowances and everything in between.
Consultation closes on 30 September 2015.
Higher earners and annual allowance
From 6 April 2016 the annual allowance of £40,000 will be tapered for individuals with “adjusted annual income” (including employee and employer pension contributions) of £150,000 or more. Individuals with income of £110,000 or less (excluding pension contributions) will not be subject to the taper. As an anti-avoidance measure, all salary sacrifice arrangements put in place on or after 9 July 2015 will be included in the £110,000 threshold.
The rate of reduction is £1 for every £2 that the individual’s adjusted annual income exceeds £150,000, subject to a minimum annual allowance of £10,000. This means that all individuals with adjusted annual income exceeding £210,000 will have an annual allowance of £10,000.
Where a member has flexibly accessed his pension rights and is subject to the money purchase annual allowance, his alternative annual allowance (which applies to non-money purchase benefits) will be reduced by £1 for every £2 that the individual’s adjusted annual income exceeds £150,000, subject to a maximum reduction of £30,000. This means that an individual with an adjusted annual income of £210,000 or more will have the money purchase annual allowance of £10,000 and a zero alternative annual allowance.
An individual affected by the taper will be entitled to carry forward unused annual allowance. The amount which may be carried forward will be limited to the unused tapered annual allowance.
In order to facilitate the taper, annual allowance pension input periods will be aligned with the tax year. Potentially generous but complex transitional measures are being put in place.
The Chancellor confirmed that the reduction of the lifetime allowance to £1m will start from the 2016/17 tax year. Transitional protection will be introduced to ensure that the change is not retrospective. From 6 April 2018 the lifetime allowance will be indexed in line with the increase in the consumer price index.
The Chancellor made the following pensions-related announcements:
- Secondary annuities market: The implementation of the secondary annuities market has been put back from 2016 to 2017 “to ensure there is a robust package to support consumers making their decision”. Further details will be available in the Autumn.
- Pensions freedoms: The Government will consult “before the summer” on options aimed at making pension scheme transfers quicker and smoother, including in relation to excessive early exit penalties. Where there is evidence of such penalties, the Government will consider imposing a legislative cap for those aged 55 or over.
- Access to PensionWise: The free guidance available under PensionWise will be available to individuals aged 50 and over instead of only those over aged 55.
- Salary sacrifice schemes: The Government is to “actively monitor the growth of salary sacrifice schemes that reduce employment taxes and their effect on tax receipts”.
- Employer-financed retirement benefit schemes: Consultation is planned on restricting the use of unfunded employer-financed retirement benefit schemes for avoidance purposes.
- Taxation of lump sum death benefits: From 6 April 2016 the tax payable on the lump sum death benefits paid on the death of a member aged over 75 will be reduced from 45% to the recipient individual’s marginal tax rate.
- Local Government Pension Scheme: the Government will work with the LGPS on the pooling of fund investments.
One of the Government’s stated aims is to ensure that all individuals are supported to save for their retirement by offering clear, simple and transparent incentives which are sustainable on the public finances in the longer term. Whilst this aim is laudable, the continual reform (and talk of reform) to the UK pensions system may have the opposite effect.
The consultation on tax relief reform is likely to lead to heated debate. It is important that the Government understands the longer term implications of any change and that transitional protections are carefully considered.
The changes to the annual allowance had been well-trailed by the Government. However, the new rules and transitional provisions are incredibly complex - the devil really is in the detail. It is crucial that trustees, employers, providers and affected members understand how the new rules affect them and their schemes.