The annual allowance charge tax rules introduced in the Finance Act 2011 are due to be amended to counter unintended charges for members who transfer from an underfunded pension scheme to another pension scheme.

Unintended Outcomes

Under current legislation members who are transferred to a defined benefit arrangement could face an unexpected annual allowance charge if the benefits credited in the receiving scheme are more generous than the actuarial equivalent of the transferring assets paid from the transferring scheme – even where the benefits in the receiving scheme are provided on a like for like basis. 

The current legislation was intended to deter attempts to avoid the annual allowance charge, i.e. by granting a disproportionately large pension in return for a transfer. However, the unintended effect is that members may face an annual allowance charge on an ordinary scheme merger where the transfer is underfunded. 

As a result of this discrepancy many schemes have reconsidered or postponed bulk transfers. 

New Draft Regulations

HMRC has consulted on new draft regulations to correct the unintended outcomes. This is the second draft to be consulted on after the previous draft in November 2012 was withdrawn. The new regulations will have retrospective effect from the tax year 2011 -12 onwards. 

The new draft regulations clarify that no pension input for annual allowance purposes will arise where the value of the benefits to be paid under the receiving scheme is “equal (or virtually equal)” to the value of the benefits a member was entitled to in the transferring scheme. The phrase “equal (or virtually equal)” is not particularly clear. However a draft update to the Registered Pension Schemes Manual suggests it means, in effect, “not materially different”. 

Therefore the draft may need clarifying, but if this is to be the test the regulations will provide some certainty for employers and trustees looking to effect a transfer or merge their pension schemes and avoid any risk that an annual allowance charge would be levied on members. 

Having retrospective effect will also give assurance to those who have taken HMRC at their word that this draft would be coming and have already carried out such transfers. Those planning a scheme merger or bulk transfer may still prefer to wait until the legislation comes into force, though no timetable has yet been put on this. 

Other Amendments

The draft regulations also clarify that schemes may continue to revalue deferred members’ accrued rights by RPI instead of CPI without the increase counting towards the annual allowance, provided the pension scheme’s rules requiring RPI as the relevant index were in force at April 2012.