55% tax on DC funds at death abolished
The Chancellor has announced the 55% tax rate n many lump sum death benefits today will cease to exist from 6 April 2015.
A new regime (sketched in the table) will apply to payments made from DC savings on or after that date even if the death happened before.
Broadly, DC funds are “crystallised” if the member began to draw from them before death.
The changes may stimulate scheme redesigns in favour of lump sums over pension, and member preferences for flexible access over transferring out and annuities.
DC may also gain new advantages over DB e.g. a survivor’s DB pension following a death before age 75 will be taxed at the recipient’s marginal rate while income from a drawdown pension would be tax free.
Benefit options will be subject to scheme rules. Some DC schemes may offer more flexibility than others.
The Treasury and HMRC plan to consult the industry over the details before finalising changes to the legislation.
Click here to view the table
Taxation of Pensions Bill
A Bill to enact the flexibilities announced in the Budget will start to go through Parliament soon. For DC savers it will create two new forms of authorised payment, introduce an new DC annual allowance and relax the rules on lifetime annuities.
Importantly, it will remove the need for amendments to scheme rules by giving trustees statutory permission to pay benefits flexibly regardless of what their rules say.
From 6 April 2015, the new authorised payments for those aged 55 or more will be:
- the flexi-access drawdown fund designed chiefly for those who want to draw income as and when. When the member designates saving to such a fund, they will be able to take up to a third of the amount designated as tax free cash. The remaining amount will be taxed as pension when drawn down. The legislation will not restrict how much can be drawn or how frequently, but scheme rules (or a provider’s terms) are likely to set limits.
- the uncrystallised funds pension lump sum for drawing lump sums. A quarter of each lump sum will be tax free and the balance will be taxed as pension. There will be no limit on the amount that can be drawn but the member must have LTA still available. Members with certain forms of tax protection will not be able to take this type of lump sum.
To prevent unfair tax advantage from recycling, the first of either of these payments will trigger an annual allowance (AA) for future DC saving of £10,000 and an AA of £30,000 for non DC saving. The DC AA cannot be increased with unused allowance from earlier years; nor can any unused amount be carried forward.
Lifetime annuities will be allowed to decrease year by year and a longer guarantee period will be permitted.
Trustees will be allowed (but not required) to make the new forms of flexible payment even if, as will often be the case, this would be contrary to their scheme’s rules. Before doing this, trustees will generally want to agree their plan with the employer. This is a helpful measure that will remove pressure to amend scheme rules in the short term.
Some other changes:
- current capped and flexible drawdown rules will not apply to funds first drawn after 5 April,
- members already in flexible drawdown will be switched automatically into flexi-access and those in capped drawdown will have the option to switch (subject to scheme rules),
- small lump sums (up to £10,000, previously £2,000) will be payable five years earlier at age 55,
- the limit for a trivial commutation lump sum death benefit increases from £18,000 to £30,000.
Guidance and DB to DC
The guidance guarantee for those taking benefits flexibly and the conditions for DB to DC transfers will be legislated for in the separate Pension Schemes Bill already making its way through Parliament. Provisions on the guarantee and DB to DC transfers will be added to the Bill as it progresses.
Annual allowance charge
Certain anomalies in the way the annual allowance (AA) charge works will be resolved by regulations HMRC is working on. They include the following.
- Transfers: on transfers of DB or cash balance rights between schemes, the intention is that the changes in value in an individual’s benefits in each scheme should be neutral for AA purposes. But current legislation fails to achieve this where the value of the assets transferred does not fully match the value of the benefits credited in the receiving scheme.
- Scheme pays: in a DB or cash balance scheme, an AA charge can be higher or lower according to whether the member pays personally or via “scheme pays”. This unintended difference will be removed. Snags with the process of electing for “scheme pays” will also be addressed.
- Deferred members: the general principle is that deferred rights can increase within defined limits, e.g. for inflation, without counting for AA purposes. Several provisions that run counter to this are being addressed, including some that mean pre 2006 deferreds who later resume active scheme membership can find the full value of their deferred benefits counting for AA purposes, not just the increase in value.
The regulations are still in draft. Having arisen out of the Finance Act 2011, many of the changes will be backdated to tax year 2011/12.