On 14 October, the Government published a series of documents (including draft legislation) on its proposals to restrict pensions tax relief for high earners. The Treasury announcement follows on from its consultation document (published on 27 July) which rejected the previous administration’s plans to introduce an income-based “high income excess relief charge” and which strongly trailed a simpler approach, to restrict the tax relief available on what the Government views as excessive contributions to pensions arrangements.

The new proposals demonstrate a lighter touch than had been feared, especially in relation to the reduction in the annual allowance. However, the Government also proposes to reduce the lifetime allowance.

Last week’s bulletin set out the key features of these proposals; this briefing examines them in more detail.

Headline measures

  • From April 2011: the annual allowance for taxprivileged pensions saving will be reduced from £255,000 to £50,000
  • Tax relief will be available at an individual’s marginal rate. The idea of capping the tax relief available at 40% (which was mooted in the July consultation document and which would have prevented additional rate taxpayers from receiving relief at their marginal rate of 50%) has been ditched.
  • From April 2012: the lifetime allowance will be reduced from £1.8 million to £1.5 million. Transitional protection will apply.
  • The flat factor applied to convert annual accrual in a defined benefit pension scheme in order to value it against the annual allowance will be raised from 10 to 16. The conversion factor for lifetime allowance purposes remains at 20.
  • A three year carry-forward option will be available to members.
  • Employer-financed retirement benefit schemes will be made less attractive.

The proposals in more detail: (i) changes to the annual allowance

From April 2011: annual allowance to be reduced to £50,000

  • The Government has decided to reduce the annual allowance (AA) (the amount which can be contributed/ accrued annually by or on behalf of an individual without incurring a tax charge – currently set at £255,000) to £50,000 from April 2011.
  • The AA will be fixed at £50,000 until the year 2015/2016, following which the Government will consider options for indexing it.
  • The tax charge for exceeding the AA will be a tailored charge, to recoup the full marginal rate relief that an individual has benefited from.

 Valuing defined benefit accrual for AA purposes: a reduced flat factor will apply

  • Valuing contributions to defined contribution arrangements is straightforward. However, valuing defined benefit accrual in order to determine whether an individual has exceeded the AA is more complex; flat factors, age-related factors and a system based on the cash equivalent transfer value of the member’s entitlements have all been suggested as options. Notwithstanding these alternatives, the Government has decided to continue with its current approach of using flat factors. The Government also looked at (but rejected) proposals to use age-related factors for lifetime allowance conversion purposes; although it indicates that it will continue to monitor its approach.
  • The level of the factor will be set at 16 (an increase from 10 at present) – meaning that an increase in annual pension benefit of £1,000 would be deemed to be worth £16,000;
  • No allowance will be made for early retirement (ie, the flat factor will not increase).

Deferred members to be exempt

  •  Deferred members will be excluded from the AA regime (specifically, where there is no increase in value attributable to ongoing service and salary, and the valuation of accrued rights is within reasonable limits).

Active members: revaluation and negative accruals

  • With regard to active members, the previous year’s benefits will be re-valued in line with the Consumer Prices Index, and any negative accruals will continue to be treated as zero. Negative accruals can arise in various circumstances, including where the member has long service and limited salary growth during a period of high inflation.

Applying the reduced AA in particular circumstances: limited exemptions

  • The July consultation paper identified various circumstances where the application of a reduced AA could potentially impact unfairly on individuals. When considering whether to grant an exemption in each case, the Government has balanced the perceived unfairness against the risk of avoidance and reached the following conclusions:
    • The exemption which currently applies to the year in which benefits come into payment will be removed.
    • Death/terminal illness: pension savings will not be tested against the AA in the year of death or in the year in which lump sums are paid where individuals are diagnosed with serious (ie terminal) ill-health.
    • Other cases of major ill-health: the Government recognises that in some cases of “major ill-health” it would be inappropriate for the AA to apply, but is concerned about potential abuse. The Government will, therefore, look to exempt ill-health benefits from the AA regime. It intends to set out further details around how such an exemption will operate and how the risks of avoidance can be managed. These proposals are due to be published for consultation in late 2010, with a view to being finalised for the Finance Bill 2011.
    • Redundancy: there will be no exemption in respect of augmented benefits on redundancy.
    • Enhanced protection: no exemption from the AA test will apply to individuals claiming enhanced protection; the existing exemption will be removed.
    • Pensions in payment: the Government notes that exceptional increases in the value of a pension in payment designed to avoid the AA should be caught by the regime. It intends to bring forward legislation setting out how it intends to close off this potential avenue of avoidance.

Providing flexibility for individuals: managing spikes in pension accrual

  • The Government acknowledges that individuals could experience a sudden one-off increase in pension accrual in a defined benefit arrangement (for example, on being promoted or on redundancy augmentations). This could cause the member to exceed the AA.
  • To prevent individuals who will typically have pension contributions below the AA (but who exceed it in a single year) from facing a tax charge, the Government has decided that individuals will be able to carry-forward unused AA from up to three previous years; they will be able to use this carried-forward AA to offset contributions in excess of the AA in a single year. This facility will be automatic, so individuals on incomes below £100,000 who are not already within self assessment will not have to complete a tax return to benefit from it.
  • The carry-forward facility will be available against an assumed AA of £50,000 for the tax years 2008 to 2009, 2009 to 2010 and 2010 to 2011 to enable affected individuals in the first years of the regime to benefit from it.
  • The Government is keen to support employers and schemes to make adjustments to scheme design, particularly where these help minimise the risk of individuals facing large one-off increases in pension accrual. It notes that trustees may not have power to amend their scheme’s documentation to smooth accruals: “It will, therefore, continue to engage with interested parties, together with the DWP and will take action if necessary, consistent with its overall principles of simplicity, fairness and protection of the public finances, to support employers and schemes in adapting to the new regime”. This perhaps hints at allowing schemes to override restrictive amendment powers in order to change benefit design for future service.
  • The Government is alive to potential abuse and confirms that it will take “appropriate action”; for example, it will not be possible to smooth accrual beyond the date on which employment ends

Helping individuals to meet tax liabilities that occur: resurrection of the “scheme pays” option

  • Where individuals face substantial tax charges, the Government acknowledges that it is possible that charges may not be manageable out of current income. Therefore, it proposes to consider options for those individuals to pay the charge out of their pension entitlement, rather than current income.
  • One option is for the scheme to pay the charge on behalf of the individual at the point at which the charge arises.
  • Another option is for excess contributions above the AA to be rolled up until the point of benefit crystallisation.
  • The Government intends to assess (and consult on) these options with a view to settling on a policy before April 2011.

Pension input periods

  • The Government has concluded that for a significant minority of pension scheme administrators, it would not be practical to align the pension input period (ie, the period by reference to which annual accrual is measured for AA purposes) with the tax year. Hence, broadly, pension schemes will continue to be able to determine the pension input period to apply to their scheme (and will, therefore, have the choice of aligning the pension input period to the tax year if they wish to do so, but will not be compelled to do this). Likewise, those schemes which prefer to align their pension input period with the scheme year will be able to continue with this approach.
  • For individuals with pension input periods ending in 2011/2012, transitional provisions apply. In very broad terms, the new AA rules apply to pension savings occurring on and after 14 October 2010.

Information requirements

  • Individuals will require information from all their pension schemes on the level of their annual pension savings, in order to determine whether or not they have exceeded the AA. The Government has had to consider the best mechanism for facilitating the provision of this information. Draft regulations on these information requirements will be published in early 2011.
  •  Obligations on the scheme (trustees/administrators):
    • Where individuals have contributions (or deemed contributions in the case of defined benefit accrual) above the AA in a pension arrangement, pension schemes will be required to provide members with their pension input amount for the relevant year within six months of the end of the tax year.
    • Where individuals have exceeded the AA, pension schemes will also be required to provide this information for the previous three years, to allow individuals to take advantage of the carry‑forward facility.
    • Where individuals request this information, pension schemes must provide their members with their pension input amount by the later of three months from the request and six months from the end of the tax year.
    • Individuals must request information about unused allowance from previous years if they do not exceed the AA (in which case the scheme must provide it).
  • Obligations on the employer: employers must provide information about employees’ pensionable pay and benefits, and length of service, to defined benefit schemes by 6 July following the end of the tax year.
  • HMRC: at this stage, the Government does not propose to require employers and schemes to provide information to HMRC on an individual’s pension input amounts.
  • Additional flexibility:
    • For the first year only, employers and pension schemes will be given an additional 12 months (ie, until 6 July 2013 or 6 October 2013 respectively) to provide the required information. If individuals do not have the required information from their pension scheme in time to file their 2011/2012 tax return, they will be able to use the existing process within self assessment to use an estimated figure in their return. Individuals will then have up to 12 months from the filing date to amend their return to reflect the final figure and pay any additional tax with interest due or receive a refund of any overpaid tax. However, in practice schemes may find it difficult to resist pressure from members who would like to obtain final figures for tax return purposes.
    • The Government does not propose to introduce new rules to require overseas schemes to provide information to members, in recognition of practical difficulties.

The proposals in more detail: (ii) changes to the lifetime allowance

From April 2012: the lifetime allowance to be reduced

  • The lifetime allowance (LTA) (ie the overall maximum capital amount of tax relievable pension savings which any one individual can accumulate in all of his or her pension arrangements) will be reduced from £1.8 million to £1.5 million.
  • The Government intends to “design a protection regime that supports those individuals who have already made pension saving decisions based on the current level of the LTA”.
  • The Government intends to publish draft clauses on the reduced LTA as part of the full draft Finance Bill in late 2010. Ahead of this, the Government wishes to engage with interested parties on the policy issues associate with reducing the LTA, especially provisions around transitional protection.

Transitional protection will apply

  • Transitional protection will apply to anyone with pension “pots” currently in excess of £1.5 million (subject to a cap at the level of the existing LTA of £1.8 million).
  • Individuals who are currently protected by primary protection and/or enhanced protection should continue to receive the benefit of these protections in relation to the LTA (but not the AA, as mentioned above). The Government will look to design the new protection regime to ensure that individuals currently in the existing forms of protection do not face retrospective charges as a result of the LTA being reduced. For example the Government will look to ensure that the current personalised LTA’s of those in primary protection are not reduced as a consequence of the standard LTA being reduced.
  • The Government recognises the issue of “pension growth protection” (ie, where individuals have planned for their pension to grow to a level of the current LTA (of £1.8 million) between now and the point of retirement, and is minded to offer some protection in these cases. It welcomes views from the industry on the form this could take. The Government suggests that one option would be give individuals the opportunity to apply for a personalised LTA set at a fixed level of £1.8 million, on condition that they must be a deferred member of any scheme in which they have entitlements.  

Other policy issues around the LTA reduction

  • The Government’s provisional view is that it is “minded” to make no change to the defined benefit valuation factor (currently 20) used for assessing pension accrual against the LTA. It does, however, welcome views on this.
  • The Government is also minded to keep the LTA excess charge at the level of 25% if paid out in the form of pension, and 55% if paid out as a lump sum. Again, the Government welcomes views on this.
  • The Government intends to “de-link” the basis on which the trivial commutation limit (1% of the LTA – currently £18,000) is set at the same time as reducing the LTA. It proposes to set it at its current level of £18,000.
  • The maximum tax-free lump sum available at retirement will remain at 25% of the standard LTA.

The proposals in more detail: (iii) funded efrbs to be less attractive

Employer-financed retirement benefit schemes (EFRBS) are unregistered pension arrangements which allow individuals to “top up” their retirement provision outside of the registered pensions tax regime. In essence, these are a type of employee benefit trust and are subject to their own particular tax requirements. The Government notes that “new and extensive use of EFRBSs to provide retirement benefits would create significant risk around the yield projected from the restriction of pensions tax relief”. It, therefore, intends to bring forward legislation as part of the consolidated draft clauses planned for the Finance Bill 2011, due to be published for consultation towards the end of 2010, that will ensure that funded EFRBSs are less attractive than other forms of remuneration.

It will also continue to monitor changes in patterns of pension saving behaviour for all other forms of EFRBSs, on which it will be ready to act if necessary. This leaves the position in relation to unfunded EFRBSs open.


Where the Government has committed itself to consider further issues, the Government anticipates decisions will be reflected in the consolidated draft clauses planned for the Finance Bill 2011, due to be published for consultation towards the end of 2010.

For the “few outstanding cases”, typically of long-serving individuals in defined benefit schemes, where large charges could occur, the Government has decided to engage with interested parties on options to make the payment of significant tax charges more manageable. The Government will bring forward proposals in November 2010 for consultation and intends to publish draft clauses on the chosen approach by February 2011.

The full draft of the Finance Bill 2011 will also include details of the action the Government will take against intermediary vehicles (such as EFRBSs).

Information requirements for schemes and employers will be set out in regulations published in draft early in 2011.

The Government intends to repeal legislation establishing and dealing with the anti-forestalling regime. It will lay the Treasury Order which achieves this in parallel with the publication of the consolidated draft clauses, planned for the Finance Bill 2011 (and due to be published for consultation towards the end of 2010).

Impact on employers

The information requirements (and, therefore, the administrative burden) on employers are limited; although timetable adjustments may be required to meet the new deadlines.

However, many employers will now turn their attention to benefit design issues in order to aid the smoothing of accrual in their schemes. Some will be prompted to look again at switching to defined contribution, cash balance or career average arrangements. Employers should note that certain changes cannot be made without a two month consultation period.