Summary and implications
The Government has published its proposals for restricting pensions tax relief with the aim of raising the same amount of revenue but by less complex means than the high income excess relief charge put forward by the previous Government. Our Pensions Alert last week announced the key proposals. This briefing looks at the detail and the implications for those involved with pension schemes.
The main features of the proposed new regime are:
- Annual allowance reduced to £50,000 from April 2011, affecting active members of DB and DC schemes, with a flat-rate ratio of 16:1 to be used to calculate DB accrual;
- Carry forward of unused annual allowance from up to three previous years to offset against any excess contribution;
- Lifetime allowance reduced to £1.5m from April 2012, with some protection for those who have already built up pension benefits based on the current allowance of £1.8m.
The Treasury’s July consultation document suggested reducing the annual allowance to £40,000 but the Government has decided that a reduction to £50,000 is feasible in conjunction with a reduction of the lifetime allowance. It therefore expects that its proposals will affect fewer individuals on low incomes.
Although the proposals are considerably less complex than those of the previous Government (to be repealed), they are not simple, and there are numerous implications for employers, trustees and scheme members.
The new proposals are set out in the Treasury’s summary of responses to its July consultation on restricting pensions tax relief and in draft legislation. The Treasury website also contains links to the GAD report on DB accrual and draft HMRC guidance. A number of specific issues are still being considered and further consultation and draft legislation will follow, to be included in the Finance Bill 2011 and in regulations. The Finance Bill 2011 will also include anti-avoidance legislation to prevent the use of intermediary vehicles, including employee benefit trusts and EFRBS, to “disguise remuneration to avoid, reduce or defer the payment of tax”.
Annual allowance: reduction
Most of the proposals concern the reduction of the annual allowance (AA). The details are:
- From April 2011, the AA will be reduced from £255,000 to £50,000. It will remain frozen at this level for the time being; the Government will consider options for indexing from 2015-16;
- Relief will be available at an individual’s marginal tax rate, not capped at 40 per cent, as some high earners had feared; but the AA charge (for exceeding the AA) will be tailored to recoup the full marginal rate relief that an individual has enjoyed;
- Deemed contributions to DB schemes will be calculated using a flat factor of 16 (on the advice of GAD), i.e. an annual accrual of £1,000 will use up £16,000 of the annual allowance; accrual is the difference between the pension input amount at the beginning and end of the pension input period (scheme year), adjusted for CPI;
- Any negative accruals will continue to be treated as zero for AA purposes.
Annual allowance: exemptions
- Deferred members will be exempt from the AA regime, provided revaluation of deferred pensions does not exceed “reasonable limits”. However, those deferred members with final salary linkage will be caught.
- There will be no exemption from the AA test for active members claiming enhanced protection.
- There will no longer be an exemption in the year that benefits come into payment.
- The AA test will not be applied in the year of death, nor in the year in which a serious ill-health lump sum is paid (life expectancy of less than a year); and the Government will consider whether there should also be an exemption for any other “major” ill-health.
- On early retirement where the pension is not reduced to reflect the full cost of bringing the pension into payment early, the increase in value of the early retirement pension will not count towards the AA or LTA. However, the Government has indicated that anti-avoidance measures are to be introduced to prevent exceptional increases in value designed to avoid the AA to close off this avenue of potential avoidance. There may nevertheless still be significant scope to augment benefits on redundancy while remaining within the AA (see next bullet).
- There will be no specific exemption for redundancy, but where an individual exceeds the AA in a given year (e.g. because of a “spike” caused by redundancy or promotion or because of a large increase in contributions or accrual), unused allowance from up to three previous years will be available to offset against the excess pensions savings. Carry-forward will be available against an assumed AA of £50,000 for the tax years 2008-09, 2009-10 and 2010-11. This facility, which will also be useful for those with fluctuating earnings, 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 in order to benefit from it.
Annual allowance: smoothing
- Although schemes will be permitted to manage spikes by smoothing pensionable pay and accruals, anti-avoidance legislation will prevent manipulation such as smoothing accrual beyond the date on which employment ends. Because not all trustees will have power to redesign their schemes without affecting accrued rights, the Government will “take action if necessary… to support employers and schemes in adapting to the new regime”.
- Where because of a spike an individual is liable for the AA charge but cannot afford to pay it from current income, the Government is considering, and will consult on, the following options:
- The individual to pay the charge out of his pension entitlement instead, or
- The scheme to pay the charge on behalf of an individual when it arises, or
- Excess contributions above the AA, or tax liabilities, to be “rolled up” until the point of benefit crystallisation.
Annual allowance: calculation
- Schemes’ pension input periods (PIPs) will not be compulsorily aligned with the tax year. There will therefore be PIPs which straddle 6 April 2011, so transitional rules will apply to individuals whose PIP ends in 2011/12 and who already have pension savings in excess of £50,000. These rules will apply alongside the existing special annual allowance regime, and alongside the new facility for carrying forward unused allowance from up to three previous years. Where the PIP begins on or after 14 October 2010, the new AA rules will apply, but where the PIP began before that date, there will be a two-part test:
- Pension savings made on or after 14th October 2010 which exceed £50,000 will be subject to the AA charge; for DB schemes the valuation factor of 16 will be applied, with revaluation offset to account for inflation;
- Where the total pension input amount across all PIPs that end in 2011/12 exceeds £255,000, the AA charge will apply to the excess, regardless of whether the savings accrued before or after 14 October 2010. A factor of 10 will apply to DB accruals up to 13 October 2010, and there will be no revaluation for inflation for active members.
Annual allowance: information requirements
- Schemes must provide members who have (deemed) contributions over the AA with their pension input amount within six months of the end of the tax year or, if later in the case of an individual who requests this information, three months from the date of the request. Employers must provide schemes with information about employees’ pensionable pay, benefits and service by 6 July following the end of the tax year. For the first year only these deadlines will be extended by a year, to 2013, to give schemes time to change their systems. Individuals who do not have the required information from their schemes in time to file their 2011/12 tax return can estimate the figure and will then have 12 months to provide the correct figure and pay any additional tax and interest. HMRC will provide guidance on this. Draft regulations on the information requirements will be published for consultation early next year. There is currently no proposal for schemes or employers to provide additional information to HMRC on individuals’ pension input amounts but this will be kept under review.
Lifetime allowance: changes
There are fewer proposals regarding the lifetime allowance (LTA), and draft legislation has not yet been published. The key points are:
- From April 2012, the LTA will be reduced from £1.8m to £1.5m, frozen in the same way as the AA;
- Transitional protection will be available for those who have already exceeded the new lifetime allowance. The Government asks for views on the form this could take;
- Unlike the AA, the valuation factor for the LTA will remain at its current level (20), though the government will continue to monitor this issue;
- The LTA tax charges will remain unchanged (55 per cent if paid as a lump sum and 25 per cent if paid from annual pension income, on top of marginal rate tax on the pension income);
- The maximum tax-free lump sum will remain at 25 per cent of the standard LTA;
- From April 2012, although the trivial commutation limit will remain at its current level of £18,000, it will no longer be determined as a percentage (currently 1) of the LTA. This is good news both for individuals with small pension pots and scheme administrators who want to cut the cost of administering those small pension pots.
Implications for trustees, scheme administrators, employers and individuals
Scheme administrators will have quite a tight timetable to put new processes in place before April 2011, assuming all the planned changes come into effect from that date. This will not be easy, as the final details are still awaited. Similarly, any scheme design issues can at this stage not be addressed fully.
These tables summarise some of the main implications of the new proposals for the different parties involved in pension schemes.