The Finance Act 2011 received Royal Assent on 19 July 2011. It restricts the amount of tax privileged savings available to individuals. However, it also offers flexibility with the introduction of more flexible drawdown pensions and the removal of the upper age limit of 75 from many lump sum benefits.

Restricting tax privileged savings

Annual allowance

The annual allowance is a limit on the amount of pension saving an individual can have in registered pension schemes each year that benefits from tax relief. The annual allowance has been reduced from £255,000 to £50,000 from the tax year 2011/12. An individual is liable to an annual allowance charge if they exceed this limit.

There have also been some important technical changes:

  • the valuation factor for defined benefit pensions has changed from 10 to 16 – this means that the pension is multiplied by a larger number to determine its capital value, making a charge more likely; and
  • benefits will now be tested against the annual allowance in the year in which the individual becomes entitled to receive all his benefits (except where the individual satisfies the severe ill-health condition), which previously was not the case.

In order to mitigate the impact of the reduced annual allowance on individuals, the Government has introduced the following measures:

  • "carry forward" - individuals can carry forward any unused annual allowance from the last three tax years (but for this purpose, the annual allowance for 2008/09, 2009/10 and 2010/11 is assumed to have been £50,000); and
  • "scheme pays" – this applies to a member who is liable to an annual allowance charge across all their schemes which exceeds £2,000 and has accrual in one scheme which exceeds the annual allowance. The member can elect for some or all of the annual allowance charge attributable to that scheme to be paid from that scheme (in which case their scheme benefits are reduced accordingly).

The reduced annual allowance is likely to affect a number of individuals, in particular high earners and members of defined benefit schemes. Schemes may wish to amend their rules to "aim off" the annual allowance i.e. to cap accruals such that the allowance is not exceeded.

Scheme administrators will be responsible for providing a "pension savings statement" to members of a registered pension scheme who exceed the annual allowance in their scheme in a tax year. The "pension savings statement" sets out details of the member's pension savings in that scheme for the tax year in question (and each of the three previous tax years) and the annual allowance for each of those years.

The scheme administrator must also provide such information to other members who make a written request. Scheme administrators will need to ensure they have systems in place to deal with these new information requirements.

Lifetime allowance

The lifetime allowance is a limit on the amount of tax relieved pension and/or lump sum that an individual can draw from registered pension schemes in their lifetime. The lifetime allowance is currently £1.8 million and will reduce to £1.5 million from the tax year 2012/13. A lifetime allowance charge is payable if an individual exceeds the lifetime allowance.

Members who expect their pension savings to be more than £1.5 million when they come to take their benefits on or after 6 April 2012 can apply for "fixed protection". Application forms can be found on HMRC's website and must be received by HMRC in hard copy form by 5 April 2012.

Fixed protection stops an individual's personal lifetime allowance falling below £1.8 million, provided they meet certain conditions. One of the conditions is that the member ceases to have benefit accrual on or after 6 April 2012 i.e. no contributions can be made to a defined contribution scheme and accrual in a defined benefit scheme must not exceed a specified level. Employees who are auto-enrolled into pension schemes from October 2012 onwards will need to make sure they opt-out within one month so that they do not lose their fixed protection.

Age 75 limits – drawdown pensions and lump sum benefits

Drawdown pensions

Income drawdown for money purchase arrangements has been made more flexible, by the creation of a new concept of "drawdown pension".  The principle of drawdown pension is that the member chooses how much pension they want to be paid each year, while leaving the rest invested. "Drawdown pensions" have replaced the former concepts of "unsecured pensions" and "alternatively secured pensions".

Drawdown pensions are capped unless the member can satisfy the requirements for flexible drawdown.

  • Under capped drawdown there is a limit on the amount of pension an individual can take from their scheme each year – broadly, the limit is the amount that would have been paid under an annuity.
  • Under flexible drawdown there is no limit on the amount of pension an individual can take from their scheme each year. In order to qualify for flexible drawdown an individual must have a secure pension income of at least £20,000 per year.

Pension schemes are allowed to offer drawdown pensions but are not required to do so.

Lump sum benefits

The upper age limit of 75 has been removed from most types of lump sum benefits. The only lump sums which require a member to be under age 75 are a lifetime allowance excess lump sum and a short service refund lump sum. However, a 55% tax charge applies to certain lump sum benefits if they are paid when the member is over age 75.

Some schemes have the old age 75 restrictions expressly built into their rules. Such schemes should consider whether or not to amend their rules to remove these restrictions. If schemes retain any age 75 restrictions they will need to consider whether this is discriminatory on the grounds of age and, if so, whether the scheme can rely on an exemption or an objective justification. 

Disguised remuneration

The Government announced on 9 December 2010 that it would be introducing legislation to tackle "arrangements involving trusts or other vehicles used to reward employees which seek to avoid or defer the payment of income tax or National Insurance Contributions." These new provisions came into force on 6 April 2011. Anti-forestalling provisions applied between 9 December 2010 and 5 April 2011.

The anti-avoidance provisions are drafted extremely widely which means that considerable care will be needed when dealing with these types of arrangement. Wholly unfunded Employer Financed Retirement Benefit Schemes (EFRBS) are intended to fall outside the scope of the new provisions. However, funded EFRBS will be caught by the new provisions.  Some EFRBS are neither funded nor wholly unfunded (e.g. they may have security over the employer's assets). EFRBS should consider their position with their advisers.