The Budget 2014 proposed radical changes to the way that pensions are taken and taxed. The Government consulted extensively on how these proposals would be implemented and on 21 July 2014 published its response to its consultation Freedom and choice in pensions (see here for further details).
In August 2014, HMRC published the draft Taxation of Pensions Bill, which will amend existing pensions tax legislation contained in the Finance Act 2004 to give individuals with money purchase pension savings greater flexibility in accessing their funds. Consultation on the draft clauses closed on 3 September 2014 and the Bill is expected to be introduced into Parliament in autumn 2014.
Options on retirement
From 6 April 2015, individuals will be able to take as much, or as little, of their pension as they wish from their money purchase arrangement once they have reached normal minimum pension age (“NMPA”, currently age 55) or before then if they have satisfied the ill-health condition in the Finance Act 2004. This will be possible in the following ways:
- by taking a scheme pension;
- by purchasing a lifetime annuity that can be shaped according to the individual’s needs;
- by entering into a drawdown arrangement known as a “flexiaccess drawdown” from which the individual can drawdown any amount over any period the member chooses; and
- by taking a single or series of lump sums from the individual’s money purchase pension arrangement (known as an uncrystallised funds pension lump sums).
The main changes proposed in the Bill are as follows.
Purchasing an annuity
The draft Bill removes some of the restrictions on lifetime annuities. Whilst an annuity must still be payable for life, it will be able to decrease once in payment. This means that individuals can shape their annuity to reflect their expected lifestyle, for example, they may want a higher pension at the start of their retirement so that they can enjoy various retirement activities whilst they are still in good health.
In addition, the current restrictions on the guarantee period for paying income from a lifetime annuity after the individual’s death will be removed so that the income may continue to be paid for whatever period is set out in the annuity contract.
Payments from a lifetime annuity will continue to be taxed as income.
Flexi-access drawdown will allow individuals to make uncapped withdrawals from a fund which they have first designated for drawdown on or after 6 April 2015. Withdrawals do not need to be for regular amounts or made at regular intervals. Payments from a flexi-access drawdown fund will be taxable as pension. However, individuals will be entitled to the 25% tax-free pension commencement lump sum on putting funds into the drawdown arrangement.
Individuals who already have a capped drawdown arrangement will be able to convert it to a new flexi-access drawdown fund to take advantage of the uncapped amounts that can be withdrawn. Where a member chooses not to convert and subsequently breaches any caps that applied to the capped drawdown fund, the individual will automatically be treated as having converted to a flexi-access drawdown fund immediately before breaching the caps. This means that the individual will not be subject to a penal, unauthorised payments tax charge, but will just have the excess above the capped drawdown maximum charged at their marginal tax rate.
Uncrystallised funds pension lump sums
Subject to some exceptions, individuals will be able to take some, or all, of their fund as cash directly from their money purchase arrangement. For each lump sum taken, 25% will be tax free and the rest taxed at the individual’s marginal rate of tax. Provided that individuals meet specified requirements as to the lifetime allowance that is available to them, there will be no limit on the amount that can be paid as an uncrystallised funds pension lump sum.
As individuals meeting the ill-health condition in the Finance Act 2004 will be able to access their funds in this way before NMPA, schemes may experience an increase in claims for ill-health retirements.
Money purchase annual allowance
Where an individual takes advantage of flexi-access drawdown or an uncrystallised funds pension lump sum, a new money purchase annual allowance of £10,000 will apply to future money purchase savings. This is an anti-avoidance provision designed to prevent individuals from exploiting the new system to gain unintended tax advantages.
Individuals who exceed the money purchase annual allowance will be subject to an annual allowance charge on the excess and the annual allowance available for the remainder of the individual’s pension savings will be reduced to £30,000 (those savings tested against the money purchase annual allowance will not be tested against this £30,000 annual allowance).
Where the money purchase annual allowance is not breached, the individual will continue to have an annual allowance of £40,000 for all pension savings (that is, for money purchase and defined benefit arrangements).
Whilst individuals can generally use carry forward from the previous three tax years to increase their annual allowance, this will not apply to the money purchase annual allowance. In addition, ‘scheme pays’ (the mechanism by which individuals can use their pension savings to pay an annual allowance charge) is unlikely to be available in respect of the money purchase annual allowance charge unless trustees offer it on a voluntary basis.
These different limits are likely to cause confusion in hybrid schemes, where it is not clear until retirement whether a money purchase or defined benefit pension will be paid, and so HMRC has released guidance on how the limits should be applied to hybrid schemes.
Offering the new flexibilities
The reforms are permissive in nature and therefore employers and trustees have discretion over whether to offer the new flexibilities to individuals. This will be welcomed by most schemes as it may not be cost effective to provide certain flexibilities through a particular scheme, such as flexi-access drawdown which could be complex and costly to administer.
Where schemes do want to offer some of the flexibilities, a ‘permissive override’ is available which will allow trustees to pay pensions within the new flexible tax rules without having to amend their scheme’s rules.
However, the permissive override has limited application and some of the other changes in the Bill, such as the changes to lump sum benefits (for example, the right for individuals to have small lump sums paid from NMPA rather than age 60), will not be subject to the permissive override and so it will be necessary to amend the scheme’s rules to take advantage of those changes.
To the extent a scheme does not want to offer the flexibilities, individuals will be able to request a transfer up until their normal retirement age to another pension arrangement that does offer them. However, trustees will need to take into account the Government’s statements on pension liberation and incentive exercises and the new safeguards relating to independent financial advice (see here for more information) before they can agree to a transfer.
Employers and trustees providing money purchase or hybrid pension arrangements should:
- consider what flexibilities they want to offer to individuals;
- start thinking about what adjustments they will need to make to their member communications and support services on retirement to reflect these flexibilities;
- check that the scheme’s administrators will be in a position to administer any flexibilities that are offered and correctly calculate any annual allowance charges that may fall due;
- consider whether amendments will be required to the scheme’s rules;
- be aware of the procedure and considerations for dealing with transfer requests and, if necessary, review the basis for calculating transfer values; and
- review their investment strategies and the scheme’s default fund in the light of the new flexibilities.