TECHTALK JANUARY 2016 ISSUE 2 VOLUME 15 NEW YEAR EDITION

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1 TECHTALK JANUARY 2016 ISSUE 2 VOLUME 15 NEW YEAR EDITION

2 EDITOR CONTENTS Sandra Hogg Sandra is the senior tax manager within Scottish Widows with 17 years of hands on experience dealing with HMRC and advising owner managed businesses as an accountant and tax adviser. She also has over 17 years insurance industry experience as a financial planning expert within the group. She represents Scottish Widows at industry forums and at the ABI s Life Insurance Product Tax Panel and is Scottish Widows expert spokesperson on Tax and Financial Planning. CONTRIBUTORS Jeremy Branton Jeremy has over 25 years experience working for financial services providers in a number of technical and advisory roles. Having joined the group in 2006 he now specialises in corporate pensions, with particular focus on pensions reform. Bernadette Lewis Bernadette joined the group in She has over 30 years experience in Financial Services with both intermediaries and providers. She has broad and deep technical experience across pensions, protection, tax and trusts. Chris Jones Chris joined the group in He s worked in a number of technical roles in marketing, product development and technical support. After many years specialising in life and investment products his recent focus has been on the new pension reforms. Lynn Graves Lynn has 15 years experience in financial services, specialising in marketing, strategy and business development roles. MBA qualified, with a career dedicated to the B2B sector, Lynn is a senior manager within the Corporate Pensions, Market Development. Tony Escreet Tony is financial planning senior manager for pensions at Scottish Widows and he has extensive experience in developing advice processes and a strong technical understanding of both group and individual pension matters. He worked as an IFA for a number of years prior to joining Scottish Widows, where he has worked mainly in technical advice based roles DEATH BENEFIT DIFFERENCES: DEFINED BENEFITS VS MONEY PURCHASE SCHEMES Bernadette Lewis Following the Pension Freedoms reforms, we provide a helpful summary of the key differences in the treatment of death benefits between defined benefits and money purchase schemes. THE LIFETIME ALLOWANCE CHARGE Chris Jones As the lifetime allowance reduces once again from 6 April 2016 many more clients will be affected. A good understanding of how and when the charge may apply will help you advise these clients whose retirement planning is becoming increasingly complex. ADDING VALUE: NON-ADVISED MONEY PURCHASE PENSION TRANSFERS Tony Escreet Advisers with employer clients can add value to their proposition by considering non-advised transfers as a means for GPP members to consolidate fragmented pension pots. SALARY EXCHANGE STILL WORTHY OF CONSIDERATION Jeremy Branton A useful reminder of how salary exchange operates and interacts with tax planning. CHILDREN OF FATCA? Sandra Hogg This brief synopsis looks at information exchange initiatives often dubbed as Children of FATCA and the impacts on providers, advisers and customers alike. The most recent of these, the Common Reporting Standard (CRS) applied from 1 January WOMEN AND RETIREMENT Lynn Graves Insights from the 11th annual Scottish Widows Women and Retirement Report and related opportunities for advisers. 2 techtalk

3 WELCOME TO THE NEW YEAR EDITION OF TECHTALK I hope you had an enjoyable Christmas and New Year break. Looking further ahead into 2016, we have covered a number of important topical subjects in this edition to help in your planning whether you are advising on individual or workplace pensions. Bernadette compares the operation of death benefits between defined benefit and defined contribution pension schemes. The treatment of death benefits is one of the key differences between the two regimes and is often cited by members of defined benefit schemes as a significant factor in choosing to transfer to a defined contribution scheme. With the forthcoming reduction to the lifetime allowance more and more clients will be subject to the lifetime allowance charge. Chris provides a useful reminder of how and when the charge applies using a number of examples to help you understand this increasingly complex area of planning. Tony Escreet explains how non-advised pension transfers can help clients who are members of a number of money purchase pension schemes to consolidate those pension pots. In its recent Autumn Statement the Government announced that it is continuing to review the growth of salary sacrifice (generally known in the industry now as salary exchange). In light of this, Jeremy has put together a helpful reminder of how salary exchange works at the moment and he has summarised some key planning points. The Common Reporting Standard, the OECD s exchange of information initiative, came into force on 1 January this year. As this is the latest in a number of similar cross border agreements to collect and share customer information, I ve pulled together a summary of where we are to date and the impacts for you and your clients. Lynn Graves completes this edition by examining insights from the Scottish Widows Women and Retirement Report. More women than ever are saving for retirement, however there is still more work to do and the combination of increased saving and changing attitudes presents some great opportunities for advisers to support female savers. You can read the Scottish Widows Women and Retirement Report at: centre/reports_women.html I hope you enjoy reading the articles we have put together for you in this edition and that we will have helped in your planning and in your discussions with your clients on these key topics. For more information on workplace pension planning and pension freedoms please also take a look at our extensive range of support at: and financial-planning/pension-planning/ retirement-income-planning Enjoy the read. Sandra Hogg techtalk 3

4 DEATH BENEFIT DIFFERENCES: DEFINED BENEFITS VS MONEY PURCHASE SCHEMES Bernadette Lewis This article summarises the key differences in death benefits between defined benefits and money purchase pensions following the Pension Freedom reforms. The death benefit differences may prompt some individuals to consider transferring out of a defined benefits (DB) scheme into a money purchase (MP) scheme. However, this is only one factor to be considered via a transfer value analysis. Importantly, it has long been the view of both the Financial Conduct Authority and The Pensions Regulator that the starting point when assessing the suitability of a pension transfer is that it will not be suitable, unless it can be shown to be in the client s best interests. It will be interesting to see if this view changes following the FCA consultation CP15/30, as the deadline for responses was 4 January techtalk

5 DEFINED BENEFIT SCHEMES Lump sum (includes refund of contributions on death where relevant). Dependant s scheme pension. Not possible. Any dependant s scheme pension must end on dependant s death at the latest. If member dies below age 75: lump sum income tax free. If member dies age 75+: lump sum taxed at recipient s own rate of income tax. (For 2015/2016 only, taxed at 45%.) Dependant s scheme pension: recipient always pays income tax at own rate. Lump sum death benefits normally outside member s inheritance tax (IHT) estate, provided scheme trustees/ administrators have discretion over payment. Dependant s scheme pensions normally outside member s IHT estate. Based on 20 x member s initial scheme pension after commutation (if relevant) plus any tax free cash. (Effectively ignores the value of any death benefit provision.) LTA test on lump sum if member dies under age 75. No LTA test on lump sum if member dies age 75+. No LTA test for dependant s scheme pension. 55% LTA charge on part of lump sum in excess of available LTA. SUMMARY OF KEY DIFFERENCES MONEY PURCHASE SCHEMES Permissible benefits on member s death Passing pension funds down the generations Income tax treatment for recipient of death benefits IHT treatment of death benefits LTA test when member takes own benefits LTA test on death benefits LTA charge where applicable Lump sum. Dependant or nominee flexi access drawdown (FAD). Annuity. Can use any funds still in FAD on dependant/ nominee s death for successor FAD or pay out as lump sum. Same applies if any funds remain in FAD on a successor s death. Beneficiary FAD is ignored for the purposes of the recipient s lifetime allowance (LTA) and pension funding. If member/ beneficiary dies before age 75: all forms of death benefit income tax free. If member/ beneficiary dies age 75+: recipient pays income tax at own rate on all forms of death benefit. (For 2015/2016 only, lump sums taxed at 45%.) Death benefits normally outside members IHT estate, provided scheme trustees/ administrators have discretion over payment. Potentially in member s IHT estate if dies within two years of transferring benefits and in ill health at time of transfer. Based on value of crystallised funds, whether designated for tax free cash, FAD, annuity. LTA test on any uncrystallised funds if member dies under age 75. No LTA test on any crystallised funds if member dies under age 75 or on any remaining funds if member dies age % LTA charge on excess over available LTA if paid as lump sum. 25% LTA charge on excess over LTA if designated for FAD. (Beneficiary FAD income paid tax free.) DEFINED BENEFIT OPS DEATH BENEFITS IN MORE DETAIL Each scheme s rules will specify who s treated as a dependant, within the following permissible categories (this also applies to who can receive dependant s FAD): the member s spouse or civil partner the member s child while under age 23 the member s child over age 23 provided they are dependant on the member because of physical or mental impairment anyone else who was financially dependant on the member anyone else who was financially interdependent with the member (eg cohabitees) anyone else who was dependant on the member because of physical or mental impairment. A dependant s scheme pension must cease on the dependant s death at the latest. If the scheme rules allow, it could stop or reduce sooner than this. For example, some schemes stop paying a dependant s pension if the recipient remarries or starts cohabitating. Many schemes have fully equalised provision for same sex couples. However, the Appeal Court ruling in Walker v Innospec confirms that schemes can restrict the value of dependant s pensions for same sex couples to a percentage of the member s benefits accrued on or after 5 December Death benefits under each scheme will depend on the scheme rules. The rules often limit the payment of dependant s benefits to narrower groups than permitted by the legislation. So, for example, the scheme rules might mean that no dependant s pension is payable to a surviving cohabitee on the member s death, even though the legislation permits this. techtalk 5

6 MONEY PURCHASE SCHEMES AND PASSING MONEY DOWN THE GENERATIONS Uncrystallised funds and any remaining drawdown/ FAD funds on the member s death can be used to provide lump sum death benefits and beneficiary FAD. Remaining funds can also be used to provide beneficiary annuities if wanted. Beneficiary FAD can be established on the member s death: for any dependant of the member for anyone nominated by the member even if they are not a dependant for anyone nominated by the scheme, but only if there are no dependants and no-one nominated by the member. If the member dies before age 75, the recipients don t pay income tax on any form of death benefits, including lump sums, beneficiary FAD or beneficiary annuities. This is why an LTA test applies to uncrystallised funds on the member s death under age 75. If the member dies age 75+, the recipient pays income tax at their own marginal rate on any death benefits. From 2016/2017, this applies to all forms of benefit. For 2015/2016 only, lump sums are taxed at 45%. If the provider establishes beneficiary FAD on the member s death, any remaining funds following this initial recipient s death can be paid as a lump sum. Or the original beneficiary can nominate a successor to receive successor FAD so the funds stay invested in a pension environment. This can happen any number of times. The tax treatment for the new recipient depends on the age at death of the previous recipient. If they died under age 75, the next in line receives the benefits tax free, but the benefits are taxable if the previous recipient died age 75+. IHT WARNING TRANSFERS FOR MEMBERS IN ILL HEALTH There s a potential IHT trap for members who are considering transferring their death benefits out of a DB scheme because they re in ill health, particularly if they have a terminal illness. Pension scheme death benefits are normally outside the member s IHT estate, provided the scheme trustees/ administrators have discretion over who it s paid to or the form of payment. This means that normally no IHT is payable in respect of the death benefits, no matter how large the amount. However, if a member transfers their benefits, the value of the death benefits is in their IHT estate if they die within two years. If they were in good health at the time of the transfer, the value of the death benefits is normally negligible so this has no real effect. However, if they were in ill health at the time of the transfer, the open market value of the death benefits for IHT purposes could be close to the eventual payout. This could cause a substantial death benefits lump sum to be subject to IHT if it s paid to someone who s not an exempt beneficiary for IHT purposes. Be aware that an HMRC form IHT 400 is used to calculate IHT on death. The IHT 400 notes confirm that HMRC will ask the deceased member s legal personal representatives to provide evidence of the member s state of health and life expectancy at the time of the transfer if they die within two years. Any funds held in beneficiary FAD are ignored when it comes to the recipient s own LTA testing. And withdrawals from beneficiary FAD don t affect the recipient s annual allowance. 6 techtalk

7 THE LIFETIME ALLOWANCE CHARGE Chris Jones As the lifetime allowance reduces once again from 6 April 2016 many more clients will be affected. A good understanding of how and when the charge may apply will help you advise clients whose retirement planning is becoming increasingly complex. THE LIFETIME ALLOWANCE CHARGE techtalk 7

8 WHEN DOES THE LIFETIME ALLOWANCE CHARGE APPLY? The charge will only apply when the value of the benefits exceed the client s available lifetime allowance (LTA) following a benefit crystallisation event (BCE). There are now 12 BCEs numbered from 1-9, 5A, 5B and the recently introduced 5C. As you would expect, most of the events occur when the member takes some benefit from their pension plan, i.e. when they buy an annuity, move into drawdown, start to receive a scheme pension or take tax free cash. There are also 3 possible events (BCE5, 5A and 5B) that can occur when a member reaches age 75 without taking all of their benefits. This will include clients who still have funds in drawdown who will face a second BCE which is covered later in the article. The payment of certain death benefits and where members transfer their benefits to an overseas pension scheme are also BCEs. The full list of events can be found here: When a BCE occurs the amount crystallised is expressed as a percentage of the standard LTA or higher LTA where clients have previously applied for protection. EXAMPLE Mark has no pension protection and a personal pension worth 500,000. In November 2015 he took 125,000 tax free cash and moved 375,000 into drawdown. Both are BCEs totalling 500,000 and will result in using up 40% of the 1.25m LTA at the time. He has 60% of the LTA remaining i.e. 750,000 based on the LTA before 6 April 2016 but this would reduce to 600,000 from 6 April 2016 when the LTA reduces to 1m. This percentage is fixed so will convert into a higher monetary amount if the LTA increases and a lower amount if the LTA reduces, as it has done in recent years. Where two or more BCEs occur on the same date it is up to the member to decide the order of the BCEs. The order will determine which benefits any LTA charge is taken from. However, when tax free cash (BCE 6) is paid in connection with a drawdown pension, scheme pension or lifetime annuity, tax-free cash is always treated as crystallising first. THE CHARGE The LTA charge broadly aims to recover the tax advantages the pension contributions and/or accrual have received both through the tax relief and the tax free environment the funds are permitted to grow in. The LTA charge is applied to the amount which crystallises at a BCE over and above the member s available LTA. The charge is applied at two different rates: 55% if the excess is taken as a lump sum before age 75 (known as a lifetime allowance excess lump sum); or 25% if the excess is retained within the scheme. Any subsequent pension income is then assessed to income tax under PAYE. EXAMPLE Hannah s benefits in her money purchase scheme exceed her available LTA by 100,000. She has the choice of taking the excess as: a lifetime allowance excess lump sum of 45,000 or 75,000 could be retained in the scheme to provide her with pension income (which would then be subject to tax under PAYE). For a higher rate taxpayer, taking the income option will mean the total tax should be largely equivalent to the tax levied against the lump sum option of 55%. For an additional rate taxpayer the income option will be worse from a tax point of view and for a basic rate taxpayer the income option is better. Subject to the scheme rules it is possible to take part of the excess as a lump sum and part as an income. With the changes to pension death benefits the income option is likely to be more popular. This is because any funds remaining on death will either be free of death benefit tax charges or taxed at the beneficiary s marginal rate of income tax depending on the age at death of the member; whether under or over age 75 at death, respectively. In this situation the overall rate of tax paid will often be lower than the 55% charge that would result where an LTA excess was taken as a lump sum. In addition, keeping the funds in the pension fund ensures they remain outside of the member s inheritance tax estate. 8 techtalk

9 SECOND LIFETIME ALLOWANCE TEST DRAWDOWN As drawdown becomes more popular more clients will be subject to the second LTA test. However, with careful planning it should be possible to avoid a LTA charge in most cases. When a client first moves into drawdown a BCE arises. A second test against the LTA also occurs when individuals use the funds to buy an annuity or reach age 75, whichever is sooner. The amounts crystallised are the annuity purchase price or value of the remaining drawdown fund, respectively. However, the amount crystallised at the second BCE is reduced by the amount originally designated to drawdown. EXAMPLE Simon, aged 65 has a fund value of 1,000,000. He takes 250,000 and uses 750,000 to provide drawdown in June 2015 when the LTA is 1,250,000. This uses 80% of the LTA. 10 years on he has taken no income and the drawdown fund has grown to 1,100,000. At age 75 there is a second BCE. The crystallisation amount is the fund less the original drawdown designation: 1,100, ,000 = 350,000. If the LTA is 1,000,000 at that point this will lead to a LTA charge on 150,000 ie 350,000-20% x 1,000,000 LTA remaining. The rules encourage drawing down growth in excess of any LTA headroom as taxable income. To avoid the LTA charge Simon could have drawn down sufficient income to prevent the fund growing above the available LTA. Now there are no limits on the amount of income that can be drawn this is largely an optional charge. The investor has the choice of paying income tax or the 25% LTA charge plus income tax later. There may still be situations where the charge is preferable - for example where the client has no intention of ever withdrawing the funds and simply wants to keep them out of their estate for inheritance tax purposes. If the member dies before buying an annuity and before age 75, the payment of the drawdown funds on death is not a second crystallisation event and no LTA tax charge can arise. AGE 75 UNCRYSTALLISED FUNDS Where a member reaches age 75 with uncrystallised funds in a money purchase arrangement the benefits will be tested at age 75 under BCE 5B. If there is an excess it is not possible for the member to receive a LTA excess lump sum as this must be paid before age 75. The scheme administrator would pay over 25% of the excess to HMRC and the balance would be retained in the scheme. NEW BCE 5C As part of the Freedom and Choice changes to pensions a new BCE was introduced - 5C. This ensures any death benefits used to provide beneficiary s drawdown are subject to a LTA test. Previously only dependant s drawdown was available and this wasn t tested. As the funds will be taken as income the tax charge on the excess will be 25%. The alternative would be to take a lump sum where the excess is taxed at 55% under the existing BCE 7. As there are no income restrictions on beneficiary s drawdown, this option will be preferable whenever the provider offers it. PRE A-DAY PENSIONS AND DRAWDOWN Pre A-day pensions in payment aren t themselves tested against the LTA. However, when a member crystallises other benefits for the first time after A-day it is necessary for a notional BCE to be applied to the pre A-day pension or drawdown. The notional value is based on 25 x the pension in payment at the point of crystallisation. For drawdown it is 25 x 80% of the maximum GAD income in the drawdown year in which the event occurs. This equates to 25 x 120% of GAD. EXAMPLE Emma has a pre A-day scheme pension and the current income is 40,000 per annum. She is considering taking benefits under her personal pension before April 2016 which is now valued at 200,000. The notional BCE for her scheme pension is 25 x annual income = 25 x 40,000 = 1,000,000. This leaves her with a remaining LTA of 250,000 for her uncrystallised rights, so there would be no LTA charge. If Emma delayed taking benefits until after April she would suffer a LTA charge on the full value of her personal pension as the existing scheme pension would use up all of the LTA. MONITORING AND REPORTING REQUIREMENTS When a member crystallises benefits under a registered pension scheme, the scheme administrator is responsible for determining whether a charge arises, so they will need to find out: Details of previous BCEs for the member under other registered pension schemes (in which case they can use the statement of LTA used up issued by the scheme administrator at the time). If the member is entitled to an enhanced LTA including primary protection, enhanced protection, fixed protection and individual protection. Note that the member must inform the scheme administrator before the BCE if they are relying on any protection. techtalk 9

10 Details of simultaneous BCEs under other schemes. Details of any pre A-day pensions in payment (pre commencement pensions) and whether these have previously been tested against the LTA as a notional BCE. The scheme administrator must then provide the member with a statement confirming the total level of the LTA which has been used up under that scheme expressed as a percentage of the standard LTA. The statement must include details of: The excess arising at the BCE(s). How the figure has been calculated. The amount of the LTA charge. Whether the scheme administrator has accounted for the charge due, or intends to do so. The scheme administrator must also report and account for LTACs through the quarterly scheme reports provided to HMRC. PENSION PROTECTION 2016 A new round of pension protection will be available to help those who are likely to exceed the new reduced LTA charge. As with the last LTA reduction there are both Fixed Protection 2016 and Individual Protection 2016 options. The application process is expected to be made available from July However, the key date is still 5 April This is the date when all contributions/benefit accrual must cease for Fixed Protection 2016 and benefits need to be valued for Individual Protection In addition, for clients who missed out on the last round of protection, where their benefits are valued at 1.25m or more as at 5 April 2014, the option of Individual Protection 2014 is still available until 5 April For more details on the protection options please see my September 2015 Techtalk article Lifetime allowance protection - ready for another round? The member needs to complete information on their selfassessment return confirming the value of the benefits taken in excess of the LTA and the tax charge paid by the pension scheme. LIABILITY During the member s lifetime, the scheme administrator and the member are jointly and severally liable. In practice, the scheme administrator is obliged to pay the charge over to HMRC. If a chargeable amount arises on the payment of death benefits the liability rests with the recipient of the payment. This applies to death benefits, either a lump sum payment or via beneficiary s drawdown, from uncrystallised funds where the member dies under the age of 75. The scheme administrator will pay the death benefit in full and the personal representatives of the member are responsible for determining whether a charge has arisen. If it has, they must report this to HMRC who will then assess the recipient of the death benefit. Note that lump sums payable from uncrystallised funds, in the event of death after age 75, are not subject to an LTA test. 10 techtalk

11 ADDING VALUE: NON-ADVISED MONEY PURCHASE PENSION TRANSFERS Tony Escreet Non-advised transfers offer an opportunity to advisers with employer clients to add value to their workplace pension proposition. Many employees want to consolidate their money purchase pensions but don t want individual advice. Advisers can work with the employer to direct these employees to their current workplace pension provider s non-advised transfer process where this is available. techtalk 11

12 FRAGMENTED PENSION PROVISION Automatic enrolment generally means an employee becomes a member of a money purchase workplace pension with a provider chosen by their current employer in consultation with its own adviser firm. So the employee won t usually have a personal relationship with a financial adviser. Many of these employees also have legacy money purchase pensions with other providers, usually left over from previous employments. The Government s proposals for a pot follows member approach are on hold, so this won t be a means for employees to avoid fragmented pension provision for the foreseeable future. A member s pension pot is perhaps their most valuable asset after their home. Having different pension pots in different places can make them difficult to administer and to see if the member is on track for the retirement income they want. It s easier to manage their retirement savings when they bring all their pension pots together into their normally low cost group pension scheme. Where they aren t willing to pay advice fees, or just fall outside their employer s adviser s chosen market segment, nonadvised transfers facilitated by group pension scheme providers can offer them a solution. ADVISERS WITH THEIR OWN NON- ADVISED (DIRECT OFFER) PROCESS Many adviser firms have developed their own non-advised processes where they will still receive commission on transfers that take place into a pre-rdr group pension scheme. Some providers offer direct offer marketing collateral to help adviser firms in this area. PROVIDERS WITH A NON-ADVISED PROCESS Not all adviser firms want to conduct pension transfers into their group pension schemes on a non-advised basis. However, where group pension scheme providers have their own non-advised pension transfer processes, members of adviser schemes can still benefit from such a service. Indeed, some providers have become proactive in this area. They ve seen a growing demand from group scheme members to transfer-in and have developed their own non-advised processes for direct schemes - and for adviser-sponsored schemes where the adviser firm does not have such a process. WHAT DOES THIS LOOK LIKE? Each provider will operate its own process along the lines of the following. PROCESS 1 GATEKEEPER APPROACH The provider promotes the service via its extranet - which is available for the adviser firm, the employer and the scheme member. The member is invited to complete a letter of authority and to send this to the provider. The provider s administration team writes out for full details of the legacy plan. The risk that a non-advised transfer will result in a poor customer outcome is minimised by obtaining full details of the legacy plan and then passing the file to the provider s pension transfer gatekeeper. The gatekeeper will assess every case and then draw up an outcome letter to the member as follows: Allowing the case to proceed without further comment. Allowing the case to proceed with warning text where the outcome is not clear. Declining the case where the outcome does not appear to be in the interest of the customer. The outcome letter will compare the charges of the legacy plan and the group pension scheme. It may also point out one or more of the following in terms of the legacy plan: Transfer penalties/market value reduction. Protected tax free cash. Guarantees: identifying where the existing policy has a safeguarded benefit in a fund under 30,000 (if the value is higher, we all know that advice is now required). Any existing premium waiver/additional life cover. Pros: mitigates the risk of a poor outcome by gathering and presenting relevant information to the member to enable them to make an informed choice. Cons: lengthy process to gather information from the legacy provider. PROCESS 2 MINIMALIST APPROACH Some providers engage their group scheme members with a simple letter and explanation leaflet highlighting issues for the member to consider before transferring. There may be a reference to an on-line website for more information. Here, the process owner is data blind - having no details of the member s legacy plan(s). There would be the option to make use of pension transfer service Origo notes where appropriate - just prior to requesting the transfer monies - to ask the legacy provider if there are any valuable features and benefits which would be lost on transfer. Here the process owner can suspend the transaction and warn the member where valuable benefits would be lost on transfer. The member might still decide to proceed but at least this would be in an informed manner. Pros: quick process, as the member can transact the transfer on the basis of the initial letter. Cons: risk that the member makes a decision without understanding the specific benefits they d be giving up. PROCESS 3 DIGITAL AND TELEPHONY SUPPORT APPROACH This process is still data blind but it offers a comprehensive online customer journey together with a dedicated telephony team to provide guidance to members where required. The member has the opportunity to discuss their legacy plan(s) with the telephony team - which will be able to point out, for example, the implications of transferring where a valuable waiver of premium benefit and such like would be lost on transfer. Pros: the transfer can be completed quickly, but with assistance where required. Cons: risk that the member makes a decision without understanding the specific benefits they d be giving up. SUMMARY Where the adviser firm does not have its own process, it should refer to the group pension scheme pension provider and find out what service(s) can be offered on a direct basis. This article outlines some of the non-advised processes that are already out there in the market place. The adviser firm needs to be happy that members of its own sponsored group schemes are being offered a safe and appropriate service. 12 techtalk

13 SALARY EXCHANGE STILL WORTHY OF CONSIDERATION? Jeremy Branton techtalk 13

14 Salary sacrifice - also known as salary exchange is a well established method for employers and their employees to save National Insurance contributions (NICs). It relies on an employee giving up part of their pre-tax salary in exchange for a non-cash benefit such as an employer pension contribution. Employers facing increased pension costs due to the introduction of automatic enrolment will welcome the opportunity this provides to reduce costs. At the same time, it s essential that advisers are conversant with how these arrangements interact with tax planning - in particular how high earners could be affected from April WHAT ARE THE BENEFITS? Once up and running, a salary exchange arrangement can deliver some very worthwhile benefits: a 13.8% saving in NICs for the employer where post exchange earnings exceed the secondary threshold - 8,112 pa for 2015/2016 and 2016/2017 a 12% NICs saving for an employee exchanging salary that remains above the primary threshold - 8,060 pa for 2015/2016 and 2016/2017 a 2% NICs savings for higher earners - salary exchanged above the upper earnings limit - 42,285 in 2015/2016 and 43,000 in 2016/2017. Salary exchange can be applied to an existing pension scheme membership or used in conjunction with new joiners. The savings can be applied in a number of different ways. Employers choosing to pass on at least some of their savings by way of a further contribution into employees pensions are more likely to see an increased take up amongst staff than those retaining the savings. EXAMPLE An employer provides a group personal pension arrangement to its employees on a matched contribution basis of 5% of salary. It decides to offer salary exchange, basing pension contributions on the pre-exchange reference salary and agrees to reinvest its NIC saving by way of an additional pension contribution. The effect in 2015/2016 for an employee with a salary of 30,000 is shown below. Pre-exchange position Post-exchange position Benefit Employer costs 34,520 34,520 Employee net pay 22,287 22, Total gross pension contribution (Calculation assumes rounding). 3,000 3, As well as an enhanced pension contribution, the employee also receives an increase to their take home pay. Further savings could be made if the employee agreed to sacrifice an additional amount representing their NICs saving. Scottish Widows offers a calculator and guidance to enable advisers to illustrate the savings to employers whether this is a requirement to save costs or to offer additional employee benefits: The same principle applies to bonus exchange. EXAMPLE Ann earns 80,000 a year and is also entitled to a performance related bonus. Her employer informs her on 1 January that she will be entitled to a bonus of 20,000, due to be paid on 1 April. If Ann makes a gross personal contribution of 20,000, she ll benefit from 40% tax relief - 20% at source and 20% via self assessment, totalling 8,000 and a net cost of 12,000. But she s also given the option of exchanging her bonus for an employer contribution into her pension provided she informs her employer by 20 February. And if she does decide to do this, the employer confirms it will add its NICs saving to the contribution. Pre-exchange Post-exchange Salary 80,000 80,000 Cash bonus 20,000 Personal allowance 10,600 10,600 Tax 29,403 21,403 NI 5,261 4,861 Net income 65,336 53,736 Employer NI 12,681 9,921 Employer contribution 22,760 Effective tax relief on contribution 49% 14 techtalk

15 SETTING UP A SALARY EXCHANGE ARRANGEMENT It s important that the terms of an employee s contract of employment are formally varied for the arrangement to be considered valid and the associated NICs savings to apply. The reduction to future earnings can be detailed in a letter signed by both the employer and employee and should be in place before the salary or bonus is due to be paid. The employer sets the duration of the arrangement - no minimum applies but employers might typically choose a 12 month period at the end of which it would review the arrangement alongside its pension scheme. Employers might also choose to restrict an employee s ability to switch in or out of salary exchange to ease administration - other than in the event of certain lifestyle changing events. These will be defined in the agreement by the employer and might include pregnancy, marriage or divorce or the redundancy of a partner. However, salary exchange agreements mustn t include any wording that seeks to restrict an employee s rights under automatic enrolment legislation - that is the right to opt out having been automatically enrolled. It s also possible to set up a salary exchange arrangement on an implied consent basis. Here the employer communicates to employees that salary exchange will apply from a future date automatically unless an employee states that they don t wish to participate. Often referred to as a smart pension scheme, an employer considering this approach should ensure affected employees are provided with sufficient information and time in which to make a decision. Due to relying on the nudge principal - it doesn t require active involvement to join and relies on employee apathy to leave, this method might be expected to lead to a greater take up from staff. SOME GENERAL CONSIDERATIONS Salary exchange may not be appropriate to everyone and will depend on an individual s circumstances: a reduction in salary may impact other salary linked benefits such as benefits payable on death and redundancy payments it will also impact on certain state benefits such as maternity and paternity pay and working or child tax credit mortgage lenders often base the amount which can be borrowed on the post-exchange salary it s not possible to exchange statutory maternity pay, statutory paternity/additional paternity pay, statutory adoption pay or statutory sick pay for a non-cash benefit such as an employer pension contribution salary shouldn t be sacrificed below the lower earnings limit - 5,824 pa in 2015/2016 and 2016/2017 as this will affect entitlement to all contribution based state benefits, including the state pension and statutory pay elements mentioned above earnings mustn t fall below the National Minimum Wage as a result of salary exchange. Once a salary sacrifice arrangement is in place, employers can ask the HMRC Clearances Team to confirm the tax and NICs implications. HMRC won t comment on a proposed salary sacrifice arrangement before it has been put in place. Guidance is available at: salary-sacrifice-and-the-effects-on-paye SPECIFIC PLANNING POINTS Pension contributions reduce an individual s adjusted net income - a specific measure excluding pension contributions, salary exchange and gift aid donations amongst other things. This can be used to avoid a high income child benefit charge and to reclaim the personal allowance and the use of salary exchange can maximise the value of the pension contribution. However, before considering this for high earning clients, advisers will need to take account of the restriction to the pension annual allowance due to come into effect from 6 April USING SALARY EXCHANGE TO AVOID A HIGH INCOME CHILD BENEFIT CHARGE A couple s entitlement to child benefit is restricted where either of them has net adjusted income of 50,000-60,000 and is lost altogether if one or other earns more than 60,000. Unless the couple chooses to opt out of receipt of child benefit, it s still paid but a high income child benefit charge applies - equivalent to 1% of the child benefit for every 100 of adjusted net income between 50,000 and 60,000. EXAMPLE John is married and has two young children for which his wife receives child benefit of 1, pa in 2015/2016 (and also for 2016/2017). John s income is 55,000 - so his tax charge will be If John had entered into an arrangement with his employer to exchange 5,000 of salary for an employer pension contribution from the start of the 2016/2017 tax year, his salary would have reduced to 50,000 and the following immediate annual savings would have applied: Income tax 40% 2,000 Employee 2% 100 Employer 13.8% 690 Child benefit tax charge saving Total savings 3, John s employer could choose to enhance the pension contribution of 5,000 it will be making for him with part or all of its NICs saving, as could John by exchanging a slightly higher amount of salary representing his NICs saving. John could, of course ultimately be taxed when drawing down pension funds but this could be at a lower rate of income tax. techtalk 15

16 HIGH EARNERS AND SALARY EXCHANGE For those whose level of earnings means they have lost part or all of their personal allowance, salary exchange could be used to reduce an individual s adjusted net income so that the full personal allowance of 10,600 is available in 2015/2016 (increasing to 11,000 for 2016/2017). However, from 6 April 2016 those with adjusted income above 150,000 contributing to a registered pension scheme will see their annual allowance reduced by 1 for every 2 of excess adjusted income. The maximum reduction is 30,000 reached by clients with adjusted income of at least 210,000 - resulting in an annual allowance of 10,000. Where pension input exceeds the annual allowance - after utilising any unused carry forward - an annual allowance charge applies at the member s highest marginal rate of income tax. A new measure - adjusted income will determine whether income exceeds 150,000 and will include employer pension contributions to prevent individuals from avoiding the restriction by exchanging salary for an employer pension contribution. This income measure also includes member contributions paid via net pay, but not member contributions paid via relief at source. And any new salary exchange arrangements set up on or after 9 July 2015 won t be effective in reducing income below the alternative net income threshold of 110,000. Further guidance may be found in our article: Fading Away: The Tapered Annual Allowance : Doc/FP0536 REDUNDANCY PAYMENTS It s also possible to exchange the taxable part of a redundancy payment for a pension contribution. Payments made in consideration of the termination of an individual s employment are exempt from both employer and employee NICs so won t provide the usual saving. But where this provides an employer pension contribution, it s exempt from tax. This means a higher rate tax payer planning to invest part of their redundancy payment into their pension could instead exchange that element of their redundancy and end up in the same position but without the requirement to claim higher rate relief via self assessment and the associated time delay. Any restructuring of an employee s redundancy package should be agreed in writing before they leave employment. IS SALARY EXCHANGE COMPATIBLE WITH AUTOMATIC ENROLMENT? The benefits of using salary exchange continue to be available but employers need to take account of the fact that automatically enrolling employees into a workplace pension scheme can t involve employees having to make a choice. The two processes can run alongside each other and an employer might consider the following options: automatically enrolling eligible jobholders on a nonsalary exchange basis, allowing sufficient time for any opt outs to be processed before offering salary exchange to members as an additional benefit postpone automatic enrolment for up to three months and invite employees to sign up for salary exchange during the deferral period contractually enrol employees on a salary exchange basis - this could be done during a postponement period. 16 techtalk

17 CHILDREN OF FATCA? Sandra Hogg Automatic exchange of financial account information encompasses a number of recent initiatives aimed at preventing tax evasion and protecting the tax systems of the jurisdictions that participate in it. The intention is that tax administrations will be provided with details of financial accounts and assets owned by individuals and entities that are resident for tax purposes in their jurisdiction, but which are held by financial institutions in another jurisdiction. techtalk 17

18 It affects customers who open certain types of investment such as investment bonds, OEICs or deposit accounts and customers who already hold these investments. This brief synopsis looks at how these information exchange initiatives often dubbed as Children of FATCA impact providers, advisers and customers alike. AUTOMATIC EXCHANGE OF FINANCIAL ACCOUNT INFORMATION The UK is party to a number of these international agreements and the UK Government has introduced legislation that imposes obligations on the UK financial sector to review and collect details of financial accounts held by persons that are tax resident elsewhere and report this to HMRC for onward transmission under the exchange of information articles in the various treaties and conventions to which the UK is party. In return, those jurisdictions supply HMRC with similar information on UK tax resident individuals and entities holding financial accounts with their financial institutions. The UK now has legislation in place for the following four strands of automatic exchange of financial account information: 1. The United States Foreign Account Tax Compliance Act FATCA; 2. The Crown Dependencies and Overseas Territory Regulations CDOT; 3. The Common Reporting Standard developed by the OECD CRS; 4. The EU Directive on Administrative Cooperation in Tax Matters DAC. The future expectation is that, with the exception of FATCA, all of the UK s exchange of financial account information obligations will be under the CRS or the DAC. This means that reporting under CDOT will be relatively short-lived. All of these regimes have significant common requirements. HMRC is responsible for ensuring that UK financial institutions (such as banks and insurance companies) comply with their obligations under the above legislation. The table below outlines dates by which key events occur for each of the obligations: FATCA CDOT DAC/CRS Due diligence procedures apply to pre-existing financial accounts in existence as at: 30 June June December 2015 Self-certification is required by the customer for new financial accounts opened on or after: 1 July July January 2016 The first reporting period ends on: 31 December December December 2016 Financial institutions report information to HMRC for the first reporting period on or before: 31 May May May 2017 HMRC exchanges information with partner jurisdictions for the first reporting period on or before: 30 September September September 2017 Following on from the above, UK financial institutions must report information to HMRC by 31 May each year. If 31 May falls on a weekend or Bank Holiday then the deadline for submitting reportable information to HMRC is the following working day. This deadline enables HMRC to process the information for exchange by the following 30 September for onward transmission. Not all financial account information is reportable in the first reporting period. Details of what has to be reported can be found in HMRC guidance at: the_automatic_exchange_of_financial_account_information Here s a brief summary of the four regimes: FOREIGN ACCOUNT TAX COMPLIANCE ACT (FATCA) FATCA requires financial institutions outside the US to pass information about their US customers to the Internal Revenue Service. In September 2012 the UK and the US signed a treaty to implement FATCA in the UK, imposing obligations on UK financial institutions to identify, maintain and report information to HMRC on financial accounts held by US citizens, taxpayers and entities. Provided these financial institutions comply with the requirements of the legislation they will not be subject to the 30% withholding tax on US source income. 18 techtalk

19 THE CROWN DEPENDENCIES AND OVERSEAS TERRITORIES AGREEMENTS (CDOT) The Crown Dependencies of Guernsey, the Isle of Man and Jersey and the UK Overseas Territories of Anguilla, Bermuda, the British Virgin Islands, the Cayman Islands, Gibraltar, Montserrat and the Turks & Caicos Islands also entered into agreements with the UK to automatically exchange information on financial accounts. Only the agreements with the three Crown Dependencies (Guernsey, the Isle of Man and Jersey) and with Gibraltar are reciprocal, imposing obligations on UK financial institutions to identify, maintain and report information to HMRC on financial accounts held by individuals and entities resident for tax purposes in those territories. The agreements with the remaining six overseas territories are non reciprocal. This means that HMRC will receive information from these territories in respect of UK tax residents, but there is no requirement for due diligence or reporting in the opposite direction. THE COMMON REPORTING STANDARD (CRS) & THE EU DIRECTIVE ON ADMINISTRATIVE COOPERATION (THE DAC) The CRS is a G20 initiative developed by the OECD. One of its aims was to maximise efficiency and reduce costs for financial institutions by drawing heavily on the approach taken to implementing FATCA. However, there are some distinct differences between the two, such as: FATCA reports on the basis of citizenship as well as tax residence, compared to only tax residence under the CRS; and FATCA introduced a 30% withholding tax for non Model I IGA countries, which is not replicated under the CRS. Following publication of the CRS by the OECD in June 2014 work started on incorporating it into an EU Directive to make automatic exchange of financial account information mandatory between EU member states. The CRS contains a number of options that are open to jurisdictions to apply if they choose, so the member states came to an agreement on which of those should be incorporated into the DAC and therefore applicable across the EU, along with any points considered necessary to the effective implementation of the CRS. The regulations that require UK financial institutions to identify, maintain and report information for exchange with these jurisdictions under the CRS and with EU Member States under the DAC, The International Tax Compliance Regulations 2015, came into force on 15 April These regulations also incorporate the previously separate FATCA provisions. The Regulations implementing the UK s CDOT agreements will not be incorporated into the International Tax Compliance Regulations 2015 as it is anticipated that they will be repealed once the UK and its Crown Dependencies and Overseas Territories start to exchange information under the CRS. The basic process is the same for each of the agreements. FUTURE PROOFING THE WIDER APPROACH A so called wider approach has been adopted which is intended to help financial institutions future proof their processes. Financial institutions are required to identify the territory in which an account holder or a controlling person is resident for income tax or corporation tax purposes, or for the purposes of any other tax of a similar character that has been imposed by that territory, and to maintain and retain this information for a period of time. The due diligence procedures are designed to identify accounts held by residents of the jurisdictions with which the UK is committed to exchange information. However, because there is an expectation that more jurisdictions will reach agreement with the UK under the CRS in the future, the regulations applying the due diligence rules have been designed to allow reporting financial institutions to record the territory in which a person is tax resident irrespective of whether that territory is a reportable jurisdiction and maintain information on the tax residence of account holders irrespective of whether or not that account holder is a reportable person for any given reportable period. This already applies for both the FATCA and CDOT regimes. This wider approach effectively allows financial institutions to future proof their processes so that when a new jurisdiction is added to the list of reportable jurisdictions the work in identifying where existing customers are resident has already been carried out. Financial institutions will only need to revisit the determination of tax residence in those cases where there has been a change of circumstance. Reducing the number of times that due diligence processes have to be carried out should result in lower costs for the financial institutions in complying with their obligations. DATA PROTECTION LAW One of the main concerns of the legislators was to provide financial institutions with the legal cover they require to comply with data protection law. The regulations therefore impose an obligation on financial institutions to collect this information without any discretion on their part. It is the financial institutions obligation to identify, maintain and retain the territory in which an account holder is tax resident. REPORTABLE INFORMATION Under all of the agreements the following information is required from financial institutions for any person identified as holding reportable accounts: Name Address Taxpayer Identification Number(s) (TIN) or an equivalent Jurisdiction(s) to which the information is reportable (i.e. non UK tax residences) The account number The name and identifying number of the reporting financial institution techtalk 19