Summer Budget 2015 the changes to the Lifetime and Annual Allowance, some of them immediate

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1 Page 1 of 9 News Alert 2015/01 30 July 2015 this is an updated version of that issued on 10 July 2015 Summer Budget 2015 the changes to the Lifetime and Annual Allowance, some of them immediate At a glance On 8 July the Chancellor confirmed: the details of the tapered Annual Allowance (TAA) applying for high earners from 6 April 2016 and to aid its implementation, he also announced the aligning of Pension Input Periods (PIPs) to tax years for all individuals, with immediate transitional arrangements; and the reduction of the Lifetime Allowance (LTA) from 1.25m to 1m with effect from 6 April 2016 together with associated protection regimes. This News Alert examines both changes. It is based on the information published with the Budget, updated in the light of the draft legislation issued on 15 July 2015 and HMRC s Newsletter 70. Key Actions Employers 6 April 2016 is not far off. Consider widening the group of employees who might be allowed to opt for salary supplement instead of pension accrual. Communicate the changes this will be vital as an individual s personal income and circumstances may influence the position. Review scheme design and executive benefit/reward packages. How many more employees will be impacted by the further reduced allowances? And what will the impact be? Can the approach used for the last round of reductions be dusted off and tweaked, or is this round of changes a final game-changer? Will the anti-avoidance measures cause any issues? For the new TAA measure scope who is clearly affected/who might be affected and the effect of variable pay elements/pension savings (both DB and DC). If DB or Cash Balance scheme rules currently limit pension accrual to the Annual Allowance (AA), they need to be rethought urgently. Consider how salary sacrifice (and flexible remuneration) arrangements made on or after 9 July 2015 might sit within the Threshold Income measure. For the LTA reduction employers should be firming up plans to assist individuals understand the protections that will be available the key features relevant to members are now confirmed. More immediately, for the AA PIP change the 2015/16 transitional arrangements could let many individuals save more now (or in the next few years) without an AA charge; and may lessen AA issues arising for some current projects. But the provisions need careful examination because they are very case-specific: some DB features mean the position could worsen and action needed to mitigate the impact.

2 Page 2 of 9 Trustees Review all communication material; and ensure the administrators are geared up firstly to understand what the new tax measures mean for the scheme; to cope with a large volume of queries particularly a higher call for information on past AA usage for carry forward; and then to satisfy any new tax management requirements that may appear in law or consequent to more individuals potentially accruing AA charges. Immediate work is needed to handle the transitional PIP arrangements (potentially urgently for retirement cases) and then to implement tax year PIPs even if an arrangement is currently aligned, there is still action required. Ensure that the scheme can manage the many different types of AA that apply in the future the main 40,000 AA provisions and its tapered variations, together with interactions where the 10,000 money purchase annual allowance (the 10K MPAA ) also applies. Active and deferred (and perhaps pensioners) should be told about the coming LTA drop and protections. Work may still be needed to continue to assist in the implementation of past measures for example information for those applying for 2014 Individual Protection. The Detail In many ways the Chancellor s announcements simply fulfilled pre-announced Conservative policy to reduce pension tax relief for high earners. However, the change in PIPs does involve schemes with work for a much wider population. The key points are: Restricting the AA for high earners: most people can contribute up to 40,000 a year to their pension tax-free. From April 2016 this will be reduced for individuals with incomes of over 150,000, including pension contributions. It seems that the proposed taper is very similar to the old Labour plans from 2009, so reflecting all taxable income; and it has a two-step process, the trigger being if total taxable income hits 110,000 at which point the pension accrual value is added on to decide where one s AA is on the taper, if at all. Alignment of PIPs for all savers: in order to facilitate the taper legislation will also be introduced to align PIPs with the tax year from 2016/17, as well as generous transitional rules for 2015/16 to protect savers who might otherwise be adversely affected by this. Reduction of the LTA from 1.25m to 1m from 6 April 2016, with associated protections and increases in line with CPI inflation from 6 April In relation to the first two points, this News Alert reflects the draft guidance issued by HMRC alongside the Budget (with subsequent notification from HMRC, via Newsletter 70, of a few changes that will be made to it) and the Bill released on 15 July. Both the guidance and the Bill may be subject to more change as the Bill progresses through Parliament until Royal Assent (expected to be in the autumn).

3 Page 3 of 9 The Tapered Annual Allowance (TAA) For tax years from 2016/17 onwards there are two tests for establishing whether an individual is caught by the TAA regime. The first is based on Threshold Income an individual who has Threshold Income of 110,000 or less in a tax year is unaffected by the new TAA measure and continues to have an Annual Allowance of 40,000. Threshold Income is (broadly) all income assessable to income tax, reduced by any relievable pension contributions made by the individual. Importantly there is an add-back of employment income given up for pension provision by way of salary sacrifice or flexible remuneration arrangements, made on or after 9 July If Threshold Income exceeds 110,000 the second test comes into play. The individual will need to check their Adjusted Income for the tax year and for each 2 that the latter exceeds 150,000 their AA for the tax year is reduced by 1, to a minimum of 10,000 if Adjusted Income is 210,000 or more. Adjusted Income is (broadly) Threshold Income plus: pension accrual or savings made (whether by own contributions or employer funding), valued using the AA methodology; plus some other adjustments applying in relatively few cases (relating to non-domiciled individuals). In the left-hand-side chart below, cases 1 to 3 would not fall into the TAA measure for the tax year concerned. Cases 4 and 5 would and their TAA would be set to 25,000 as shown in the right-handside chart below. The Bill includes anti-avoidance provisions whereby attempts to move threshold income and /or adjusted income between tax years with the aim of reducing or eliminating the reduction in the AA are unwound. These measures are not yet mentioned in the draft guidance and it is unclear how they will be interpreted in practice.

4 Page 4 of 9 The Threshold Income figure is vital it means it will be very clear for many individuals that they will be well below the Threshold Income and so will have a 40,000 AA. But circumstances change for example unexpected bonuses or windfalls and see the case of Barry in our Case Studies below. Equally, an individual may have such high Threshold and Adjusted Income figures that it is easy to see that their AA is 10,000. But for many individuals, predicting their AA for a tax year will be complex, subject to variation for lots of factors, many outside their direct control; and only ascertainable after the tax year in which the pension savings tested against the AA are made a real block to pension planning. The two income measures will include at their core both employment-related taxable income so the likes of salary, regular variable pay, bonuses, commission, taxable benefits in kind and redundancy payment beyond the 30,000 tax exempt element and personal taxable income such as investment returns, rental income and taxable income from pension schemes and state pension. As an employer will usually only have half the story, when designing remuneration packages it may be difficult for them to know which individuals have little scope for tax efficient savings. Interestingly, an individual with a salary of say 120,000 (and no other income) will be below the Threshold Income if he is making contributions of more than 10,000 towards pension (whether that is a contribution to qualify for DB accrual, or a DC contribution). Is the safest approach for executives to keep their pension savings down to 10,000 pa? Perhaps not. Some individuals have legacy DB (possibly from leaving some time ago), which may be using up what would now be a significant part (or even more than) a 10,000 AA. Various other issues like this may emerge now that an AA measure that was intended originally to bite rarely is a significant limit on savings. The Government s data suggests that around 300,000 taxpayers currently exceed the Threshold Income and save into pensions, and of course not all will be affected by the TAA measure. But many employer pension arrangements will have at least one. Carry forward will work as before for impacted individuals no AA charge will apply to savings until the savings overflow both a tax year s AA and effectively any unused AA from the past three tax years. We see a high call for past information from individuals caught by the measure so as to check their carry forward in particular bearing in mind the changes for 2015/16 PIPs described later. In any case we also await any legislation on additional information burdens that may be put on to pension schemes to provide individuals with the post-event information they need to spot, report

5 Page 5 of 9 and pay their AA charges and perhaps measures to assist individuals who accidentally trigger an AA charge. Case Study 1 Ann expects her income for the year to be solely salary, of 100,000 (she has no private sources of income), and so she thinks she is outside the TAA measures (as her Threshold Income is below 110,000). As she expects her AA to be 40,000 she agrees to employer pension contributions of 40,000. But she gets an unexpected bonus of 30,000 which takes her Threshold Income over 110,000 and brings her into the TAA measures. Her Adjusted Income is now calculated as 170,000 ( 100, , ,000) and her AA for the tax year drops to 30,000. So she would be subject to perhaps 4,000 additional tax ( 10,000 x 40%) as well as the normal tax on her bonus. Case Study 2 Barry is sure that his only income for 2016/17 will be salary and bonus from one employer, total taxable amount 110,000. He will not exceed the Threshold Income, so will be safe from the TAA measure. He will therefore have a 40,000 AA. His pension savings paid for by his employer use 50,000 of the AA but do not trigger an AA charge because he has unused AA from the past tax year totalling 10,000. It is a non-contributory scheme. But before the end of the tax year, he receives an unpredicted extra 1 of taxable income. He is now potentially subject to the TAA. His actual AA is determined based on his Adjusted Income, which is his 110,001 taxable income plus the 50,000 value of pension accrual making 160,001; meaning his AA is reduced by 5, His extra 1 would cost him 2, in tax ( 5, x 40%). But he realises this in time and makes a charitable donation through payroll that reduces his taxable pay for 2016/17 by 1. So he is back in his happy starting position. (Extraordinarily the same outcome as regards escaping the TAA here can be achieved by his making a personal contribution toward pension) To celebrate this near miss, he cashes an old money purchase policy he has for 20,000 (as an UFPLS using the new Freedom and Choice flexibilities) ahead of the end of the tax year. All but 25% of this counts as taxable income. This increases his Threshold Income again, to above 110,000, so his Adjusted Income comes into play, this time at 175,000 ( 110, , ,000). So his AA reduces again but by 12,500. Cashing in his old policy has resulted in a 5,000 AA charge (as well as the income tax he will pay on the cash-out).

6 Page 6 of 9 Re-alignment of Pension Input Periods to tax years A key aspect of the TAA is the need to align Pension Input Periods (PIPs) with tax years to ensure Income and AA are compared like-for-like. This change applies to all arrangements, not just those for high earners. Part of the original rationale for giving the ability to vary PIPs was that some schemes would prefer to carry out their PIA (Pension Input Amount) calculations at different dates, to avoid duplication. For example, a scheme issuing benefit statements based on a scheme year of 1 January to 31 December would not want to also do a whole new set of figures for tax management based on tax years. That flexibility is now a casualty of HMT s desire to link the AA to income, and schemes will need to get used to the fact that, going forward, more calculations will be required. That said, the current misalignment of PIPs and tax years is one of the areas of AA that causes the most confusion, difficulties and errors, both for schemes and for individuals. For the 2016/17 tax year onwards, all PIPs will be aligned with tax years, with no ability for that to be varied by either the scheme or the individual. But in order to get to this aligned position there will be an immediate (retrospective) adjustment to how PIPs and AA testing work for 2015/16 as follows: Any open PIPs will cease on 8 July 2015 (these and any PIPs that ended after 5 April but before 8 July 2015 are the pre alignment PIPs ) A new PIP will run from 9 July 2015 to 5 April 2016 (the post alignment PIP ). The picture below shows how schemes with various PIPs might fit into this. Accrual/DC savings in each of the above PIPs (either two or three depending on the current PIP structure of an arrangement) will be tested against the AA for 2015/16.

7 Page 7 of 9 Recognising that some individuals will already have made contributions in the expectation they will be tested against the 2016/17 AA, the 2015/16 AA has been doubled to 80,000. There will be two separate tests: 1. Total accrual/savings allocated to the pre alignment PIPs are tested against 80,000 (plus any previously unused carry-forward). 2. Total accrual for the post alignment PIP is tested against any unused balance of the 80,000 up to a maximum of 40,000 from the first test (again, plus any remaining unused carry-forward). AA charges can arise from either (or both) of the above tests. So how are the savings that use up the AA (technically the PIA) to be allocated to the two 2015/16 PIP elements? For most money purchase arrangements, the PIA is simply the contributions made and these can easily be allocated (according to the date made) to the pre or post alignment PIPs. However, HMRC recognises that requiring schemes to perform similar calculations for DB or Cash Balance arrangements would lead to a disproportionate amount of work. HMRC has therefore set out a welcome simplified approach whereby one calculates what would be the total PIA for an arrangement over the whole period ie from the start of the earliest pre alignment PIP to the end of the post alignment PIP (generally 5 April 2016) and then allocate the PIA pre and post alignment on a pro-rata basis. In general, this means the proportion allocated to the post alignment PIP will be (272 / the days in the combined PIP). The combined PIP PIA calculation (before proportioning) has special tweaks to reflect the longer than typical period. The key change is that the uplift to the value of benefits at the start of the PIP is 2.5%, rather than the 1.2% CPI which would normally have been used for PIPs ending in 2015/16. If the member became/becomes a deferred pensioner during the period and would have satisfied the Deferred Member Carve Out, there are potentially adjusted provisions to try to ensure that some leaver revaluation is not unfairly captured by the new PIA calculation. HMRC has not asked schemes with DB or Cash Balance to calculate additional figures as at 8 July 2015, so schemes have avoided a significant additional burden. The proposed approach to allocate pensions accrual into the pre and post alignment PIPs have some anomalous and unintuitive outcomes which we are working through. What about carry forward? The draft guidance confirms that any unused AA out of the 80,000 from what is effectively the first mini tax year from 6 April 2015 to 8 July 2015, can be carried forward to future tax years (including the second mini tax year to 5 April 2016), subject to a maximum of 40,000. Carry forward could be very useful for individuals who are trying to mitigate the impact of the TAA.

8 Page 8 of 9 Once an earnings-based TAA was confirmed it was always likely that PIPs would need to be aligned with tax years, and HMRC s proposals seem the least painful way of achieving that goal. Inevitably there will be some rough edges, many people will now have additional scope for pension savings but some will be worse off (because of the unintuitive outcomes from the approach to DB). And many individuals (and schemes!) may not even know their current PIP. The work involved should not be underestimated. Picking up one small example: there may be individuals who retired from a scheme in the three months since 5 April 2015 and, thinking they had an AA charge for 2015/16, arranged Scheme Pays. It may now be that they are in the happy situation of no AA charge but perhaps a Scheme Pays arrangement that needs unscrambling. Any current retirements need careful rethinking of calculations (unfortunately based on draft legislation). And certainly any current exercises sending out estimates of 2015/16 AA usage need to be held up and modified! But some individuals have a 10,000 Money Purchase Annual Allowance too? The above describes the main AA applying to all savings. Some individuals will, since 6 April 2015, have used the new Freedom and Choice flexibilities in a way that means they now fall under the 10,000 Money Purchase Annual Allowance ( 10K MPAA) regime as well as the main AA. The 10K MPAA has its own version of the PIP-alignment transition (its nature depending on whether the member fell into the 10K MPAA regime before or after 8 July 2015). The reduction in the Lifetime Allowance from 6 April 2016 Although the Chancellor didn t mention the LTA from the dispatch box, the backing papers released after he sat down confirmed that the Government will go ahead with the plan, announced in March by the then Coalition Government, to reduce the LTA from its current 1.25m level to 1m from 6 April Transitional protections will be available for those already with large pension rights (to ensure the change is not retrospective ). The LTA will then be indexed annually in line with CPI from 6 April HMRC s Newsletter 70 then confirmed that the 2016 protections will have the same conditions as the 2014 protections, but the notification process will be different. Individuals will not need to notify HMRC in advance where they want to rely on fixed protection or have three years to apply for individual protection. Instead, HMRC is considering options around removing the deadlines for applying for these protections and will be consulting informally with stakeholders over the next few weeks so that it can publish full details later this summer. The indication of (perhaps?) not having to register for protections leaves huge questions about how such a regime can operate in the real world we can only wait to hear HMRC s ideas. But the Newsletter item closes off some points of doubt the deadline for stopping benefit accrual if wanting to hold Fixed Protection 2016 will be 5 April 2016 (there had been some consultation discussion as to whether that might move). So that means 5 April 2016, no longer a

9 Page 9 of 9 registration deadline, is still a deadline for a key decision/action (opt-out?) for many individuals. (We note that HMRC has confirmed to us that benefit accrual here has the same complex meaning for DB and cash balance schemes that it had for 2014 protections.) Even without the final details on registration, this means the key details for decision making are confirmed many employers/trustees will now (if not already) want to firm up options and roll out communications around this urgently to members. A final word The operation of the LTA and AA is now unbelievably complicated. It will be difficult for individuals to understand, and there is a high likelihood of error in every aspect of its operation (by everyone involved, including HMRC). This News Alert does not constitute advice, nor should it be taken as an authoritative statement of the law. If you would like any assistance or further information on the contents of this News Alert, please contact David Everett or the partner who normally advises you at LCP on +44 (0) or by enquiries@lcp.uk.com. LCP is a firm of financial, actuarial and business consultants, specialising in the areas of pensions, investment, insurance and business analytics. Lane Clark & Peacock LLP London, UK Tel: +44 (0) enquiries@lcp.uk.com Lane Clark & Peacock LLP Winchester, UK Tel: +44 (0) enquiries@lcp.uk.com Lane Clark & Peacock Belgium CVBA Brussels, Belgium Tel: +32 (0) info@lcpbe.com Lane Clark & Peacock Ireland Limited Dublin, Ireland Tel: +353 (0) enquiries@lcpireland.com Lane Clark & Peacock Netherlands B.V. Utrecht, Netherlands Tel: +31 (0) info@lcpnl.com Lane Clark & Peacock UAE Abu Dhabi, UAE Tel: +971 (0) info@lcpgcc.com All rights to this document are reserved to Lane Clark & Peacock LLP ( LCP ). This document may be reproduced in whole or in part, provided prominent acknowledgement of the source is given. Lane Clark & Peacock LLP is a limited liability partnership registered in England and Wales with registered number OC LCP is a registered trademark in the UK (Regd. TM No ) and in the EU (Regd. TM No ). All partners are members of Lane Clark & Peacock LLP. A list of members names is available for inspection at 95 Wigmore Street, London, W1U 1DQ, the firm s principal place of business and registered office. The firm is regulated by the Institute and Faculty of Actuaries in respect of a range of investment business activities. The firm is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are licensed by the Institute and Faculty of Actuaries. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. Lane Clark & Peacock UAE operates under legal name Lane Clark & Peacock Belgium Abu Dhabi, Foreign Branch of Belgium. Lane Clark & Peacock LLP.