Finance Bill 2011 and pension legislation changes

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1 Tech Talk April 2011 Finance Bill 2011 and pension legislation changes The Finance Bill was published on the 31 March and contains provisions that affect the pension tax regime. These provisions in draft form were published towards the end of last year and have been covered in Tech Talks 12, 13, 15 and 16 of This Tech Talk will therefore focus on the changes to this draft legislation set out in the Bill that are of most interest to advisers and their clients. The Bill will now progress through the parliamentary process and become law in due course. It is worth bearing in mind that there may be further amendments to the Bill before it reaches the statute book. The changes set out below take effect from 6 April 2011 unless otherwise stated. Features Drawdown pension Flexible drawdown Minimum income requirement (MIR) Benefit crystallisation events (BCE) Pension commencement lump sum (PCLS) General Lump sum death benefit from uncrystallised funds Charity lump sum death benefit Annual allowance test Liability for the AA charge Pension input periods (PIP) Carry forward of unused AA PCLS and the reduction in SLA Comment For professional advisers only 1

2 Drawdown pension Drawdown pension replaces unsecured pension (USP) and alternatively secured pension (ASP) as a method of drawing income under a money purchase arrangement. However, there is still the need to conduct a review of the maximum income limit where additional fund designation occurs under an arrangement. Additional fund designation occurs where an arrangement contains both uncrystallised funds and drawdown funds and the existing drawdown fund absorbs further amounts as more uncrystallised rights are taken. As the revised limit applies in the drawdown pension year it occurs, there is potential for the maximum income limit to be reduced part way through the year and so the Bill contains provision for the existing limit to continue to apply in such circumstances, regardless of the age of the individual. The earlier draft legislation limited this provision to those individuals under age 75. The Bill contains provision for a member/ dependant in drawdown to notify the scheme administrator that the next drawdown pension year under an arrangement is to start on the same day as the next drawdown pension year in respect of another arrangement held by the member/ dependant under the pension scheme. Such an alignment of drawdown pension tranches is possible, provided the member/dependant has reached age 75 and alignment can be done involving tranches held by an individual as a member or as a dependant. Scheme administrators may agree to carry out such a request and therefore it is not binding on them. Where the scheme administrator agrees to it, it cannot be done more than once in respect of an arrangement. Flexible drawdown Two sets of draft regulations were published at the same time as the Bill. One set covers what is to be included as part of a valid declaration made by an individual to the scheme administrator in connection with flexible drawdown. The other prescribes the provision of information by scheme administrators to HMRC where flexible drawdown occurs. Minimum income requirement (MIR) In order for individuals to gain access to flexible drawdown and be able to draw income in excess of the capped maximum they must make a valid declaration that certain conditions are satisfied. One of these conditions is the MIR. To satisfy the MIR an individual must be in receipt of relevant income of at least 20,000 in the tax year in which the declaration is made. The Bill itself extends the definition of relevant income to include certain payments made from the Financial Assistance Scheme (FAS). There is no change in that the payments from a scheme pension or a dependant s scheme pension are classed as a form of relevant income. However, draft regulations have been published at the same time as the Bill defining which particular payments are not regarded as relevant income. For example, payments of scheme pension under the registered pension scheme where there are less than 20 members, including dependants, in receipt of a scheme pension. There is an exception in the case where a scheme pension under a money purchase arrangement is secured by the scheme administrator through an annuity policy. Another example is a lifetime annuity contract that permits the annual amount paid under it to reduce. Any amount over the minimum payable under the contract as defined by regulations is ignored for the purpose of relevant income. 2

3 Benefit crystallisation events (BCE) To coincide with the introduction of the facility for members to defer taking benefits beyond age 75, the draft legislation contained a provision amending the definition of BCE 5A to include uncrystallised funds held under a money purchase arrangement at age 75. This amendment does not appear in the Bill, rather there is a new BCE 5B which will catch such uncrystallised funds. BCE 5A will continue to apply as before to drawdown funds at age 75 derived from a previous BCE 1. Pension commencement lump sum (PCLS) Where a member does not benefit from any form of PCLS protection, the maximum PCLS payable is capped by the available portion of the member s lump sum allowance. In simple terms, this cap equates to 25% of the remaining standard lifetime allowance (SLA) available in respect of the member at the time PCLS is taken. SLA is used up each time a BCE occurs. Because it will be possible for benefits, including PCLS, under a pension scheme to be taken on or after age 75, legislation needs to be changed to allow for this, and it is for that reason that the Bill contains provisions clarifying how this impacts on the calculation of this cap. For the purpose of determining the remaining SLA, any amounts used up through BCE 5 and BCE 5B are to be ignored. BCE 5 and 5B occur in respect of uncrystallised funds held at age 75 under defined benefit and money purchase arrangements respectively. Where benefits have been taken in the past after the member had reached age 75, although no BCE occurred at that time in respect of these benefits, there is still an impact on PCLS that can be taken by the member at the current time. The reason for this is that the Bill requires that when calculating the remaining SLA a BCE is treated as having taken place in respect of each tranche of previous post 75 benefits taken by the member even though it did not. General There are certain authorised benefits payable from a registered pension scheme where their authorised status is dependent on the individual having all or part of his/her lifetime allowance available. When determining whether or not this is the case the following assumptions should be made: BCE 5 and 5B are ignored for this purpose; and anything that would have been a BCE but for the fact that it occurred on or after the member had attained the age 75 is treated as a BCE for this purpose. 3

4 Lump sum death benefit from uncrystallised funds It is possible for a lump sum death benefit to be paid in respect of uncrystallised funds on the death of the member, regardless of age. Where the member died before reaching age 75, the benefit must be paid within 2 years of the earlier of the following dates: The date the scheme administrator first knew of the member s death; or the date the scheme administrator could reasonably have been expected to know of the member s death If it is not, then it is treated as an unauthorised payment. However, where the member died on or after age 75 this 2 year rule does not apply. This change applies to a defined benefits lump sum death benefit as well as an uncrystallised lump sum death benefit. Charity lump sum death benefit In terms of the draft legislation this type of benefit was only available in respect of drawdown funds. The Bill sees the definition of this particular lump sum death benefit extended to include payment in other circumstances. In particular, where all of the following conditions are met: The member had reached age 75 at the date of death; there are no dependants of the member; it is paid in respect of uncrystallised funds held under a money purchase arrangement; and it is paid to a charity nominated by the member. Annual allowance test In relation to the severe ill-health condition, the Bill reflects the content of the draft legislation and in addition extends the definition to include members of the armed forces who become entitled to a wounds and disability pension as defined in s641(1) of ITEPA Where the severe ill-health condition as defined in the Bill is satisfied, the pension input amount for that arrangement is nil for the purposes of the annual allowance (AA) test. Liability for the AA charge The liability for the AA charge rests with the individual. However, the Bill contains provision for this charge to be paid by the scheme administrator under certain circumstances, in return for a reduction in the individual s benefit entitlement under the pension scheme. The circumstances are as follows: The AA charge for the tax year exceeds 2,000; and the pension input amount (PIA) for the pension scheme in the tax year exceeds the AA. Where both conditions are met, the individual may give notice to the scheme administrator of his/her 4

5 intention to make use of this provision. The deadline for giving such notice is 31 July in the year following that in which the tax year ends, or where a BCE occurs in respect of the individual in the tax year in question, before the date of the BCE. This results in the scheme administrator and the individual becoming jointly and severally liable for the AA charge. In respect of the 2011/12 tax year the 31 July 2013 deadline is pushed back to 31 December The amount of the liability taken on by the scheme administrator cannot exceed the amount of the excess identified in the second bullet point above. In terms of meeting the liability, the charge falls on the scheme administrator in the period ending 31 December in the year following that in which the tax year ends. This deadline is extended to 31 March 2014 for a charge in respect of the 2011/12 tax year. In the situation where the above conditions are met, and the individual transfers all of his/her rights under the scheme to another pension scheme before any notice is given, any notice subsequently given by the individual may only be given to the scheme administrator of the receiving scheme. The scheme administrator does not become liable in the following circumstances: During an assessment period in connection with the pension protection fund or where the scheme administrator having become liable, the scheme enters an assessment period having not met the liability; where the scheme administrator cannot adjust the member s benefit entitlement under the scheme because of a restriction imposed by legislation, or as prescribed in regulations laid by the Treasury. Even if none of the above applies, the scheme administrator s liability may be discharged on application to HMRC, where paying the AA charge would be detrimental to other scheme members, and given the circumstances it would not be just and reasonable for the scheme administrator to meet the charge. The corresponding reduction in the individual s benefit entitlement referred to above must follow normal actuarial practice. HMRC may by regulations modify pension scheme rules to facilitate the operation of this provision. Pension input periods (PIP) The Bill makes changes to the definition of a PIP. There is no change when determining the date on which the first PIP starts. In the case of a money purchase arrangement e.g. a SIPP, it is the date on which the first contribution is paid. However, the end date of the first PIP is altered in line with the following: A nominated date falling before the anniversary of the date the PIP started, or where there is no such nominated date the first 5 April after the date the PIP started (or, if the PIP start date is 5 April, that date). This means that if no such nomination is made in respect of the first PIP, subsequent PIPs will be aligned with tax years (assuming no change in the end date of any of the subsequent PIPs). It is still possible to change the end date of a subsequent PIP by nomination. The Bill contains a change of wording in connection with this. If a nomination is made, the end date of the PIP must fall in the tax year following that in which the previous PIP ended. In the absence of such a nomination the PIP will run for a period of 12 months. Therefore it is possible that a PIP (other than the first one) could last more than 12 months. These changes apply to PIPs commencing on or after 6 April

6 Carry forward of unused AA For the purposes of establishing whether there is any unused annual allowance in respect of the tax years 2008/09, 2009/10 and 2010/11, pension input amounts calculated in respect of money purchase arrangements should be reduced by the amount of any contribution refund lump sums paid to the individual, as defined in paragraph 15 of Schedule 35 to the Finance Act This refund is paid in connection with the anti-forestalling legislation where an individual seeks to avoid the special annual allowance charge through the refund. PCLS and the reduction in SLA The Bill confirms that, as mentioned above, where a member does not benefit from any form of PCLS protection, the maximum PCLS is capped at 25% of the remaining SLA available in respect of the member at the time PCLS is taken. Therefore the reduction in the SLA from 6 April 2012 will reduce this cap. However, the reduction in the SLA will not affect those members that benefit from the new form of protection available, sometimes referred to as fixed protection, because for these members the SLA is replaced with 1.8m where it is greater for the purpose of determining the cap. Comment While the possibility of aligning drawdown tranches will be welcomed by advisers and their clients, many will question why this provision is not being made available prior to age 75. The facility to allow scheme funds to be used to meet the AA charge in certain circumstances seems reasonable. However, when considered in conjunction with the information requirements in connection with flexible drawdown, the administration burden for pension providers is set to increase. Given that the purpose of the MIR is to ensure that individuals who opt for flexible drawdown do not subsequently become reliant on state benefits as a result of poor investment performance, it is not surprising to see that the definition of what constitutes relevant income has been tightened up. The risks associated with certain forms of scheme pension and annuities available in the pension market mean that future income levels may fall below the MIR threshold, thus creating a conflict with the stated purpose. The rationale behind the tinkering with the PIP definition is in response to representation made by certain parties who want it to be easier to align PIPs with tax years. For certain individuals that have enhanced protection, but do not have any form of PCLS protection, where maximising their PCLS is important they have a decision to make. Do they give up enhanced protection and opt for fixed protection before 6 April 2012? Pursuing such a 6

7 course of action may result in an increase in the amount of PCLS available, but this may be offset by the occurrence of a lifetime allowance charge. As mentioned above, this Tech Talk provides a brief summary of some of the changes made to earlier draft legislation and if further scrutiny of Bill reveals anything of interest, or if the content of the Tech Talk needs to be expanded upon, we will endeavour to produce the necessary updates. John Dunn Pension Specialist Technical Support Unit Please contact us on: Pensions Technical Support: pensions.techsupport@jameshay.co.uk Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue & Custom s practice are subject to change. James Hay Partnership is the trading name of: James Hay Insurance Company Limited (JHIC) (registered in Jersey number 77318); James Hay Pension Trustees Limited (JHPT) (registered in England number ); James Hay Administration Company Limited (JHAC) (registered in England number ); James Hay Wrap Managers Limited (JHWM) (registered in England number ); James Hay Wrap Nominee Company Limited (JHWNC) (registered in England number ); IPS Partnership Plc (IPS Plc) (registered in England number ); PAL Trustees Limited (PAL) (registered in England number ); IPS Pensions Limited (IPS) (registered in England number ) and Union Pension Trustees Limited (UPT) (registered in England number ). JHIC has its registered office at IFG House, 15 Union Street, St Helier, Jersey, JE1 1FG. JHPT, JHAC, JHWM, JHWNC, IPS Plc and IPS have their registered office at Trinity House, Buckingway Business Park, Anderson Road, Swavesey, Cambs, CB24 4UQ. PAL and UPT have their registered office at Queen Square House, Queen Square, Bristol, BS1 4NH. JHIC is regulated by the Jersey Financial Services Commission and JHAC, JHWM, IPS Plc and IPS are authorised and regulated by the Financial Services Authority. JHSTT 01 APR11 GDF 7