Pension Income Drawdown

Transcription

1 Pension Income Drawdown Module

2 Pension Income Drawdown (PID) Module This module is a core part of any Pension exam syllabus for 2017/18. Especially, if you are planning to sit the R08 exam then this module is a core element to that exam. It forms an important part of all pension examinations (and CPD) and focuses on the technical essentials, designed to be easily read and a one-stop reference point on all things involving flexible pension income options. There are also very useful additional reading documents within the module, with summaries from various sources to help establish, clarify and confirm your understanding. Pension Income Drawdown is effectively about one thing: Benefit Crystallisation Events (BCEs). The Taxation of Pensions Act 2014 received royal assent on 17 December We ve been using the new rules since April The Taxation of Pensions Act 2014 has completely re-written retirement options history. There is now much more choice of pension income options to meet your clients needs, where taxation and planning death benefits is now even more valuable to every client. Throughout the module (in topics 1-5), you will develop a detailed understanding of benefit crystallisation event rules and how to value BCE events against LTA limits as described within the Taxation of Pensions Act 2014 and updated for 2017/18 tax year. These notes have been revised for the 2017/18 tax year (includes new QROP rules). These notes are applicable to English and Wales Tax Law. Topics Pension Income Drawdown Options Scheme Pension and Lifetime Annuity Secured Income Options Age 75 BCE Test and Relevant Lump Sums Lump Sum Death Benefits Tested Under BCE 5 and 7 Pension Transfers and HMRC Reporting Requirements 1

3 Pension Income Drawdown Options Testing against the lifetime allowance and Benefit Crystallisation events BCEs occur when pension benefits are tested against the lifetime allowance (LTA). LTA is important because the amount of LTA available (either using Standard or an Enhanced/Increased LTA) could reduce any excess LTA tax charge substantially and it helps defines the amount of TFC available to the member. If the crystallised value is more than the personal lifetime allowance available, a lifetime allowance tax charge of 55% applies to the excess amount. This is the excess LTA tax charge when the excess is taken as a lump sum. It s now even more important within the LTA allowance that BCE s are identified and valued not just from an LTA perspective (which remains important), but from an income tax, IHT planning and wealth management point of view, for all clients, irrespective of whatever size of pension pot they might have. The essence of this module is defining what BCE s are being actioned; how they are valued for taxation/lta purposes, and understanding how that applies to specific client scenarios. Benefit crystallisation event (BCE) 1: Pension Income drawdown These are funds or assets held under a money-purchase arrangement, designated to provide a member with flexi-access pension income drawdown (FAD). From 6 April 2015, there are 2 arrangements for pension income withdrawal: 1. Capped drawdown 2. Flexi-access drawdown (FAD) 1. Capped Pension Income Drawdown (PID) These are pre-april 2015 Capped Drawdown funds and would be the mainstay of the drawdown market, available pre-april You will be very familiar with this concept. Capped drawdown remains post-april 2015, for those who started capped drawdown before 6 April 2015, but not available to start as a new capped arrangement from 6 April This is important: there would be no new capped drawdown arrangements setup post-april 2015 for anyone and that also means for beneficiaries/dependants. A new arrangement for capped drawdown cannot be started post-6 April 2015, but a previously set-up capped drawdown arrangement can be continued and added to by the member only (in some specific circumstances where the arrangement construction is set-up appropriately). The maximum level of annual income available from 26 March 2014 is 150% of the basis amount, which is calculated using rate tables provided by the Government Actuary s Department (GAD) and this continues into this tax year. 2

4 The rate is expressed as an income per thousand pounds of fund designated to income withdrawal, net of any PCLS taken and is dependent on the member s attained age and the current gross redemption yield on UK gilts (15 year gilts) from the previous month, rounded down to the nearest 0.25%. From 21 December 2012 (Gender-neutral EU pricing directive) women have used the same GAD rates as men. The minimum annual income is zero, which effectively provided a means to take a PCLS and defer drawing any income (but, this has implications for 2 nd drawdown test and we ll review the new death benefits rules later under BCE 7: death benefits). Two further drawdown tests could take place: On subsequent BCE events where the value of the drawdown fund less the amount originally moved into income drawdown at the outset, is tested (that s what I call the 2 nd drawdown test). The two most likely situations which lead to overlap/2 nd drawdown test are: Move into drawdown pension and then later a purchase of a lifetime annuity or scheme pension before age 75 by the member Move to drawdown pension and then reaching age 75 (BCE 5 test) So, if a member moves funds into a flexi-access drawdown pension, the benefits would initially be assessed under BCEs 6. If then later they purchase a lifetime annuity from the drawdown pension fund, then BCE4 would apply. But, the prevention of overlap rules (the second drawdown test), make sure that the amount tested under BCE4 (annuity) is reduced by the amount already tested under BCE1. The income limit increased from 120% to 150% of GAD for anyone entering drawdown, or starting a new drawdown year, after 26 March Previously, PID plans being taken out after 26 March 2013, the maximum limit was 120%. The maximum capped amount must be reviewed at least every three years for all those remaining in capped drawdown (as opposed to five years under pre 6 April 2011 rules) or until the member attains age 75, after which annual reviews are taken. However, if either: a) You designate the capped drawdown arrangement as a flexi-access arrangement; b) The amount received as capped drawdown income is more than your capped amount, or c) You have flexibly accessed any other pension arrangement by either using flexiaccess income (unlimited access) or using uncrystallised funds lump sums. Then the new money purchase annual allowance (MPAA) rules apply. 3

5 There are a number of triggers for MPAA: Takes an income withdrawal from a flexi-access drawdown fund Takes an uncrystallised funds pension lump sum (UFPLS). Notifies the scheme administrator of their intention to convert capped drawdown fund to a flexi-access drawdown fund and then subsequently takes an income withdrawal from that fund Takes more than the permitted maximum for capped drawdown Receives a stand-alone lump sum when entitled to primary protection where the lump sum protection exceeds 375,000. Receives a payment from a lifetime annuity where the annual rate of payment can be decreased (flexible annuity) Receives a scheme pension paid directly from the funds of a money purchase arrangement where the arrangement is providing a scheme pension paid directly from the funds of the money purchase scheme to less than eleven other members (SSAS) Payment of one of the types of benefit listed above from an overseas pension scheme that has benefitted from tax relief will also be a trigger event. Those members who entered flexible drawdown before 6 April 2015 will automatically be subject to the MPAA rules from 6 April 2015 Events that do NOT trigger MPAA rules: Receives a pension commencement lump sum. Receives a trivial commutation lump sum. Receives a small pots lump sum. Receives a payment from a scheme pension from a defined benefit arrangement. Receives a payment from a scheme pension paid directly from the funds of a money purchase arrangement where at least 12 people Receives a scheme pension secured by way of an annuity from a money purchase scheme of any size. Is in receipt of a lifetime annuity where payments cannot go down except in prescribed circumstances (conventional lifetime annuity). From 6 April 2015, takes no more than the permitted maximum for capped drawdown from a pre-6 April 2015 capped drawdown pension fund. Any excess above the capped drawdown limits is not an unauthorised payment. It immediately converts the capped drawdown to flexi-access drawdown and the excess is immediately chargeable as flexible pension income and the MPAA rules are triggered. It is taxed as pension income and in any of these circumstances described, you will lose access to your capped drawdown option and be subject to the MPAA. Additional fund designations/contributions to a capped drawdown fund will be possible for members after 6 April 2015, provided that there were funds previously designated to Capped drawdown and there still remains capped drawdown funds within the same arrangement (and it still is capped drawdown). Further designations will increase the capped drawdown income limits, have full access to the full normal AA and be regarded as non-flexible income for MPAA purposes. GAD calculations 4

6 Until 1995 the only method to produce an income from a pension fund was to buy an annuity, but the Finance Act 1995 introduced the concept of Pension Fund Withdrawal (PFW). Its aim was to have an alternative to buying an annuity when rates were low, yet still be able to receive an income from the fund. A drawdown pension is only available from a money purchase scheme (defined benefit schemes can only offer scheme pensions) and most likely from a personal pension. It is a crystallisation event that will trigger a lifetime allowance test (BCE 1) Once the member designates a drawdown pension fund the maximum GAD income is set. If you ve never seen a GAD table (excel spreadsheet), you ll find them here: The chart is a spreadsheet with ages down the vertical axis and gilt yields on the horizontal one. This enables the amount of annual income per 1,000 of fund to be calculated depending on the individual's age, sex and current gilt yield. New tables are being introduced from 1 July 2017, with extended gilt yields down from 2% toward lower gilt yields and thus lower maximum incomes. The figure shown in the table for a person's age is the equivalent rate that would be obtainable from a lifetime annuity assuming it is: A level annuity Based on the individual's age With no guarantees Payable in advance The gilt yield is calculated by: Using the 15-year gilt yields Published on the 15th day of the preceding month in the Financial Times Rounded down to the nearest 0.25% The minimum income is zero and it is possible to vary the amount taken between the maximum and minimum from year to year (amount per pension year). In all cases the income taken (in advance or arrears) in a pension year must not exceed the maximum calculated by the administrator when the fund was designated as drawdown or the MPAA rules will apply and any excess taxed as pension income. 5

7 Example GAD calculation Tim is aged 63 and has a 200,000 SIPP fund. He takes his maximum PCLS of 50,000 and designates the balance of 150,000 to PID. The current gilt yield (based on June 2017 GAD table with gilt yield at 2.00%) shows a figure of 50 per The maximum annual income Tim can draw is 50/1000 x 150,000 x 150% = 11,250 (gross). Income payments are paid net of income tax (20%) under the PAYE system. This kind of calculation is still applicable post-april 2015 for those in capped drawdown. These calculations will still be need to be understood for clients who remain within capped drawdown limits and who want to do so until accessing their pension options using flexibility rules. It means the MPAA are not triggered. The current capped drawdown rules will remain for all those in drawdown and the rules governing transfers, reviews and limits remains intact. Review dates/recalculations For capped drawdown arrangements, the member can take an income of between zero and 150% of the basis amount during a drawdown year, as we discussed. This is calculated at the date of original designation. The next GAD review for a Capped drawdown member would fall on the original three-year anniversary/reference period and a new basis amount would be calculated at that date, if aged under 75. Previously, the GAD reviews were undertaken every 5 years (pre- April 2011 drawdown years). The member can ask for a review before the 3-year anniversary, but this has to be on an anniversary date at the start of a drawdown year and not mid-term (and can be calculated up to 60 days before the reference date). After age 75, and from the first drawdown year start date after age 75, the income must be reviewed annually. But, there are other situations where the immediate income limit is re-calculated. Income reviews within the three-year period will be done, where: a) Additional funds are designated, or b) A secured pension (either lifetime annuity or scheme pension) is purchased with part of the PID fund, or c) The fund is reduced as a result of a divorce pension sharing order. 6

8 Whilst any of these 3 events would trigger an immediate income review on the new fund basis (using appropriate income calculation with fund values, age and GAD rates applicable at the time of the trigger event), the next triennial three-year reference period review would still fall on the original three-year anniversary/reference period and a new basis amount would be calculated at that point as well. Where an individual was already in receipt of drawdown benefits prior to 26 March 2014, the increased drawdown limit (150%) will apply to the maximum income that can be taken in the next drawdown year commencing on or after 26 March All capped drawdown members will have access to the 150% limit and all capped drawdown members this tax year will have a maximum limit of 150% of their basis amount for income purposes. Transfers A member can transfer their pension rights into another registered pension scheme that offers a drawdown facility. That is a normal transfer, pre-crystallisation (and that s important it s the full fund that is transferred, not after TFC has been paid out by one provider and then a transfer to another). Drawdown-to-drawdown transfers are allowed. Funds already in drawdown can be transferred to PID with another scheme provider. Upon transfer, the existing Capped Drawdown GAD basis amount and review year timetable is maintained. The key transfer rules are: No further entitlement to a cash lump sum will arise from the transfer The transfer must go into an arrangement that has no existing funds at outset A full transfer must take place all the designated funds must be transferred. If a fund in income drawdown is transferred, there's no impact on the income limits or the review period. Partial/Phased income withdrawal (or annuity) Phased income withdrawal allows an individual to take a specific level of income limiting the amount of funds that need to be crystallised and ensuring a full AA of 40,000 if kept within the capped drawdown limit and not the new MPAA limit of 10,000. Phased income withdrawal is normally achieved by clustering or segmenting the pension plan into a number of separate arrangements, enabling the income to be drawn from a number of the arrangements to achieve the required income level. Using a Phased retirement option with drawdown gives even more flexibility since the income taken from the drawdown can vary between 0 and 150% of GAD and it's even possible with this method to have no income at all in a year (0% income). 7

9 Mortality Gain and Critical Yield This is the additional return that can be paid by fact of it being a pooled investment. Annuities are a form of pooled investment. The death of members who die earlier cross subsidises those who live longer. The actuary takes this into account in the rate offered by annuity. A Pension Fund Withdrawal is not a pooled investment and therefore an extra return has to be made to match the income from an annuity. The loss of this subsidy requires the investment funds to achieve an additional return to match the amount that could be obtained from an annuity and this increases as you get older. There are lots of good articles on mortality gain and sustainable income which have been written since the new flexibility rules. Here is one: How Much Can You Safely Withdraw Annually from Your Pension Pot? There is a growing body of literature on safe withdrawal rates for retirees, but most of this research is based on the returns in the United States. This article is based on some UK research. Against the background of the UK pension freedom legislation, it is important that retirees have a reasonable expectation of the proportion of their assets they can withdraw each year to fund their cost of living, while ensuring sufficient capital remains to deliver a similar level of income into the future. This is commonly known as the safe withdrawal rate. The paper goes on to explore sustainable income from a UK perspective and a very useful perspective when discussing transfers from DB to DC schemes. At this point you may want to remind yourself about COBS : When a firm is making a personal recommendation explanation of possible disadvantages in the suitability report should include the risk factors involved in entering into an income withdrawal. these may include: (1) the capital value of the fund may be eroded; (2) the investment returns may be less than those shown in the illustrations; (3) annuity or scheme pension rates may be at a worse level in the future; (4) the levels of income provided may not be sustainable; and (5) there may be tax implications. 8

10 1. Lifetime Allowance calculations and valuations? How are income drawdown pension funds tested against the lifetime allowance on initial designation of capped drawdown funds? Normally, benefits are only tested against the LTA once. But for income drawdown, there could be two tests: 1) Initially going into income drawdown (after TFC is paid), and 2) If the fund is used to buy an annuity, provide a scheme pension, or where the member reaches age 75 (if earlier). This is the second drawdown test and takes into account funds crystallised and tested in the first test. This second test doesn't apply to drawdown pension funds that were already in income drawdown before 6 April 2006 (and/or remain in that shape, even when reaching age 75). This initial test/bce against the LTA Is value of the funds designated for drawdown. Pre-6 April 2006 (A-Day) drawdown in payment and for first BCE events post-april 2015: Pre-ADAY drawdown pensions in payment, will be tested at the first BCE post-aday. Valuation of pensions already in payment before 6 April 2006 Pensions in payment before 6 April 2006 are valued at 25 times the maximum yearly pension: For Capped drawdown = 1. First BCE before 6 April 2015: x25 the maximum GAD on the day that first BCE occurs. 2. First BCE after 5 April 2015: x25 times x80% of the max GAD on the day that first BCE occurs. Note the critical/subtle difference here in part 2; where the first BCE is after 5 April 2015, for those with pre-aday drawdown. It uses an income multiple of x25 and an income limit of 80% of max GAD for the purpose of the LTA calculation. 9

11 2. Flexi-access drawdown (FAD) funds Flexible drawdown (2014/15) During 2014/15, the minimum income requirements for flexible drawdown were changed. Anyone with secured pension of more than 12,000 in 2014/15 was able to access flexible drawdown. These rules are now superseded by the new flexi-access drawdown and all flexible drawdown arrangements are now deemed as flexi-access drawdown with a new MPAA rather than no AA as was before April This is positive news for those in pre- April 2015 flexible drawdown. This initial test/bce against the LTA is value of the funds designated for drawdown for all new funds post-2006, since ADAY. For the purposes of calculating the BCE value against the LTA when pre-aday funds became Flexible drawdown, it depends on the date the fund first became flexible drawdown: For Flexible drawdown designations before 27 March 2014 = 25 x the maximum yearly income that could have been paid under capped drawdown on the date it was designated for flexible drawdown Flexible drawdown designations after 26 March 2014 = 25 x the maximum yearly income that could have been paid under capped drawdown on the date it was designated for flexible drawdown x 0.8. Both these valuations happening on the first event BCE after ADAY, because they were using pre-aday pension drawdown which had not been tested against the LTA. Flexible drawdown turns out to be the pre-cursor of flex-access drawdown. 3. Flexi-access drawdown (FAD): 2015/16 This is a crystallised fund. Designating new funds into flexi-access drawdown is a BCE (as opposed to converting previously designated flexible drawdown or capped drawdown funds into a new flexi-access drawdown account, which is not another BCE). Designating funds into flexi-assess drawdown is a BCE and it is a separate BCE from taking any PCLS (which is valued under BCE 6); any PCLS entitlement (normally 25% of total funds) has to be taken BEFORE funds are designated for flexi-access drawdown. This is a crystallised fund. It no longer has any entitlement to any PCLS from subsequent withdrawals, or any uncrystallised funds lump sum. As soon as you access any funds (take taxable income or lump sum payments) from the flexi-access account (FAD), you will be subject to the new MPAA rules and be liable to be charged income tax on the withdrawals as pension income, but there is no limit on withdrawals. 10

12 The capped drawdown rules do not apply to flexi-access drawdown. As the name implies, the access and rules surrounding the flexi-access are very flexible and less onerous than capped drawdown. Many commentators have classified it as a pension bank account. It does come very close. From 6 April 2015, there will be four forms of flexi-access drawdown pensions: 1. Member's flexi-access drawdown pension (member alive, member taking income) 2. Dependant's flexi-access drawdown pension (member s dependant taking income after members death) 3. Nominee's flexi-access drawdown pension (member s non-dependant nominees taking income after members death) 4. Successor's flexi-access drawdown pension (successor is other than members nominated dependant or non-dependant taking income after death). We ll deal with the dependents, nominees and successor s flexi-access drawdown under BCE 7 (death benefits). These are critical planning aspects for member funds and tax planning and must be clearly understood. As we discussed previously, for Pre-ADAY income drawdown and where these are the only pension benefits the individual has, they'll never be considered for lifetime allowance purposes. But, if a BCE takes place after ADAY, then they will be tested. Pre-ADAY drawdown pensions in payment, will be tested at the first BCE post-aday. And, there are some changes to that since April Here is a complete summary: Valuation of pensions already in payment before 6 April 2006 Pensions in payment before 6 April 2006 are valued at 25 times the maximum yearly pension: Note the critical/subtle difference here in part 2; where the first BCE is after 5 April 2015, for those with pre-aday drawdown. It uses an income multiple of x25 and an income limit of 80% of max GAD for the purpose of the LTA calculation. Again, where a pre-aday pension income drawdown fund has gone into FAD New Flexi-access drawdown (post 6 April 2015) = x25 times x80% max GAD under capped drawdown when the BCE occurs Lifetime annuities and scheme pensions = x25 times the yearly pension in force on the day that first BCE occurs. 11

13 Here s a neat summary table: Whilst there has been no change (other than an updated GAD max) to how newly designated drawdown funds are tested against the member s lifetime allowance, the way in which pre-6 April 2006 drawdown funds are valued for the first post-6 April 2006 BCE that occurs on or after 6 April 2015 for flexi-access or 27 March 2014 for flexible drawdown: BCE Valuation of pre-6 April 2006 drawdown pension when 1st post-5 April 2015 BCE occurs: Pension Drawdown when the BCE occurs Pension drawdown prior to 6 April 2015 Calculation Capped drawdown Capped drawdown 25 x 80% of the maximum annual amount (basis x 150%) that can be paid as a capped drawdown pension at the date of the BCE. Flexi-access drawdown Flexi-access drawdown Flexi-access drawdown Flexible drawdown plan where the nomination was accepted to change from capped drawdown to flexible drawdown in a drawdown year starting before 27 March Flexible drawdown plan where the nomination was accepted to change from capped drawdown to flexible drawdown in a drawdown year starting on or after 27 March Capped drawdown (which was converted to flexi-access drawdown on or after 6 April 2015). 25 x maximum annual amount (basis x 150%) payable as a capped drawdown pension at the point the member made the declaration to be a flexible drawdown pension. 25 x 80% of the maximum annual amount (basis x 150%) that could be paid if the contract was a capped drawdown pension at the date of the BCE. 25 x 80% of the maximum amount (basis x 150%) of capped drawdown pension that could have been paid at the point the member s drawdown pension fund became a flexi-access drawdown fund. 12

14 Why the 80% change? This effectively creates two GAD max tests; one for income which is 150% and one for LTA testing which is 120% - to avoid somebody who crystallises benefits on or after 6 April 2015 having their capped drawdown funds assessed as a larger percentage of their lifetime allowance than would have been prior to the increase in GAD max income. Prior to 27 March 2014 the max GAD was 120% and is now 150%, 150% x 80% = 120%. Finally, a brief overview of overseas residency considerations. The legislation amended the rules regarding the taxation of payments from flexible drawdown plans whilst temporarily non-resident, to include payments in respect of a dependant, nominee or successor of the client. Whilst the member is non-resident some payments will become taxable if, when the member becomes resident again, the total payments from these UK pensions, plus any received from relevant non-uk pensions, is more than 100,000 and the 100,000 limit applies: *Member UK-resident for 4+ years out of last 7 before the year of departure from UK *They return to UK and become tax resident *Fewer than 5 years between departure and return 13

15 Scheme Pension and Lifetime Annuity Secured Income Options Scheme Pension Where a member becomes entitled to a scheme pension (whether from a defined benefits arrangement or a money purchase arrangement), this is BCE 2. The crystallised value is 20 x the initial yearly scheme pension. Compare that with a lifetime annuity which is the market value of the fund being used to buy the annuity, but the scheme pension is 20 times the yearly pension which has been bought and this can produce some interesting results, especially in occupational schemes where there is a comparison between a trust-bought scheme pension (x20) and a memberbought annuity from the pension funds. There is a significant LTA difference.? What is a Scheme Pension? A scheme pension is a secured pension: a promise to pay an individual a given level of pension income. A scheme pension must be paid: by the scheme administrator (or insurance company) at least once a year for the life of the member without being reduced (with a few exceptions) A scheme pension can be secured via a money purchase or defined benefit arrangement (although under a defined benefit scheme only a scheme pension can be secured for members pensions). This has had implications since 2011 and legislation has been introduced to tighten-up the definition of money purchase pensions (which will ensure that a scheme defined as a money purchase scheme must always meet its member liabilities and no deficit could arise in a money purchase scheme). From April 2015 the normal pension benefits available from a money purchase arrangement will be: A lifetime annuity A drawdown pension: Capped drawdown or Flexi access drawdown An uncrystallised funds pension lump sum A scheme pension A pension commencement lump sum These will only be available if the scheme administrators allow each option. Many won t be able to offer all the options and hence transfers will be necessary to facilitate the client needs (particularly from DC occupational schemes). The normal pension benefits available from a defined benefit arrangement: 14

16 A scheme pension for the member (taxed as pension income) A scheme pension for member s dependants only (taxed as pension income) A pension commencement lump sum Drawdown (of any kind), flexible lifetime annuity or uncrystallised funds lump sum are not available from a DB scheme, nor are benefits outside the immediate dependent family. Transfers and unfunded public sector DB schemes Transfers from occupation schemes will be allowed up to the members normal scheme retirement age, but it won't be possible to transfer DB rights from unfunded public service schemes (for example, the NHS DB pension scheme is an unfunded public service scheme), where they want to access flexible benefits or the scheme offers flexible benefits. But, if they want to transfer and buy a secured lifetime annuity this could still be allowed. Effectively, the vast majority of public sector workers (apart from the funded local authority scheme, the University Superannuation Pension Scheme and one or two others) are no longer able to consider a transfer out option for their CETV of accrued DB pension benefits for access to flexible benefits. Members of funded (mainly private) defined benefit (DB) pension schemes will be allowed to transfer to defined contribution (DC) or money purchase to access the new income flexibility if it fits their needs, but only if they've taken advice from an independent FCA-regulated adviser. This applies where the CETV is worth more than 30,000. There is a whole raft of information on the pensions guidance available (see more under HMRC tax and reporting section and background on pension regulator guidance notes). You wouldn t want to be advising someone on a DB transfer if you don t have the permissions and if a DB pension is already in payment pre-april 2015, it won't be possible to transfer to access the new income flexibility rules post-april There is more on these rules in future modules. 15

17 BCE 3 Above permitted margin (of increases allowed for scheme pensions) No change pre/post April Where a scheme pension in payment is increased (at any point) above the permitted margin of 5% or RPI) the crystallised value is 20 x the additional increase, above the permitted margin ; it is only the increased amount which is measured and valued as a BCE amount. There is an exemption for larger schemes where everyone (>20 pensioner members in that particular class) is given the increase and this is why Pension Increase Exchange (PIE) exercises within occupational pension schemes as a retirement option for everyone are not caught by BCE 3. The reason for this BCE 3 test is to stop a scheme pension being paid at outset at a very low level and then increased dramatically shortly afterwards even between the ages of 74 and 76; BCE 3 is the only BCE post-aged 75 that could still be tested to stop abuse of the rules pre and post 75. BCE 4 Lifetime annuity purchase Where the member becomes entitled to a secured standard or flexible pension lifetime annuity, purchased from a money purchase arrangement. If the lifetime annuity is bought from uncrystallised funds, the crystallised value (for LTA purposes) is the market value of the fund used to buy the lifetime annuity.? What is a lifetime annuity? A lifetime annuity is a secured pension provided by using a money purchase pension fund to buy an annuity contract from an insurance company: Post-April 2015 and into this tax year Must be bought from an insurance company, but with no legal requirement for the member to have an opportunity to select the insurance company (open market option doesn t need to be offered) Be paid for the member's life Be paid at least once a year Provides annuity capital protection or a guarantee for any length of annuity contract (not restricted to 10 years and now normally available for years). Pay an amount of pension income which could stay level, decrease or increases each year to provide a flexible income = Flexible annuity The MPAA rules will be triggered where a flexible income annuity is used that is, where an annuity is or could use flexibly reducing income other than in previously prescribed events (mainly investment-linked), then the MPAA rules will be applicable to that member. They will apply from the first payment of the flexible annuity (see more under the MPAA heading for details of how it works and what triggers the MPAA). The member s annuity payments will be taxed as normal taxable pension income. (For more under death benefits from an annuity purchase, see BCE 7.) But, it is worth mentioning death benefits from annuities at this stage (which we ll repeat under BCE 7): 16

18 Death before 75: Joint life annuity provides tax free pension payments if death was after 3 December 2014 and payments are made from 6 April 2015 these are no longer restricted to dependants. Lump sum capital protection payments are paid tax free (annuity protection), so long as they're paid within two years of the date of death or then marginal rate applies. In addition, any remaining annuity guarantee payments up to 30,000 could be commuted as a trivial commutation death benefit lump sum which is taxable PAYE. Death after 75: pension payments are subject to income tax at the beneficiary's marginal rate: Income and lump sums. And lastly, under annuities, it s worth noting that Fixed term or Short term annuities, is an expression also used by HMRC, although it is not a lifetime annuity: These are short term annuities bought (after 5 April 2015) within the drawdown wrapper could go up or down and can be written for a maximum 5 year term (no minimum). 17

19 Age 75 BCE Test and Relevant Lump Sums At age 75, funds are tested and effectively crystallised for the purposes of a BCE and tested against the LTA. There are now 5 key tests and this is one area of most significant change since pension flexibility started in April BCE 5 Defined benefit test at age 75 Where a member reaches age 75 with uncrystallised scheme pension (and possible lump sum benefits) from a defined benefit scheme. The crystallised value is (20 x the yearly scheme pension plus the amount of any separate lump sum payable). This value is tested as if the member were effectively crystallising the funds at this point. All the same criteria applying to testing BCE 2 apply here, but it s done at age 75, as an LTA test. These funds are then effectively regarded as crystallised, even though, in reality, they may not have been taken it is an LTA test for excess LTA. The same applies for the BCE 5(a) and BCE 5(b) 2. BCE 5(A) Test at age 75 for drawdown pension Where a member with a drawdown pension fund reaches age 75, there is a second drawdown test. The crystallised value is (the market value of the member's drawdown fund at 75 less the amount originally moved into income drawdown) at the outset or calculated at the last BCE (BCE 1 would have applied). The reason for this deduction is to reflect that these funds have effectively already been tested for lifetime allowance purposes through previous BCE 1, but the increased growth on the investment has not. I like to call this the 2 nd drawdown test (as previously discussed). Drawdown which was setup pre A-day is not tested at 75. ONLY IF, it is the only pension benefit and no further BCE s have taken place or funds remain untested. This is the same for secured pre-a day pensions in payment; they are only tested at 75 if there is a reason. That reason is if they have untested funds accumulated under the post-a day rules and then BCE 5, 5A or 5B applies as a full test on the LTA at that point. 18

20 3. BCE 5(B) Test at age 75 on unused funds 'Unused Funds in a money purchase arrangement. The uncrystallised value is the market value at age 75; these funds are then effectively regarded as crystallised, even though, in reality, they may not all have been taken as pension at this point. What is also worth bearing in mind is that these tests are done on reaching 75. The excess LTA charge is 25%. It's only possible to pay a lifetime allowance excess lump sum to the member before age 75 (if the rules allow it). 4. BCE 5(C): NEW Where the designation into a dependants'/nominees' flexi-access drawdown is made in respect of uncrystallised deceased member funds and the member died prior to attaining age 75, they will be assessed against the late member's remaining lifetime allowance, under a newly introduced benefit crystallisation event, BCE 5(C). In respect of BCE 5C the normal excess LTA rules will apply; 25% excess LTA tax charge (on excess amount above available LTA), when being accessed as income or 55% when being taken as a lump sum. On death before 75, any death benefit will be paid tax free within the available Lifetime Allowance (LTA). This will apply to survivors' annuities and pension guarantee payments as well as nominee/successor FAD drawdown. 5. BCE 5(D): NEW Where the purchase of a dependants'/nominees' lifetime annuity is made in respect of uncrystallised funds and the member died prior to attaining age 75, they will be assessed against the late member's remaining lifetime allowance, under a newly introduced benefit crystallisation event, BCE 5(D). This is a particularly interesting section and will be covered more under BCE 7 (death benefits). The principles of flexibility extend beyond FAD to dependents/nominees annuities where the annuity options are much more flexible than previously available. The eagle-eyed amongst you will have noticed that this effectively means that dependent s pensions can now be tested against members LTA. In previous years, they were not. 19

21 BCE 6: Relevant Lump sums Please note this is not death benefit lump sums, these are limp sums which could potentially be payable to the member whilst still alive. This is where the member becomes entitled to a relevant lump sum during lifetime. The most popular being a tax free lump sum, of which there are several types (see the list of TFC available further on) and post-april 2015 relevant lump sum options have expanded. Post-April 2015 Change/Additional relevant lump sum: UFLPS This is the uncrystallised funds pension lump sum (UFPLS). This enables the member to flexi-access money purchase pension savings that are uncrystallised. There is no need for an associated pension to access this lump sum. It is not a pension commencement lump sum (PCLS) nor a small pots lump sum. You cannot have a PCLS in connection with a UFLPS/FLUMPS; you are not commencing any pension. It is not available from any drawdown arrangement, as these are crystallised funds and this is an uncrystallised lump sum. It is not available from defined benefit pension schemes. It is not available if you have transitional protection on registered TFC lump sum rights in excess of 375k or where you have greater than 25% TFC entitlement under schemespecific TFC protection, the higher TFC rights will have to be forgone. It is a lump sum pension income payment, where 25% is (normally) tax-free (this is NOT a PCLS) and 75% is taxable as pension income immediately. The remaining funds remain uncrystallised. The value of the BCE is the monetary value of the total lump sum taken from the money purchase fund. It is available from uncrystallised money purchase arrangements at normal minimum pension age (NMPA), which is increasing with state pension age, which won t always be 55. State Pension age (SPA) is the earliest age that State Pension can be taken. Currently, it's 65 for men. Before 6 April 2010 it was 60 for women. The provisions within the Pensions Act 2011 will equalise ages at 65 for men and women by November 2018 and then increase it to 66 for men and women by October Between April 2026 and April 2028 the state pension age will increase to 67. From 2028 the NMPA will be linked by a 10-year period to the SPA of 67. An UFLPS is available where there the member has available LTA remaining or an excess LTA charge of 55% will apply on the amount over the LTA limit, without any tax free element, before age 75. It is still available post-age 75; where there is LTA remaining then it is taxed in the same way as for pre-aged 75 clients taking the UFLPS; 25% tax free and 75% taxed as income. If there is not sufficient LTA, then the UFLPS is split (between available LTA and no LTA remaining) with the excess being fully chargeable at the member marginal rate and the part 20

22 covered by the LTA taxed in the normal way (25% tax free and 75% taxed as pension income at marginal rate). Taking an UFPLS will trigger the 10,000 money purchase annual allowance (of course, they still have an overall AA of 40,000), but no more than 10,000 can be paid to money purchase schemes; and it won't be possible to carry forward any unused money purchase annual allowance this is covered under MPAA topic. Other types of relevant lump sum include Tax Free Cash (PCLS), triviality (DB schemes or winding up trivial payments, small pots lump sum, winding up lump sums, short service refunds from DB schemes and serious ill health commutation lump sums payable to members). It s worth also noting that there is an overseas context here. A payment from a RNUKS (relevant non-uk scheme) (read a nice little summary of overseas schemes here: ) that would be considered to be an UFPLS if it were paid from a UK registered scheme, will be taxed in the same way as if it had been paid from a UK registered scheme. If the member is a UK resident (or is deemed to be) they will be liable to UK tax on the UFPLS in the same way as if it had been paid by a UK registered scheme. We re going to look at two lump sums in a bit more detail: Tax-free cash and Triviality. Tax free cash Normally, up to 25% of the crystallised value of the benefits can be paid as a tax free lump sum, so long as it doesn't exceed 25% of the individual's available LTA. This 25% rule applies to all types of registered pension scheme, including both money purchase and defined benefit schemes. But, of course, there are members who have protected and registered TFC entitlements greater than 25% (this is covered extensively in tax free cash module, but extracts are added here for continuity). Taking an UFLPS with >25% tax free cash It is not available if you have transitional protection on registered TFC lump sum rights in excess of 375k or where you have greater than 25% TFC entitlement under schemespecific TFC protection, the higher TFC rights will have to be forgone. Tax free cash after age 75 There is no longer a need to take the tax free lump sum by age 75, but any unused funds will be tested against the lifetime allowance at age 75. When the member eventually decides to take their TFC, the amount available will be the lower of: 1. 25% of the remaining unused fund coming into payment, from the balance of unused funds at age 75 (within the LTA), less any subsequent TFC withdrawal 2. Or, 25% of the remaining lifetime allowance, at the time of taking the TFC in future. 21

23 For TFC purposes post-75, the value of BCEs up to age 75 is included, but not the unused funds just tested through BCE 5, there remains TFC access to those tested unused funds which means you can take TFC post 75, if you have remaining uncrystallised funds. Trivial commutation lump sums and small pots Pre-April 2015, those over age 60, with total pension savings of 30,000 or less, could have taken it all as a trivial commutation lump sum, from both money purchase and DB pension schemes. From 6th April 2015, a trivial commutation lump sum will only be payable from a defined benefits arrangement and the earliest age at which it can be paid will be cut to normal minimum pension age (NMPA)* of 55, or earlier if it s commuted under the ill-health rules or protected ages. This is for members remember, this is payment of a trivial lump sum to a member. The UFPLS removes the need for trivial commutation to continue to apply to money purchase arrangements, but because UFLPS doesn t apply to DB schemes. The normal 30,000 trivial lump sum can still be paid from a DB scheme, if the value from all registered pension scheme sources, including pensions in payment doesn't exceed the 30,000 limit and the person has reached age NMPA*; and has some unused lifetime allowance left; and the payment eliminates their rights under that scheme; and the payment is made within 12 months of the first trivial commutation lump sum. The triviality rules can be used for both crystallised rights and uncrystallised rights, including GMP and section 9(2B) rights. It s also a lot easier to value benefits for triviality now. There is no longer a need to revalue any previous BCEs. They are just added together at the value when they were taken (using the different BCE valuation methods), making it MUCH easier to calculate: NO revaluation needed. A winding-up trivial commutation lump sum (which has an 18,000 limit), is very flexible: unlike normal trivial commutation lump sums, a winding up lump can be paid before NMPA and all benefits from other pension schemes can be ignored. 22

24 All these are member benefits. Survivors' pension triviality: Trivial Commutation Lump Sum Death Benefit This extends to defined benefit or defined contribution schemes, payable to survivors on the member's death and can be commuted and paid as a one off lump sum (known as a trivial commutation lump sum death benefit) in some circumstances. This is allowed where the lump sum isn't more than the trivial commutation limit of 30,000 and the lump sum is the full rights under THE scheme (not including anything else it is done per scheme). This ALSO EXTENDS to include the ability to commute the remaining instalments of a guarantee period under a lifetime annuity or scheme pension, if the capitalised value is within the 30,000 limit. Normally, guaranteed payments are taxed as income. They are NOT recognised lump sum payments and any commuted guarantee is effectively taxed as income. That can be a little confusing. There is a key difference between member s triviality which is DB schemes only, and survivor s triviality, which can be money purchase or DB pension scheme benefits when commuting guarantee payments to lump sum. As we ve described, Post-April 2015 the trivial commutation lump sum death benefit rules increase the maximum to 30,000 (per scheme) and amend the circumstances when it can be paid to include the commutation of a lifetime annuity or scheme pension. After April 2015, a trivial commutation lump sum death benefit of up to 30,000 may be paid from either type of scheme. The whole lump sum is taxable as pension income of the dependant or individual entitled to receive it. The pension scheme administrator must apply PAYE to the lump sum payment before paying the lump sum. As the payments are taxable as pension income the rate of tax is the lump sum recipient s marginal rate of tax for the tax year in which the lump sum is paid. So, if the individual is a basic rate taxpayer, the rate is basic rate and if the individual is a higher rate taxpayer the rate is the higher rate applying to the individual. Where the lump sum payment is in respect of a pension already in payment to the dependant or individual, the PAYE code already in operation should be used. 23

25 Small pot rules/triviality Small (stranded) pension pots of up to 10,000 can also be taken as a lump sum. The number of small stranded money purchase personal pension pots that can be taken as a lump sum is three, TOGETHER WITH unlimited stranded/small occupational pots. A defined contribution or defined benefit occupational pension scheme can pay a small /stranded pots trivial commutation lump sum of up to 10,000 if: the member isn't a controlling director (or connected to a controlling director) of the sponsoring employer, the member has reached normal minimum pension age (NMPA) the payment extinguishes the member's entitlement, and there are no transfers out within the last three years (for occupational schemes). Money purchase Personal pensions are also able to commute a pot of up to 10,000: the member has reached age NMPA the payment extinguishes the member's entitlement under the arrangement a payment of this type hasn't been made more than twice before. In both these cases the NMPA applies (now age 55) or, if applicable, early ill-health access. Before April 2015, the earliest age for triviality was 60. The Taxation of triviality and small pots: It is split into two: (1) 25% of the lump sum can be paid tax free and (2) the balance of the fund (75%) is taxed as pension PAYE income with 20% deducted at source. Triviality and small pots are not taxed under the emergency tax month 1 rules, unlike flexible access UFLPS. You will be familiar with the various forms from HMRC [e.g.: P53 for triviality tax overpaid] and can find them here Are trivial payments tested against the lifetime allowance? The payment of any lump sum under small pots pension triviality isn't a BCE and doesn t use up any LTA. Triviality of the larger amount of 30,000, whilst still not a BCE and not tested against LTA, there needs to be available LTA; small pots commutation under triviality requires no LTA. And finally, a nice little TFC types summary sheet. Tax free cash isn t always what it seems, as I am sure you can appreciate at this stage. This table has been adapted from a very useful prudential table; TFC, of some shape or form will appear in almost any and every pension exam. 24