unravelling tax simplification: benefit crystallisation events

Transcription

1 FEBRUARY 2005 countdown to A-day time to make it simple unravelling tax simplification: benefit crystallisation events Here we give information about benefit crystallisation events and how they will be used from 6 April 2006 (A-day). The Finance Act 2004 sets out the basis of the Inland Revenue s new pensions tax regime. Further details will be set out in regulations and guidance, which we expect to become available later this year. This communication is directed at professional financial advisers. It should not be distributed to, or relied upon by, private customers. contents why are they being introduced? what are they? how will this work in practice? are there any rules to prevent benefits being double-counted? some current irregularities action

2 why are they being introduced? When benefits under a registered scheme come into payment for any reason, including lump sums payable on death, they must be tested against the lifetime allowance. Any event which results in payment of a benefit is known as a benefit crystallisation event. Benefit crystallisation events will generally only happen before an individual reaches age 75. The only exception is if an individual s pension payment is increased (after age 75) by more than an allowable level (known as the permitted margin ). An individual could have several benefit crystallisation events throughout their working life. The benefit crystallisation framework is designed to make sure that the lifetime allowance is applied to the total of an individual s benefits across all registered schemes. Pension benefits already in payment before A-day will also be taken into account and this is covered in the summary unravelling tax simplification: valuing pension benefits. This summary looks at the different types of benefit crystallisation events and how they will trigger checks against the lifetime allowance. You should read it together with other summaries: unravelling tax simplification: taking pension benefits this focuses on what the lifetime allowance means, when a lifetime allowance charge could arise and the different types of pension benefits available from A-day. unravelling tax simplification: valuing pension benefits this discusses how all pension benefits are valued for testing against the lifetime allowance. what are they? The Inland Revenue has identified eight different types of benefit crystallisation event and defined how benefits should be valued (crystallised) on each event for testing against the lifetime allowance. The eight events are summarised in the following table. Benefit crystallisation event 1. Movement of money or assets held under a money purchase arrangement into unsecured pension (drawdown and, where offered, short-term annuities). 2. When an individual becomes entitled to a scheme pension. 3. A scheme pension already in payment is increased above the permitted margin. (In most cases this is the original level of pension increased by 5% or the Retail Prices Index (whichever is higher).) 4. An individual becomes entitled to buy a lifetime annuity under a money purchase arrangement. 5. An individual reaches age 75 and has a future entitlement to receive a pension and/or a lump sum under a defined benefits arrangement. Crystallised amount The total value of the amount moved into unsecured pension. Any assets moved will be valued at market value. 20 times the pension payable to the individual in the first year. The Inland Revenue and the scheme administrator may agree a higher valuation factor than times the excess pension arising from this increase. The total amount of the individual s rights under the arrangement used to buy the lifetime annuity. Any assets used will be valued at market value. 20 times the pension, plus the lump sum the individual would be entitled to if these benefits were taken at age 75.

3 Benefit crystallisation event (continued) 6. Payment of a relevant cash lump sum (other than on death) before age 75. This could either be a lump sum payable: when the individual becomes entitled to pension benefits in place of pension benefits for an individual in serious ill-health for an individual with no remaining lifetime allowance 7. Payment of a lump sum death benefit (both insured death benefits or a return of funds under any money purchase arrangement), where: the individual died before age 75 and the lump sum is payable within two years of the individual s death Crystallised amount (continued) The amount of the lump sum. The amount of the lump sum death benefit. how will this work in practice? Each time one of the above events happens, the crystallised amount will need to be tested against the individual s lifetime allowance. This test is generally carried out by the scheme administrator or scheme trustees and the Inland Revenue reporting framework has been designed to cater for this. The lifetime allowance is not a limit; benefits above the allowance can be paid but the excess will be subject to a lifetime allowance charge. This is covered in more detail in the summary unravelling tax simplification: taking pension benefits. For an individual who has been a member of only one registered scheme and for whom all benefits are paid at the same time on or after A-day (either on death or retirement), the comparison against the lifetime allowance will be fairly straightforward. But, where an individual takes benefits in stages on or after A-day, whether from one or more registered schemes, the comparison against the lifetime allowance gets more complicated. Each benefit crystallisation event will use up some of the individual s lifetime allowance, leaving less against which the remaining benefits can be tested. The summary unravelling tax simplification: valuing pension benefits covers this in more detail. 8. Payment of a transfer value to a recognised overseas pension scheme. (The conditions a scheme must meet to qualify as a recognised overseas pension scheme are being defined in regulations.) The amount transferred. Any assets transferred will be valued at market value.

4 are there any rules to prevent benefits being double-counted? The good news is, yes. The Inland Revenue has recognised that more than one of these events can take place in an individual s lifetime and has introduced prevention of overlap rules to avoid the same benefits being double-counted under different benefit crystallisation events. The situations which could most commonly lead to overlaps are: initial move to an unsecured pension and later purchase of a lifetime annuity initial move to an unsecured pension and later transfer to a recognised overseas pension scheme transfer to a recognised overseas pension scheme and later payment of pension from the amount transferred The prevention of overlap rules would apply in a similar way in all of the above cases to prevent the value of the first benefit crystallisation event also being taken into account when assessing the second benefit crystallisation event arising from the same layer of benefits. For example, if an individual takes tax-free cash and moves the balance of their fund into an unsecured pension, the benefits would initially be assessed under benefit crystallisation events six and one respectively. If the individual then purchases a lifetime annuity from the same fund, benefit crystallisation event four would apply. To avoid any overlap of values between benefits, the prevention of overlap rules would make sure that the amount already crystallised from the same assets for the unsecured pension move is deducted from the amount crystallised for the lifetime annuity purchase before being tested against the lifetime annuity purchase. The following example may help explain how this will work. Mr Andrews moves 500,000 into an unsecured pension in April 2007 and this value is tested against his lifetime allowance at that time using benefit crystallisation event one. When he buys a lifetime annuity in 2010 his fund has grown to 750,000. As 500,000 of this money has previously been tested, only the balance of 250,000 will be tested against his remaining lifetime allowance. The Inland Revenue has no current intention, under the prevention of overlap rules, to allow original benefits set up from the same assets to be revalued in proportion to the increase in the lifetime allowance. The situation would be different if the second benefit crystallisation event was for a different layer of benefits. some current irregularities With such a radical change in the tax laws and the introduction of so many new options, rules and terminology, it is perhaps inevitable that a few inconsistencies will emerge. Some which you may wish to keep an eye on are: The treatment of a move to an alternatively secured pension from an unsecured pension. Unlike a move from an unsecured pension to a lifetime annuity, which would require another check against the lifetime allowance, there appears to be no further check against the lifetime allowance on a similar move to an alternatively secured pension. Similarly, if an individual in a money purchase arrangement doesn t take benefits, reaches age 75, and then moves into an alternatively secured pension, they do not seem to be caught by any benefit crystallisation event, other than taking a lump sum benefit. This is unlikely to be intentional.

5 For someone in a defined benefit arrangement the amount of tax-free cash taken and the scheme commutation factor can affect the value of the amount crystallised. An example may help: Mr Brown is due to receive a pension of 90,000 from his defined benefit arrangement in January Valuing this purely as income would mean that the fund to be tested against the lifetime allowance would be 1.8 million (20 x 90,000). This would result in an excess of 300,000 above the 1.5 million lifetime allowance, against which a lifetime allowance charge would be due (25% if taken as income, 55% if taken as cash). action Having a clear understanding of the interaction of the benefit crystallisation events and the lifetime allowance will be increasingly important as you help guide your clients through the new simplified rules after A-day. This factsheet represents Scottish Equitable s understanding of the Finance Act But, if Mr Brown takes a cash lump sum of 450,000 (tax free) and the scheme commutation factor is 12:1 then the pension he receives would reduce to 52,500. The total value of this pension plus cash combination to be tested against the lifetime allowance reduces to 1.5 million ((20 x 52,500) + 450,000), resulting in no lifetime allowance charge. Scottish Equitable plc, Registered Office: Edinburgh Park, Edinburgh EH12 9SE. Registered in Scotland (No ). Authorised and regulated by the Financial Services Authority. GD/9901 GEN/07173/02/05