Summer Budget 2015 Changes to Pension Taxation Webinar 16 July 2015
Introductions Paul Darlow is the Head of Proposition Development at Xafinity Steve Hobbs is an actuary, and one of our leading experts on the Annual and Lifetime Allowances 1
Agenda for Today 1. The Lifetime Allowance ( LTA ) a) Recap b) Latest changes c) Implications and considerations 2. The Annual Allowance ( AA ) a) Recap b) Latest changes c) Implications and considerations 3. Suggested actions 2
Agenda Item 1a The Lifetime Allowance - Recap 3
The Lifetime Allowance (LTA) A limit on the pension benefits that can be built up by an individual across his or her lifetime without being liable for a Lifetime Allowance tax charge. LTA is currently 1.25 million. Individuals can earn benefits in excess of the LTA, but they will be subject to a tax charge on any benefits in excess of the LTA. Excess A tax charge will fall due on these excess benefits Total value of benefits Lifetime Allowance 4
How the LTA tax charge is calculated Subject to scheme Rules, excess benefits can be paid as a cash lump sum rather than pension. Where excess benefits are paid as a cash sum they will be subject to a 55% tax charge. If excess benefits are paid as pension they will be subject to a 25% tax charge upfront. They will also be subject to income tax when paid: For a member who is a 40% tax payer in retirement the total effective tax rate on excess benefits taken as pension is 1 (1-25%) * (1-40%) = 55% Upfront 25% tax charge Income tax on receipt 5
How benefits are valued against the LTA Defined benefit Each 1 of pension is valued at 20 Each 1 of cash is valued at face value Defined contribution Funds are taken at market value Benefit received by member Cash lump sum of 300,000 from DB Scheme Residual DB pension of 50,000 p.a. DC fund of 200,000 + + Face Value X 20 Face Value Value on Lifetime Allowance Test 300,000 + 1,000,000 1,500,000 + 200,000 6
Agenda Item 1b The Lifetime Allowance - Most recent changes 7
Changes to the Lifetime Allowance Lifetime Allowance ( ) 2,000,000 1,800,000 1,600,000 1,400,000 1,200,000 1,000,000 800,000 600,000 400,000 200,000 - CPI increases from April 2018 Protection options are to be introduced for members who were planning on utilising an LTA of 1.25 million. Details are awaited. 8
Bringing it all together LTA Example Benefit received by member Cash lump sum of 300,000 from DB Scheme Residual DB pension of 50,000 p.a. DC fund of 200,000 + + Face Value X 20 Face Value Value on Lifetime Allowance Test 300,000 + 1,000,000 + 200,000 Value of 1,500,000 This is 500,000 above the new LTA Unless Protection is held a penal tax charge will fall due on 500,000 of excess benefits If excess benefits are taken as cash a tax charge of 55% is due. The Administrator would pay a tax charge of around 275,000 1 (55% * 500,000) to HMRC and 225,500 1 (45% * 500,000) to the member. 1 The actual mechanics are complex and depend on decisions taken by the Scheme s Trustees. This is a simplified description and illustration. 9
Agenda Item 1c The Lifetime Allowance - Implications 10
Who will be impacted by the new LTA? LTA 1 million DB pension 50,000 p.a. DC pot 1,000,000 65 year old with salary 100,000 and 30 years service in a 1/60 th scheme 65 year old with salary 150,000 and 20 years service in a 1/60 th scheme 50 year old with deferred pension currently 32,000. Likely to be worth 1,000,000 by age 65 A 25 year old with 30,000 salary and 10% contributions (on average) each year until 65* A pot of 600,000 at age 55 could become: 1.1 million at age 65 1.4 million at age 70 with no further contributions* * Assuming 6% p.a. investment growth 11
Implications Members Trustees Sponsors Need to understand whether impacted or not (and when) The need to make members aware and answer questions Pensions not an efficient way of remunerating senior employees Suffer a reduction in benefit expectations (if impacted) May take action to reduce the impact: Take benefits early Maximise tax-free cash Cease accrual Stop paying AVCs Take Protection (where available) Updating booklets etc Operating additional Protection regimes Factors and procedures for paying the tax PIE at retirement less attractive to members (higher initial pension = higher LTA value) DB to DC transfers unappealing from an LTA perspective Money being paid to HMRC as tax could otherwise be used to increase member benefits, increase benefit security, or reduce company costs 12
Agenda Item 2a The Annual Allowance - Recap 13
The Annual Allowance (AA) A limit on the pension benefits that can be built up by an individual in any one year ( Pension Input Period or PIP ) without incurring an Annual Allowance tax charge. AA is currently 40,000. (Although a reduced Money Purchase Annual Allowance of 10,000 applies if members flexibly access benefits.) Individuals can earn benefits in excess of the AA, but they will be subject to a tax charge on any benefits in excess of the AA. Value of benefits earned in the year Pension Input Amount Annual Allowance Excess A tax charge will fall due on this excess accrual unless they have sufficient carry-forward of unused Annual Allowance 14
Carry Forward Carry Forward Unused AA from last 3 tax years can be carried forward 2013/14 AA = 50k PIA = 46k 2012/13 AA = 50k PIA = 40k 2011/12 AA = 50k PIA = 36k Unused = 4k Unused = 10k Unused = 14k Total carry forward amount into 2014 / 2015 = 28k Many high earners will already have exhausted their carry forward, but lower paid members who breach the AA due to a promotion could well benefit 15
How the AA tax charge is calculated Excess accrual treated as income, and subject to income tax. Tax charge can either be paid: by the member (BUT this would be paid out of post-tax income), or by the pension scheme (in which case the scheme would reduce the member s benefits by an amount equal in value to the tax due Scheme Pays ). 16
How benefits are valued against the AA Defined benefit Step 1 Calculate the value of benefits at the start of the year/pip, and allow for inflationary increases over the year (A) = Pension at start of year x 16 x inflationary increase over the year Step 2 Calculate the value of benefits at the end of the year, allowing for additional accrual and salary increases over the year (B) = Pension at end of year x 16 Defined contribution Contributions paid (both employee and employer contributions) Step 3 Pension Input Amount = (B) (A) An example of how this works in a DB scheme is shown on the next slide 17
Example Member A (significant promotion) Step 1 - Calculate the value of benefits at the start of the year, and allow for inflationary increases over the year 20/50 th (service / accrual) 60,000 (salary) 1.03 (inflation) Defined Benefit pension of 24,720 Defined Benefit pension of 24,720 16 (valuation factor) Pension value of 395,520 Step 2 Calculate the value of benefits at the end of the year 21/50 th 70,000 Defined Benefit pension of 29,400 Defined Benefit pension of 29,400 16 Pension value of 470,400 Step 3 Pension Input Amount = 470,400-395,520 = 74,880 18
Example Member B (high earner, long service) Step 1 - Calculate the value of benefits at the start of the year, and allow for inflationary increases over the year 30/50 th 125,000 1.03 Defined Benefit pension of 77,250 Defined Benefit pension of 77,250 16 Pension value of 1,236,000 Step 2 Calculate the value of benefits at the end of the year 31/50 th 132,000 Defined Benefit pension of 81,840 Defined Benefit pension of 81,840 16 Pension value of 1,309,440 Step 3 Pension Input Amount = 1,309,440-1,236,000 = 73,440 19
Agenda Item 2b The Annual Allowance - Most recent changes 20
Changes to the AA (1 of 2) Income (excluding pension contributions) Impacted by the changes? Details of the changes < 110,000 No Between 110,000 and 150,000 Possibly > 150,000 Yes No change Annual Allowance remains at 40,000 Need to calculate income including pension contributions (employer and employee) Adjusted Income If Adjusted Income > 150,000 then 1 of AA is lost for each 2 of Adjusted Income in excess of 150,000 (AA has a floor of 10,000) 1 of AA is lost for each 2 of Adjusted Income in excess of 150,000 (AA has a floor of 10,000) To calculate Adjusted Income, DB members need to include the Pension Input Amount (as employer and employee contributions ) 21
Changes to the AA (2 of 2) 45,000 40,000 35,000 Annual Allowance ( ) 30,000 25,000 20,000 15,000 10,000 5,000 0 130000 133000 136000 139000 142000 145000 148000 151000 154000 157000 160000 163000 166000 169000 172000 175000 178000 181000 184000 187000 190000 193000 196000 199000 202000 205000 208000 211000 214000 217000 220000 223000 226000 229000 Adjusted Income = Income plus pension contributions ( ) 22
Example Revisiting Member B (1 of 2) Step 1 - Calculate the value of benefits at the start of the year, and allow for inflationary increases over the year 30/50 th 125,000 1.03 Defined Benefit pension of 77,250 Defined Benefit pension of 77,250 16 Pension value of 1,236,000 Step 2 Calculate the value of benefits at the end of the year 31/50 th 132,000 Defined Benefit pension of 81,840 Defined Benefit pension of 81,840 16 Pension value of 1,309,440 Step 3 Pension Input Amount = 1,309,440-1,236,000 = 73,440 23
Example Revisiting Member B (2 of 2) Income 132,000 Pension Input Amount 73,440 Adjusted Income 205,440 Adjusted Income 205,440 Income Threshold 150,000 Adjusted Income over Threshold 55,440 Annual Allowance 40,000 Adjusted Income over Threshold 55,440 / 2 Tapered Annual Allowance 12,280 Pension Input Amount 73,440 Tapered Annual Allowance 12,280 Excess Accrual 61,160 If no carry-forward is available, a tax charge is due on Excess Accrual of 61,160 24
Changes to Pension Input Periods From 5 th April 2016, all Pension Input Periods will run in line with the tax year. Transitional provisions have been introduced PIP open on 8 th July 2015 New mini-pip for remainder of 2015/16 tax year Start of previous PIP 8 th July 2015 5 th April 2016 Annual Allowance of up to 40,000 Annual Allowance of up to 40,000 This provides individuals with the opportunity to make additional pension contributions before the reduced allowances come into force They may be able to pay up to 80,000 plus any available carry-forward in tax year 2015/16 25
Agenda Item 2c The Annual Allowance - Implications 26
Implications Members Trustees Sponsors Need to understand whether impacted or not (and when) complicated! Suffer a reduction in benefit expectations (if impacted) May take action to reduce the impact: Utilise carry-forward Stop paying AVCs Cease accrual Short-term opportunity to pay additional contributions? The need to make members aware and answer questions Updating booklets etc Additional administrative complexity of operating Scheme Pays Additional reporting requirements Pensions not an efficient way of remunerating senior employees Pay rises and promotions can cause unexpected tax charges (that can be very large) Money being paid to HMRC as tax could otherwise be used to increase member benefits, increase benefit security, or reduce company costs 27
Agenda Item 3 The Annual and Lifetime Allowances - Suggested actions 28
Suggested actions Trustees Sponsors July / August 2015 Thereafter Understand high-level impact: Number of people impacted now, and in the future, in different scenarios Expected amount of tax payable Scope out practical implications and options for this group Communicate with members Update member booklets and other Scheme documentation as appropriate Consider pension strategy for high earners Revisit (or put in place) scheme policy regarding factors to reduce members benefits (when paying tax to HMRC) Be mindful of the specific tax implications of liability management exercises for high earners 29
Questions? 30
Close A recording of this webinar (together with a copy of these slides and Q&A document) will be made available on www.xafinity.com shortly we will email you when available Your usual Xafinity consultant would be delighted to answer any supplementary questions Or please feel free to contact one of us Paul Darlow paul.darlow@xafinityconsulting.com Telephone: 0118 918 5525 Steve Hobbs steven.hobbs@xafinityconsulting.com Telephone: 0118 918 5423 31