Annual Allowance charge payment option confirmed

Introduction

The reduced AA of £50,000 from the tax year 2011/12 will inevitably affect a greater number of pension savers than the current AA of £255,000. Following aconsultation 1 in the autumn, the Government has now set out how affected members will be able to meet high AA charges from their pension savings.

Key points

Pension scheme members will be required to pay AA charges at the point when they arise.
It will be possible for AA charges to be met from all types of scheme, subject to an eligibility threshold of £2,000.
The facility to meet AA charges from schemes will apply in connection with charges arising in the tax year 2011/12 and beyond.

Background

As a result of the reduced AA, potentially far more pension savers will be subject to an AA charge. To help affected individuals manage this cost, the consultation looked at the possibility of allowing the AA charge to be met by an individual’s nominated pension arrangement, either by:

meeting the liability “in real time” while pension benefits are still accruing (i.e. following the tax year in which the charge arises); or
rolling-up the liability, so that payment of AA charges is deferred until the individual’s pension benefits crystallise.

On 3 March 2011, the Government announced in a Written Ministerial Statement that where AA charges are met from pension benefits, the tax should be paid at the point the charge arises.2

Eligibility

The Government expects that most individuals and schemes will adapt their pension savings behaviour to avoid incurring a charge by exceeding the AA. However, for DB scheme members in particular, pay rises may result in a much greater increase in pension accrual than anticipated.

As such, the eligibility threshold for meeting AA charges from pension savings will be set at £2,000 – the lowest end of the range originally proposed in the consultation.3 This threshold applies to total pension savings across all schemes.

Obligations on schemes

Although it will be open to all schemes to offer a facility for meeting high AA charges from pension savings, it will be mandatory for a scheme to do so where a member’s pension savings in that particular scheme exceed the AA in any given year. The consultation suggests that, in these circumstances, the scheme must offer the “scheme pays” facility “free of charge”.

Individuals incurring an AA tax charge of more than £2,000 as a result of pension savings across several pension schemes (but without having exceeded the AA in any one scheme), will be able to request that one of their schemes operates the facility to pay the charge. However, in this situation, no scheme will be required to offer this facility or to pay any AA charge.

Design and implementation

Schemes will have flexibility to set the terms on which they offset AA charges through reductions to pension benefits, as well as their terms of engagement with individuals. This will allow them to set their own timetable, subject to overarching time limits (see below).

For DC schemes, the calculation is expected to be relatively straightforward, with the payment of a cash amount equal to the AA charge to be taken from the member’s pension pot. In DB schemes, trustees will be responsible (on actuarial advice) for ensuring that any offsetting adjustment “delivers a just and reasonable outcome to that individual and to other scheme members”.

Overarching time limits

A member will report any AA charge, and the amount they wish to have paid by their scheme, using their Self Assessment (SA) tax return. The member will then have until 31 July following the relevant SA deadline to make an irrevocable election for the scheme to pay the tax charge.

Any AA charges due will be payable by scheme trustees using the Accounting for Tax (AFT) return the following December. However, to ensure that trustees have time to engage with individuals on the basis of accurate information, in the first year schemes will be able to use the March 2014 AFT return.

Individuals approaching retirement will need to make an election for a scheme to pay their charge before their benefits crystallise. An adjustment to account for the AA charge will then be made before the pension is put into payment, any tax-free lump sum is calculated or any annuity purchased.

Exemptions

Schemes which have entered a PPF assessment period will be exempt from offering the facility to pay the AA charge, as will those schemes which enter a PPF assessment period after an individual has elected to meet their AA charge from their pension benefits but before the scheme has been able to process it.

There will be no general exemption for schemes which are underfunded. The Government considers that most schemes which are funding for high benefits will be in a position to meet the charge. However, legislation will allow an exemption in “exceptional circumstances”, where trustees are able to demonstrate to HMRC that offering such a facility would “detrimentally affect the overall health of the scheme to a substantial extent”.

Next Steps

The draft clauses published alongside the Government’s consultation response are subject to informal consultation until 17 March 2011, and will be published as part of the full Finance Bill on 31 March 2011. HMRC also intends to produce guidance for individuals.

1 Published on 30 November 2010
2 The statement was accompanied by the Government’s formal consultation response, as well as draft legislation, a draft explanatory note and a revised Tax Impact and Information Note from HMRC
3 The consultation proposed a de minimis threshold in the range of £2,000 – £6,000