Restricting pensions tax relief: the verdict

Introduction

The Government has today published its final plans for the restriction of pensions tax relief. In a move which will come as a relief to many DB scheme members, the revised AA has been set at £50,000 – higher than originally proposed.

The new approach represents a significant improvement, both on the previous Government’s plans and the Coalition’s original proposals. However, the Government is still forging ahead with implementation in April 2011.1

Key points

The AA has been set at £50,000. In what the Government recognises is a “stretching timetable”, it will apply from the tax year 2011/12.
The LTA will also be reduced – to £1.5 million – but from April 2012 to allow a transitional period.
Individuals will continue to receive relief at their marginal rate (up to the AA), not at 40% as proposed in the July consultation.

The new Annual and Lifetime Allowances

The AA limits the amount of tax relief available on pension savings paid by or in respect of an individual to a registered pension scheme. Where pension savings exceed the AA, an AA charge applies.

From April 2011 (when the existing anti-forestalling provisions will fall away), the AA will be £50,000 (and may be indexed after the tax year 2015/16). While this represents a significant reduction on the current AA of £255,000, it is higher than the Coalition’s original proposals for an allowance of between £30,000-£45,000.

Individuals who exceed the AA due to one-off spikes in accrual will be able to set-off excess contributions against unused allowance from up to three years previous. The Government will also consult in November on options to enable tax charges to be met out of an individual’s pension.

A reduced LTA of £1.5 million (down from the current £1.8 million) will complement the new AA, with transitional protection for those whose savings are based on the current LTA.

Valuing DB accrual

Central to the reduced AA is the need to value pension scheme contributions over the “pension input period” (PIP).2 While relatively straightforward for DC, DB benefits require a factor to measure “deemed contributions”.

The current flat factor of 10 will be increased to 16 from April 2011. Although a big jump, it is at the lower end of the Government’s proposed range of 15-20. In practice, this broadly means that an increase in annual pension benefit of £1,000, would be deemed to be worth £16,000. For now, there is no change in the current LTA factor of 20, but the Government will continue to monitor this.

Deferred benefits will be excluded from the AA calculation, but additional accrual will take account of any link to final salary benefits in a closed scheme. An allowance for revaluation of accrued rights for active members will be made and negative accruals will continue to be treated as zero.

Transitional provisions will protect individuals whose PIP for the tax year 2011/12 has already begun and who would otherwise be caught by the new AA. However, the Government has abandoned plans to align the PIP with the tax year.

Some exceptions

As mooted in the consultation, benefits on serious (terminal) ill-health will be exempt from the new AA. The Government also plans to consult later in the year on a possible exemption for ill-health benefits generally, a key concern being to manage risks of avoidance.

However, there will be no exemption for benefits payable on redundancy, for individuals claiming enhanced protection, or in the year when benefits come into payment.

Additional changes

Aiming off the AA

The Government intends that schemes should be able to make changes to their benefit structures, so that few people will face charges for exceeding the AA. Smoothing of pensionable pay and accruals will be permitted before benefits are put into payment, subject to anti-avoidance measures to prevent the manipulation of benefits to avoid payment of tax properly due.

The Government will liaise with the DWP to ensure that all schemes can smooth benefits in this way. This suggests an easement may be on the cards, to help those whose amendment powers would otherwise prevent such changes being made.

Information requirements

Schemes will need to provide information to members on their pension input amount if they have individuals who have made contributions above the AA. Individuals who have not exceeded the AA will need to request this information, with an entitlement to one such request free of charge in each tax year.

Employers of DB schemes will also be required to provide details about employees’ pensionable pay and benefits, together with length of service, to trustees by 6th July following the end of the relevant tax year.

Draft regulations on the information requirements are expected to be published in early 2011.

Alternative arrangements

In order to prevent a mass exodus to unregistered pension saving arrangements such as EFRBS and other EBTs, the Government will include draft legislation in the 2011 Finance Bill to “ensure that funded EFRBS are less attractive than other forms of remuneration”.

What next?

The Government estimates that 100,000 pension savers will be affected by the drastic reduction in the AA, and that this measure should generate around £4 billion annual revenue. This is comparable to the revenue which Labour’s plans were predicted to achieve,3 the Government’s overriding objective in putting forward its alternative approach.

With a higher AA than originally proposed and a revaluation factor at the lower end of the Government’s proposed range, wholesale scheme re-design may not be needed in many cases. However, employers will need to identify as soon as possible those individuals with accrual that would regularly take them above the AA and consider possible alternatives.

Provisions to enact the reduced AA and LTA will be included in the Finance Bill 2011.

1 For more information, see our Alert: “Restricting pensions tax relief: The Coalition’s alternative approach” dated 29 July 2010
2 This is the period over which pension savings are assessed for the purposes of testing against the AA
3 For more information, see our Alert: “Scant relief for pensions in Darling’s pre-election Budget” dated 25 March 2010