The Finance Bill rides again

Introduction

The third Finance Bill of the 2010/11 Parliamentary session was formally published on 31 March 2011, and will ultimately implement the Coalition Government’s plans for restricting pensions tax relief which were first announced on 14 October 2010. These include the reduction of both the AA to £50,000 and the LTA to £1.5 million.1

In this Alert:

• Key points
• The New Annual and Lifetime Allowances
• Dealing with high accrual
• Pension Input Periods
• Disguised remuneration
• Changes to benefits available under pension schemes
• Next steps?

Key points

• As anticipated, the reduced AA of £50,000 is to take effect from the tax year 2011/12, while the new lower LTA will come into effect in April 2012.
• A number of measures for dealing with high accrual, including carry forward provisions and the ability to pay charges from pension benefits, are covered.
• The Bill will also amend the requirements relating to PIPs so that, going forward, the default end date will be aligned with the tax year.

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 in any tax year. Where pension savings exceed the AA, an AA charge applies.

From April 2011 (when existing “anti-forestalling provisions”2 will fall away), the AA will be £50,000. The Bill will increase the factor used for measuring “deemed” contributions to DB schemes (for the purposes of testing against the AA), from 10 to 16.3

The LTA will be reduced from 6 April 2012 from £1.8 to £1.5 million. The Bill also includes a new protection regime for individuals who may already have built up pension savings in the expectation that the LTA would remain at its current level of £1.8m. Individuals in this category will be able to apply for “fixed protection” by 5 April 2012, enabling them to keep an LTA of £1.8m. But they will no longer be able to contribute actively to a DC arrangement, or build up additional pension above an allowable “relevant percentage” in a registered DB or cash balance scheme.

Individuals already entitled to primary protection and/or enhanced protection will continue to receive their current levels of protection, but will not be eligible to apply for fixed protection.

Dealing with high accrual

At its original level4 the AA had limited impact, generally affecting only the highest earners. Now, however, far more pension savers will potentially be affected.

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.

For those who experience occasional spikes in accrual, for example, as a result of a significant pay rise or redundancy payment paid into their pension scheme, the Bill incorporates new carry forward provisions. These are designed to enable pension scheme members to set off excess pension savings against unused allowance in the last three tax years.

The Bill also includes provisions to allow members to pay AA charges from their pension benefits, subject to an eligibility threshold of £2,000.5

Pension Input Periods

PIPs have been an area of concern since the announcement of the reduced AA in October 2010.6

A PIP is used to assess annual increases in the value of members’ pension savings for the purpose of testing against the AA. Increases are measured against the AA for the tax year in which the PIP ends.

For PIPs ending in the tax year 2011/12 which began on or after 14 October 2010, the AA of £50,000 will apply. PIPs ending in 2011/12 which started before 14 October 2010 are subject to transitional rules. This means that many individuals will already be affected by the reduced AA.

Due to a quirk in the drafting of the Finance Act 2004, where trustees of DB or cash balance schemes in existence at A-Day (6 April 2006) have not nominated their own PIP, the scheme will generally have a default PIP ending on 6 April (i.e. in the 2011/12 tax year).

To address concerns raised by different industry bodies, the Bill proposes an amendment to the Act to align default PIPs with the tax year. Although this change is only due to come into effect after the Bill receives Royal Assent, it is likely to simplify administration going forward for those in the default position. As before, it remains open to trustees (or trustees / members in DC arrangements) to nominate their own PIP (but not retrospectively once the Bill receives Royal Assent).

Disguised remuneration

In a bid to prevent tax avoidance, the Bill includes provisions which are aimed at tackling “arrangements involving trusts and other vehicles to avoid, reduce, or defer liabilities to income tax on rewards of an employment or to avoid restrictions on pensions tax relief”.

The Government has already confirmed that EFRBS will be caught here. However, as the Bill’s provisions are widely drafted, certain unfunded pension arrangements may also be in the frame.

Changes to benefits available under pension schemes

Also included in the Bill are provisions to deal with the cessation of compulsory annuitisation at age 75.

From 6 April 2011, individuals with DC pension funds will no longer be required to purchase an annuity before the age of 75. Capped drawdown7 will be available to anyone over the age of 55, with individuals who satisfy a “Minimum Income Requirement” (MIR) able to draw down unlimited amounts from their pension pots. The purpose of the MIR is to ensure that individuals have sufficient secured income to avoid the possibility of them “exhausting savings prematurely”, and subsequently falling back on the State. The MIR will initially be set at £20,000 and will be reviewed at least every five years.

Finally, with effect from 6 April 2011, most of the rules preventing registered pension schemes from paying lump sums to members who have reached the age of 75, such as pension commencement lump sums, will be removed.

Next steps?

The Bill is widely expected to receive Royal Assent in July. But the Bill becoming an Act may be just the beginning, as we can undoubtedly expect regulations and guidance to follow.

1 Please see our Alert: “Restricting pensions tax relief: the verdict” dated 14 October 2010
2 Please see our Alert: “Finance Act 2009 – This time it’s personal” dated 24 July 2009
3 In practice, this broadly means that an increase in annual pension benefit of £1,000 would be deemed to be worth £16,000
4 £255,000 in the tax year 2010/11
5 Please see our Alert: “Annual Allowance charge payment option confirmed” dated 8 March 2011
6 Please see our Alert: “The perils of Pension Input Periods” dated 16 February 2011
7 The cap will be set at 100% of the equivalent annuity, broadly the single-life level annuity that could have been bought with the pension fund using annuity rates set by GAD, and will be subject to review