Restriction of pensions tax relief: further developments

Introduction

When the Government published its final plans for restricting pensions tax relief on 14 October 20101, the headline issue was the significant reduction in the AA from £255,000 to £50,000 from the tax year 2011/12. However, following a pre-Christmas splurge in new consultations, we now have a clearer picture of how the restrictions will work in practice.

In this Alert:

• Key points
• Finance Bill 2011
• Who is already affected by the reduced AA?
• LTA protections
• Consultation on high AA charges
• Conclusion

Key points

• The new AA provisions will be enacted in the Finance Bill 2011. Revised draft clauses were published on 9 December 2010, alongside draft guidance for individuals.
• Although legislation to enact the reduced AA will only come into force when the Bill receives Royal Assent, some pension scheme members may already be affected by the change.
• With the LTA set to be reduced back down to £1.5 million from 6 April 2012, a recent Ministerial Statement has revealed details of a limited protection which will be available to individuals whose pension savings have been built around an LTA of £1.8 million.
• The Government is consulting on options for paying high AA charges from members’ pension arrangements.

Finance Bill 2011

As announced in the Government’s response to consultation on 14 October 2010, the AA is to be reduced from £255,000 to £50,000 by legislation to be included in the Finance Bill 2011. In addition, the LTA will be reduced from 2012 from £1.8 to £1.5 million.

On 9 December 2010, the Treasury published draft clauses and explanatory notes for the Finance Bill 2011, alongside an overview of the draft legislation anddraft guidance. The full Finance Bill 2011 is due to be published on 31 March.

Who is already affected by the reduced AA?

Pension input periods

A PIP is the period over which pension savings are assessed in an arrangement for the purposes of testing against the AA. PIPs need not correspond with the tax year and can instead match the scheme year. However, there must be a PIP ending in each tax year.

As different PIPs can apply to different pension arrangements, an individual who is a member of more than one arrangement could have several PIPs. When testing against the AA, an individual’s pension savings across all PIPs ending in the relevant tax year will need to be considered (and reflected in their tax return).

Recognising that the PIP ending in the tax year 2011/12 may already have begun in some pension arrangements, the Government will include transitional rules in the Finance Bill.

Transitional provisions

PIPs ending in 2011/12 that begin on or after 14 October 2010 will be subject to the AA of £50,000. However, where a PIP ending in 2011/12 started before 14 October 2010, under the transitional rules:

• the AA of £50,000 will apply to an individual’s pension savings from 14 October 2010 until the end of the current PIP; and
• an individual’s maximum tax relievable pension savings across all PIPs ending in 2011/12 (whether accrued before or after 14 October) will be £255,000.

HMRC’s guidance for individuals sets out some examples of how this will operate in practice.

Changing the PIP?

Although the concept of a PIP has been with us since A-Day (6 April 2006), the prospect of a significantly reduced AA has made the possibility of changing it (for example, to align it to the tax year) one of the hot topics for trustees. For more information as to how the PIP works, please see our Alert: “Pension Input Periods” dated 28 March 2007. Recent Guidance from HMRC explains that, in schemes where no PIP has been nominated, a retrospective nomination can be made (although the ability to do so looks set to disappear from 6 April 2011). However, schemes which have already nominated a PIP in a particular tax year will not be able to change it.

Care needs to be taken when considering changing a PIP as this could affect an individual’s tax liability (as a result of contributions or benefit accrual falling within a different tax year).

LTA protections

On 9 December, a Ministerial Statement announced 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. Those potentially affected will be able to apply for “fixed protection”, enabling them to keep an LTA of £1.8m. In exchange, an individual 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 who are already entitled to primary protection and/or enhanced protection will continue to receive their current levels of protection (but will not be able to apply for fixed protection as well).

Consultation on high AA charges

The reduced AA will inevitably affect a greater number of pension savers than before. Generally, those caught will be the highest earners, but also potentially affected are DB scheme members with long service and/or a generous accrual rate in their scheme.

The Government anticipates that most individuals and employers will want to adapt their pension savings behaviour to ensure that pension contributions (or “deemed contributions” in DB schemes) remain below the new AA. However, its latest consultation (which closes on 7 January 2011) looks at ways of facilitating payment of the AA charge for those who are subject to it.

The options

Two broad options (aimed primarily at DB schemes) are put forward in the consultation for meeting AA charges from pension benefits. These would permit 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
• by rolling-up the liability, so that payment of AA charges is deferred until the individual’s pension benefits crystallise.

It is intended that the AA charge will not be met from a scheme before a certain threshold is reached; the consultation suggests this will be in the region of £2,000 – £6,000.

Also being considered

Other issues covered in the consultation include:

• whether individuals in DC schemes would have need of and/or make use of a facility to meet AA charges from pension benefits; and
• the treatment of individuals who are members of more than one pension scheme – the consultation proposes that individuals be permitted to elect a single scheme to pay the charge.

Conclusion

With so little time left before the new tax relief changes take effect, employers are no doubt busy identifying individuals potentially affected by the change in the AA to allow future saving plans to be considered. Trustees also need to consider communicating with members whose current PIP ends in the 2011/12 tax year to ensure that any risk of incurring high AA charges can be addressed without delay.

1 For more information, please see our Alert: “Restricting pensions tax relief: the verdict” dated 14 October 2010