Freedom & choice in pensions: Annuities

Introduction

HMRC has published draft legislation and explanatory notes on pension flexibility and annuities for a technical consultation.

The new provisions are designed to ensure that payments of annuities to beneficiaries can be made tax free on the death of an individual, subject to certain conditions. This extension was first announced in the Autumn Statement 2014 and is one of the last major tax pieces of the flexible DC benefits puzzle.

Key points

From 6 April 2015, “nominees” and “successors” will be able to receive payments of annuities from DC arrangements.
Such annuity payments will be available tax free, subject to certain conditions being met.
The new rules will apply in respect of deaths on or after 3 December 2014 – the date the measure was announced in the Autumn Statement.
The two week technical consultation on the draft legislation closes on 4 March 2015.

Background

As we outlined in our Alert, in the Autumn Statement on 3 December 2014, the Chancellor announced an extension to the new rules for taxing pensions and lump sums on death. The idea is to put payments from annuities on an equal footing with other options for taking DC benefits on and from 6 April 2015.

The changes proposed in the draft Finance Bill (“the Bill”) broadly mirror those made by the Taxation of Pensions Act 2014 in respect of drawdown funds.

Annuities for nominees and successors

Currently, death benefits paid as an annuity can only be paid to a member’s “dependant” under the tax legislation, which is quite narrowly defined. Through the draft Finance Bill, the Government plans to introduce new authorised payments, making it possible to pass on DC annuities to a member’s nominees or successors tax free.

Nominees’ annuities

A nominee is an individual other than a dependant who is nominated by the member or, in the absence of such a nomination, by the scheme trustees. However, an individual nominated by the scheme trustees can only be taken into account as a nominee when the member has no dependants.

An annuity will count as a nominee’s annuity if it is purchased:

as a joint life annuity, together with the member’s lifetime annuity, on or after 6 April 2015 or
after the member’s death, provided the member died on or after 3 December 2014 and the nominee does not become entitled to the annuity before 6 April 2015.

A nominee’s annuity must be payable by an insurance company and be payable until the nominee’s death or until the earliest of their marrying, entering into a civil partnership or dying.

Successors’ annuities

A successor is an individual who has been nominated by a dependant, nominee or successor of a member (“the beneficiary”) or, in the absence of such a nomination, by the scheme trustees. However, an individual nominated by the scheme trustees can only be taken into account as a successor when there is no individual or charity nominated by the beneficiary in relation to the benefits.

A successor’s annuity can only be payable where the beneficiary dies on or after 3 December 2014 and the successor becomes entitled to it on or after 6 April 2015. The annuity must also be purchased using undrawn funds and be payable by an insurance company until the successor’s death or until the earliest of the successor’s marrying, entering into a civil partnership or dying.

Tax free payments?

A key element of the new provisions is that annuities can be passed on to a member’s beneficiaries tax free in certain circumstances. Broadly:

Dependants’ or nominees’ annuities can be paid tax free where the member dies on or after 3 December 2014 but before reaching age 75, and no payment was made to the beneficiary in question before 6 April 2015 in connection with the annuity. Such an annuity can be purchased together with a member’s lifetime annuity or by using undrawn drawdown funds or unused uncrystallised funds. If the annuity is purchased using uncrystallised funds, the entitlement to the annuity must arise within two years beginning with the earlier of the day on which the trustees first knew of the member’s death and the day on which they could first reasonably have been expected to know of the member’s death. Using uncrystallised funds to purchase an annuity in these circumstances, will also trigger a test against the LTA (see below).
Successors’ annuities can be paid tax free where the beneficiary dies on or after 3 December 2014 but before age 75, and no payment is made to the successor before 6 April 2015 in connection with the annuity.
Test against the LTA? The Bill will introduce a new benefit crystallisation event – BCE 5D – triggering a test against a member’s available LTA where the member dies on or after 3 December 2014 and the annuity to which a dependant or nominee becomes entitled on or after 6 April 2015 is purchased using “relevant unused uncrystallised funds” (namely, funds which have not previously been tested against the LTA).

Next steps

Among other things, the draft Bill will amend the Taxation of Pensions Act 2014 and the Income Tax (Earnings and Pensions) Act 2003. The provisions are due to be confirmed in the 2015 Budget on 18 March 2015.

This is a technical consultation to help the Government ensure that the proposed amendments work as intended. There is a very short window for providing comments on the draft legislation – comments must be submitted by 4 March 2015.