Restricting pensions tax relief: Sackers’ response to consultation

Background

HMRC and HMT published a consultation on 9 December 2009 on the proposal to restrict pensions tax relief for high earners from 6 April 2011 (the Consultation).

From 2011, the Government’s intention is that tax relief on pension savings will be restricted for those earning £150,000 or more.  Relief will be tapered away (the Taper) so that those earning £180,000 or over will receive tax relief of 20% on their pension savings (the same as for a basic rate tax payer).

In assessing whether a person has hit the £150,000 “gross income” threshold, the intention is that both individual and employer contributions to a pension scheme will be taken into account.  Therefore, any individual whose relevant income is £130,000 or more (excluding employer pension contributions) will need to have the value of any pension benefit funded (or ultimately funded) by their employer assessed.  To provide certainty for individuals and reduce administrative burdens for schemes, the tax relief restriction will not affect anyone whose income (including the pension contributions they make themselves) is less than £130,000 (the Income Floor).

A number of practical issues flow from this and we set out below our comments in response to the Consultation questions.  However, many of the questions posed by the Consultation are either actuarial in nature or are aimed very specifically at some of the more practical implications for employers and trustees.  We have therefore not attempted to answer all of the questions posed by the Consultation.

In this response:

• Applying the restriction of relief
• Should the PIP be aligned with the tax year?
  
• Using gross income to assess tax
• Effect of redundancy payments
• Valuing the defined benefit contribution
• Enhancements
  
• Statements
  
• Scheme Pays

Applying the restriction of relief

The Government asked for views on the best balance to strike between the smoothness of the taper and simplicity for individuals.

The Taper will apply to those earning between £150,000 and £180,000, and assumes that pension savings form the top slice of an individual’s income.  As identified in the Consultation, the effect of reducing tax relief by 1% for every additional £1,000 of gross income could produce very different results for an individual than reducing relief by 0.01% for every £10 of additional gross income.  The Consultation points out that the latter would provide a more graduated reduction, but may well be less straightforward for individuals to operate in practice.

In addition, measures are proposed to ensure that the Taper appropriately reflects an individual’s marginal relief.  Where the Taper indicates that relief on pension contributions should be between 40 and 50%, it will only apply to contributions that would, but for the April 2011 changes, have received 50% tax relief.

The approach taken to the Taper is not a legal issue and, therefore, we have no specific comments on the two options.  However, whatever approach is taken, individuals who are caught by the Taper will need very clear guidance to help them understand its implications.

Should the PIP be aligned with the tax year?

Given that the restriction of pensions tax relief for high-income individuals will apply over the tax year, the Governmentasked for views on whether the pension input period for the purposes of assessment against the annual allowance should be brought in line with the tax year.

The pension input period (PIP) is the period used to assess the annual increases in the value of a member’s benefits for the purpose of testing against the annual allowance.  Under the changes (from 6 April 2006), trustees of occupational pension schemes were generally able to nominate the most appropriate PIP for their scheme (for example, to coincide with the scheme year).  However, the position in DC schemes was more complicated as members could also determine their own PIP.  Where nominations were made by both the trustees and a member, the legislation gave priority to the first nomination past the post.

Although our own experience is that DC scheme trustees generally nominated a scheme-wide PIP as soon as possible after A-Day, or for new schemes as soon as possible after being established, it is nonetheless conceivable that in some DC schemes there may be any number of PIPs in operation.

For the above reasons, and depending on a scheme’s administration systems and the ease with which they can be changed generally, bringing the PIP into line with the tax year may cause difficulties for some.
A.4

Using gross income to assess tax

The Government asked for views on the proposal to use the higher of gross income in the current or previous tax year for the purposes of assessing whether individuals are affected by the restriction of tax relief in the year that benefits are drawn.

Assessing gross income in this way will also affect anyone retiring on grounds of ill-health.  There appears to be no intention to treat such individuals differently even though, for some, their future income may be substantially reduced.

Effect of redundancy payments

The Government asked for views on ways in which the impact on individuals affected by the restriction due to a redundancy payment of over £30,000 could be further mitigated without opening up scope for abuse.

A redundancy payment could tip an individual who usually earns well below the £130,000 Income Floor over the £150,000 plus gross income threshold.  Given current economic conditions, many individuals are facing the possibility of redundancy and, for some, finding new employment will not happen immediately.

It would be helpful if something could be done for individuals in these circumstances, perhaps by assessing income over a two year period, or ignoring the redundancy payment if it is paid under the terms of a redundancy scheme that is open to all employees with that employer.
See our comments in relation to enhancements.

Valuing the defined benefit contribution

The Government asked for views on how well the valuation methods meet the objectives of fairness and simplicity, and whether any other factors should be taken into consideration; in particular whether the use of a one way or two way scale of age related factors or ARFs or using LCETVs is the best approach.

The methodology for valuing the DB contribution in relation to gross income is clearly an actuarial, not a legal, question.  However, using either a cash equivalent calculation or ARFs would represent a departure from the current methods used for valuing benefits under the Finance Act 2004 for the purposes of testing against the annual and the lifetime allowances (AA and LTA).  These are currently based on the “flat factor” method set out in the Consultation, namely, the value of the increase in the benefit is multiplied by a factor of 10:1 and 20:1 respectively when assessing the AA and the LTA.

The Consultation explains that it was not felt appropriate to develop a more complex methodology for use when testing against the AA and LTA because the corresponding charges for exceeding the allowances apply to very few individuals each year.  In our view, simplicity and clarity are highly desirable regardless of the number of individuals likely to be caught by the tax relief restriction.

If the Government proceeds with its favoured method for valuing the deemed contribution in DB schemes, the two-way scale of ARFs, care will need to be taken with the definition of normal pension age (NPA).  The interpretation of NPA in section 180 of the Pension Schemes Act 1993 has been fraught with difficulty.  For example, with views differing as to whether it is the earliest age at which benefits become payable without actuarial adjustment or without the need for anyone’s consent (regardless of actuarial adjustment).  There is also uncertainty as to whether an individual can have more than one NPA, an issue which has caused difficulty where different periods of pensionable service have attracted different retirement ages owing to the application of equalisation in a pension scheme.

Perhaps recognising these difficulties, a new definition of NPA was developed specifically for the purposes of the PPF under section 138 of the Pensions Act 2004.  HMT / HMRC may wish to consider following a similar approach here.

Enhancements

The Government asked for views on whether there are any instances in which contributions or enhancements made to an individual’s pension should not be subject to the restriction of pensions tax relief and why these exemptions are justified in the light of the Government’s stated objective of fairness; and how these exemptions might best be crafted to avoid opening up scope for avoidance.

As mentioned above, many individuals may currently face the prospect of redundancy.  Redundancy exercises usually apply to a group of individuals and scheme rules often provide for an enhanced early retirement pension benefit in these circumstances where the member is over a certain age (typically age 50).  (Such early retirement provisions are very common in the public sector.)

We would suggest that such redundancy packages fall outside the scope of the restrictions on tax relief, especially where the individual has not previously exceeded the £150,000 gross income threshold.  Such enhanced benefits have formed an integral part of scheme rules for many years and are not within the affected individual’s direct control.

Similar considerations also apply to a member who qualifies for an enhanced ill-health early retirement benefit.

Statements

Employers will need to identify any employee to whom they provide gross pay and taxable benefits of £130,000 or more where they also contribute to that individual’s pension arrangement.  They will then have to request a benefit statement from the pension scheme on the employee’s behalf.  The statement, which should be provided by the pension scheme within three months of a request, should reflect the actual or deemed employer contributions, as well as those of the employee to that scheme over the previous year.

As these benefit statements will need to be available by 6 July in any year, in the same way as form P11D (benefits-in-kind), in effect, an employer will have to make a request before the end of the tax year.

Question A.13 is posed by the Consultation in the context of an individual whose income with an employer is less than £130,000 (namely, below the Income Floor) but who has significant additional sources of income unknown to the employer.  Requiring employers to ask for automatic pension statements where one has previously been requested may help to deal with this circumstance, but it may also blur the dividing line between the employer’s and the individual’s own responsibility where the individual’s earnings are below the Income Floor.  As the onus is on the individual to declare their earnings through self-assessment and to obtain the information needed to enable them to do so, it would seem more logical to require the individual to take responsibility here.

Scheme Pays

Where the pensions tax relief restriction leads to a charge exceeding £15,000, it is intended that the individual affected will have the option of electing that the recovery charge is paid on their behalf from their pension scheme, (this is called “scheme pays”).

Section 91 of the Pensions Act 1995 prevents a member’s benefits under an occupational pension scheme being assigned, commuted or surrendered except in very limited circumstances.  If “scheme pays” is adopted a further exception will need to be built in to section 91.

It may also be questionable whether, as a matter of trust law, a deduction can be made in these circumstances to an individual’s benefits so that a payment can be made to HMRC.  The main purpose of occupational pension schemes, which were traditionally set up under irrevocable trusts so as to meet HMRC requirements for tax exempt approval, is generally to pay pension and death benefits to members and their beneficiaries.  Where no corresponding benefit is becoming payable in respect of a member or their beneficiary, making a payment to HMRC (a non-beneficiary) in effect to discharge a tax bill would appear to fall outside such a purpose.

As referred to in the Consultation, the effect of scheme pays in a DC scheme is likely to be more straightforward.  However, in a DB scheme, there will need to be an “actuarially fair reduction to future pension benefits” to take account of the payment.  An analogy is drawn here to the process which schemes adopt when implementing a pension sharing order.  However, in that instance, it is the Court that decides what percentage of an individual’s cash equivalent should be attributed to his/her ex-spouse, not the trustees.  Therefore, at the very least, trustees are likely to want guidance as to how to calculate the deduction.

Many DB schemes are severely underfunded and the current economic climate is exacerbating this situation.  As a minimum, it would seem sensible to have an exemption from the scheme pays requirements where a scheme’s funding level is below that needed to secure benefits on a PPF basis.

But a scheme may be disproportionately affected by scheme pays for any number of reasons, for example, because it has a particularly large number of high earners.  In addition, although a scheme’s funding level may appear reasonable, there may be possible events on the horizon which could give rise to trustee concern (for example, a weakening employer covenant).  It may therefore be appropriate to give schemes a more general ability to opt-out of scheme pays.