Budget changes for pensions: What’s happening on 27 March 2014?

The 2015 changes to the rules on the use of members’ DC pots at retirementare proposed with the twin aims of simplifying the pensions tax regime and giving individuals more choice and flexibility.

Drawdown allows members to take an income stream from their pension pot, without purchasing an annuity.  The rules on drawdown introduced in April 2011will be significantly relaxed:

• the capped drawdown limit will be increased from 120% of the value of an equivalent annuity to 150%
• the Minimum Income Requirement for unlimited drawdown limit will be reduced from £20,000 to £12,000.

Not all DC schemes offer drawdown as it can be complicated to administer.  Schemes may, therefore, see an increase in requests for transfers from members who wish to take advantage of these new limits – particularly for those members who are coming up to retirement and who wish to avoid purchasing an annuity ahead of the more radical reforms proposed for April 2015. Indeed schemes may receive requests from members to halt annuity purchases recently requested.

Members do not have a statutory right to take a transfer (a CETV) in the year before their scheme’s NRA so it may be necessary to check that scheme rules will allow a transfer to be taken in these circumstances.  An appropriate discharge should also be sought if the transfer is not a CETV and does not therefore benefit from a statutory discharge.

The amount which can be taken as a lump sum under the general rules on trivial commutation will be increased on 27 March 2014 from £18,000 to £30,000.  HMRC have confirmed that this new limit will apply in both DC and DB schemes.

However, the current intention is that the £18,000 lump sum limit will continue to apply to both winding-up lump sums and trivial commutation lump sum death benefits payable to dependants.  The reason for this distinction may be because these lump sums do not need to be aggregated across pensions savings in all registered pension schemes.

Trustees will need to deduct tax on any trivial commutation lump sum or small pots in the normal way.

Before being taxed, a 25% deduction is generally made to reflect the fact that, if the trivial commutation lump sum or small pot lump sum was not paid and normal benefit rules applied, the member would (generally) be entitled to a tax-free pension commencement lump sum.

Tax on the balance is payable at the member’s marginal rate.

These new limits will apply from 27 March 2014 but legislation will need to catch up.

The proposed changes to legislation will be made as part of the Finance Act 2014 which is unlikely to receive Royal Assent until July 2014.  Until these Finance Act changes are made, the increased payments will, strictly speaking, be unauthorised payments.  However, HMRC are proceeding on the basis that these new limits are in force on and from 27 March 2014.

HMRC is introducing a change via a resolution made under the Provisional Collection of Taxes Act 1968 to allow it to collect (and trustees of registered pension schemes to account for) income tax on lump sums paid on or after 27 March 2014 based on the higher limits before the Finance Act 2014 is in force.

There will therefore be a gap between the Finance Act changes coming into force and what the announcement says the trustees can pay and then account for via PAYE.  There may be other consequential legislative amendments required as well – for instance, in relation to contracting-out.

The critical element in this four month gap will be to establish whether there are any barriers to paying benefits at the higher limits in the scheme rules.

Before paying any increased benefits, the trustees should check:

• to see whether a higher amount can be paid under the scheme’s special terms and/or augmentation rules
• whether there are restrictions in the scheme rules on paying unauthorised payments – often the rules give the trustees discretion to do so
• any specific restrictions built into relevant rules – for example, a trivial commutation rule may require member consent (but this is not required under the Finance Act 2004)
• whether the scheme rules contain any discharges as statutory discharges may not be available for this interim period (this information should also be included in member communications – see below).

Based on the results of checking the scheme rules, some trustees may wish to implement the changes with effect from 27 March 2014 and rely on HMRC’s announcement and any appropriate discharges.  Others may wish only to implement the changes when the Finance Act 2014 is in force.

Whatever the trustees decide to do, it is essential that trustees communicate to members, especially those currently “in transit” to retirement and those nearing retirement.

It will be necessary to explain what proposals are on the table for April 2015 and what flexibilities are being introduced earlier.  This means that members, especially those coming up to retirement, are aware of the current changes and future proposals, and can plan for them.  Existing communications, including the scheme booklet, are likely to reference the current rules and may now be misleading.  Trustees may wish to send out a special flyer by post or email or include a notice on the scheme’s website regarding the changes.

In addition, trustees should check that appropriate discharges are requested from members taking advantage of the higher limits from 27 March as, before legislation catches up with the relaxation in the rules, statutory discharges may not be available.  Discharges will ensure that members understand that, for example, after taking a trivial commutation lump sum or a small pot, their rights under the scheme will be extinguished.

Further advice

Please refer to your normal Sackers contact as soon as possible for further advice.