Consultation on options to meet high annual allowance charges: Sackers’ Response

Background

The joint HMT / HMRC consultation (published on 30 November 2010 ) on “Options for meeting high annual allowance charges from pension benefits” (the Consultation), sets out two broad options (aimed primarily at DB schemes) 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.

We set out below our comments on a number of practical issues arising from the consultation. However, given that many of the questions posed by the consultation are aimed at some of the more practical implications for employers, trustees and administrators, we have not attempted to answer all of the questions raised in the discussion document.

Pay tax from income

We understand the Government’s current thinking is that it would be appropriate for individuals to pay the first £2,000 to £6,000 of any AA tax charge from their current income; and welcomes evidence to indicate an appropriate threshold figure, (paragraph 2.9)

We recognise that the threshold suggested for “scheme pays” is significantly lower than the figure of £15,000 put forward by the former Labour Government. However, given the reduction of the AA to £50,000 and the likely impact of the new AA threshold on a greater number of pension savers, it seems reasonable to suggest a lower threshold. This will be particularly important for those pension savers who are not high earners, but who are affected by the reduced AA as a result of long service and/or high accrual, who may not otherwise have the necessary cash flow to deal with charges arising.

Pay tax from benefits

The Government asked for views and evidence on whether individuals in DC schemes would have need of and / or would make use of a facility to meet AA charges from pension benefits. Views are also sought on whether restricting access to members of DB schemes only creates significant material administrative or communication issues for schemes, (paragraph 2.11)

In our view, the payment of AA charges is a facility which should be made available to all pension schemes, both DB and DC.

We do not consider there to be any reason to prevent members of DC schemes from having access to the same AA charge payment options as their DB counterparts. Making the facility available to all pension scheme members creates a level playing field and should result in a simpler system in terms of administration.

One example of this relates to members of hybrid arrangements who have paid AVCs on a DC basis. It is likely to be easier for such members and their schemes to calculate and pay the charge from their AVC pot (provided there are sufficient funds to cover the charge).

Another example relates to members who have been saving via a salary sacrifice arrangement. Affected individuals may be restricted from using scheme pays from a DB scheme in the light of HMRC’s requirements for a salary sacrifice arrangement to last at least twelve months. Connected with this, DC scheme members who contribute via salary sacrifice will potentially be less able (particularly in the early years of the new AA) to aim off the AA. Such members could therefore benefit from access to the scheme pays option.

Exemptions

The Government consultation asked for views on whether there are other exceptional circumstances in which it is appropriate to exempt certain schemes from facilitating payment of AA tax charges, including whether this would differ under the broad options, (paragraph 2.13)

We agree that an essential factor will be whether it is appropriate to make specific provision for members of schemes who enter a PPF assessment period. Another circumstance which merits consideration includes schemes which are underfunded on the PPF basis.

The position of schemes in wind-up should also be considered, as payment of the AA charge from the scheme could potentially favour one member over other members.

Multiple pension holders

The Government has asked for views on its proposed approach to multiple pension-holders. That is, that individuals are allowed to elect for a single scheme – in which they are an active member – to meet the AA charges each year; and that where the AA has been exceeded outright in a single scheme in a given year, that is the only scheme that can be elected to meet the liability from their pension benefits, (paragraphs 2.14 and 2.15)

Administratively, for both individuals and schemes, it is likely to be easiest if members who have exceeded the AA in more than one scheme are obliged to choose a single scheme from which the charge will be met.

Where members have benefits in hybrid schemes, HMT/HMRC may wish to consider requiring AA charges to be met from DC benefits in the first instance, in order to simplify the administrative process for pension schemes.

Adverse affect?

The Government sought views on whether it would adversely affect schemes, administratively or otherwise, to meet a charge that did not arise exclusively in that scheme, (paragraph 2.16)

Where an AA charge arises as a result of pension savings in more than one scheme, we agree with the consultation view that it is likely to be administratively easier for individuals if the charge can be met from a single scheme. Such an approach would benefit from the ability to use DC schemes for meeting the charge, particularly as this approach should not affect the overall balance of scheme funding. While the ability to nominate a single scheme will inevitably impose a burden on the chosen scheme (most notably in DB schemes), the overall burden is likely to even out across all schemes.

The paying scheme will be reliant on information provided to it by the member, as well as on communications between schemes, in order to obtain the necessary information to implement the charge correctly. There will therefore inevitably be an increased administration burden on the paying scheme. As such, it seems unrealistic to expect schemes to provide this service to members without charge. (An analogy can be drawn here with pension sharing on divorce where there is a clear facility to charge members in connection with the implementation of a pension sharing order). We therefore do not agree with the Government’s suggestion that individuals should not have to pay an administrative charge where they choose to meet their AA tax liabilities from their pension benefits (paragraph 3.9).

While the alternative proposal in the consultation (to allow schemes to stipulate their own terms of engagement with members looking to offset AA charges from their pension benefits) is a reasonable one, we suggest that any guidance produced includes a model scale of charges, so that schemes (and members) have a clear expectation as to what is reasonable.

Guidance should also set out HMRC’s expectations in terms of members’ responsibilities for collecting information from their various schemes and passing it to the paying scheme in a timely fashion.

Member communications

The Government asked for views on whether respondents agree that it would be insufficient to report the value of the charge to be offset without explaining the corresponding effect on pension benefits to members; and whether the level of detail and precision required varies across the options, (paragraph 3.13)

If trustees do not explain to members the consequences of off-setting the value of the AA charge against pension benefits, they may leave themselves open to the possibility of being challenged by members in the future. We therefore suggest that a statutory discharge is made available to trustees who make payments at the request of a member, to the extent of the pension which is given up to fund the tax liability.

We agree with the Government’s current thinking (set out in paragraph 3.11) that schemes should be given flexibility over how the value of the offset is determined. However, in connection with the proposal that it is for schemes to set their own terms of engagement with the member to ensure that the election for the scheme to pay the charge is made in a timely way (paragraph 3.17), we consider that in some cases members may not realise they need to take action until it is too late. Guidance from HMRC could give trustees a clear framework within which to operate. We also favour guidance over regulation, to allow schemes to operate flexibly within their own set-up.

Benefit Crystallisation Events

The Government asked for views on whether it is necessary for individuals in the year of benefit crystallisation to have access to the option to meet their liability from the pension benefit, and if so how to ensure that this process works sensibly for both schemes and members, (paragraph 3.22)

We consider that it would be preferable (as opposed to “necessary”) to allow an individual to meet any AA charge from benefits in the year of, and year preceding, benefit crystallisation. While it may be complicated for schemes to administer, it is important to consider the position of those individuals who have not built up sufficient benefits in their current arrangement to meet the charge.

Other circumstances

The Government welcomes views on whether there are other circumstances in which the application of either option may need to be given specific consideration? (paragraph 3.23)

We agree that AA liabilities will need to be properly accounted for in situations of death and divorce. Other circumstances which ought to be given specific consideration include: transfers-out; mergers; schemes in a PPF assessment period; and on winding-up.

In addition, for schemes which enter the PPF, given that benefits are subject to a cap, is it intended that any AA charges will be deducted from the reduced benefit, or will they be written off in these circumstances?

Standard approach?

The Government consultation has asked for views and evidence to indicate where legislating for a standard approach would reduce burdens, or be necessary to ensure that the policy intent is delivered; and whether there are areas where the Government should be even less prescriptive, (paragraph 3.25)

We agree with the Government’s intention to allow schemes flexibility as to how they operate “scheme pays”. This should help to ensure that they are not unduly burdened by the new measures. For example, strict deadlines may not allow sufficient time for liaison between schemes and providers in all cases.

However, it will be important to have a framework within which trustees and others can operate. This could be achieved by making available clear guidance setting out (among other things) the parameters within which scheme pays should operate. This will help employers, trustees and others to organise their processes in a timely and controlled manner, and so as to allow members’ expectations to be managed.