Summary
Following the Chancellor’s announcements in the budget of 19 March 2014 and subsequent statements, the Taxation of Pensions Act 2014 becomes possibly the most thorough pension reform since 1921. It puts into law new rules regarding the flexibility of pension drawdown, a reduction of tax charges on certain lump sum payments and an extension of death benefits to nominees or successors as well as to dependents.
While the changes are lengthy, there are some crucial points to be made about how they may create greater choice and flexibility, making pensions an increasingly attractive vehicle for savings.
Professional financial planning and investment advice is crucial to ensure that savings are positioned optimally and advantage is taken of the new rules consistent with meeting aims and objectives.
The Taxation of Pensions Bill received Royal Assent on 17 December 2014 and has become the Taxation of Pensions Act 2014. The Act will provide for the changes in pension taxation due to have effect from 6 April 2015.
Choices for taking benefits from a money purchase arrangement
From 6 April 2015, an individual taking benefits from a money purchase arrangement under a registered pension scheme will have the following choices:
- buying a lifetime annuity;
- designating some or all of the fund to provide a drawdown pension;
- taking an uncrystallised funds pension lump sum;
- taking a scheme pension.
More details of these choices are set out below.
Lifetime Annuity
- As now, a tax free pension commencement lump sum may be taken, equal to up to one-third of the amount used to buy the lifetime annuity (equating to a maximum of 25% of the total fund allocated to buy a lifetime annuity and lump sum).
- Some of the current restrictions on lifetime annuities will be removed:
- the annual rate of the annuity may go down as well as up (for example, it may reduce when the member reaches State pension age and starts drawing the State pension), subject to any anti-avoidance provisions set out in regulations;
- the current 10 year limit for continuing to pay the annuity after the member’s death will be removed: instead, the annuity may continue to be paid for any period set out in the annuity contract.
Drawdown Pension
From 6 April 2015, a new drawdown pension may be either:
- a short term annuity, payable by an insurance company for up to five years; or
- income withdrawal, by designating the funds into a flexi-access drawdown fund (please see below).
Unlike the current rules, from 6 April 2015, the income from a short term annuity may go down as well as up.
Where a drawdown account is in existence before 6 April 2015, different rules will apply. These are explained below.
Uncrystallised funds pension lump sum
- A new form of authorised payment will be introduced, known as an “uncrystallised funds pension lump sum” (UFPLS).
- An individual aged 55 or over (or meeting the ill health condition) may take a single UFPLS or a series of UFPLSs from his/her uncrystallised money purchase funds.
- The first 25% of each UFPLS will normally be tax free, with the remainder taxable as income.
- An individual who has taken a UFPLS will thereafter be subject to new “money purchase annual allowance rules” (see below), with tax relief on money purchase saving reduced to £10,000 per year.
- There will be restrictions on taking a UFPLS for certain individuals with primary or enhanced protection or a lifetime allowance enhancement factor.
Scheme pension
- As now, a tax free pension commencement lump sum may be taken, equal to up to one-third of the amount used to provide the scheme pension (equating to a maximum of 25% of the total fund allocated to provide the scheme pension and lump sum).
Flexi-access drawdown fund
- As an alternative to taking one or more UFPLSs, an individual may put his/her money purchase funds in a “flexi-access drawdown fund“, from which the individual may choose to draw down any amount over any time period.
- When funds are put into a flexi-access drawdown fund, up to 25% of the funds may be taken as a tax free pension commencement lump sum.
- Amounts taken from the flexi-access drawdown fund will be taxable as income.
- An individual who has flexibly accessed a drawdown fund will thereafter be subject to new “money purchase annual allowance rules” (see below), with tax relief on money purchase saving reduced to £10,000 per year.
Existing flexible drawdown funds
- Flexible drawdown funds set up before 6 April 2015 will automatically convert to flexi-access drawdown funds on 6 April 2015.
- Individuals with pre-existing flexible drawdown funds may not currently make further saving in a registered pension scheme without paying an annual allowance charge (that is, they effectively have a nil annual allowance).
- From 6 April 2015, individuals with pre-existing flexible drawdown funds may make tax-advantaged pension savings, subject to the “money purchase annual allowance rules“. However, they may not carry forward any annual allowance from tax years which occurred before 2015/16 and after they first took a flexible drawdown payment.
Existing capped drawdown funds
Transitional rules apply to capped drawdown funds set up before 6 April 2015.
- Further funds may be designated to the capped drawdown fund. Up to one-third of the value of the newly-designated funds may be taken as a tax free pension commencement lump sum.
- An individual with a capped drawdown fund will retain an annual allowance of £40,000 provided they do not:
- draw down more than their capped drawdown amount each year; or
- flexibly access other pension arrangements or take a UFPLS from another arrangement.
- From 6 April 2015, taking a payment in excess of the capped drawdown amount will no longer be an unauthorised payment but will cause the capped drawdown fund automatically to convert to a flexi-access drawdown fund.
- An individual with a capped drawdown fund may also choose to convert it to a flexi-access drawdown fund.
- An individual whose capped drawdown fund has converted to a flexi-access drawdown fund will then be subject to the “money purchase annual allowance rules“.
Money purchase annual allowance rules
- The money purchase annual allowance rules will apply where an individual takes:
- income withdrawal or a short term annuity from a flexi-access drawdown fund (designating funds for flexi-access drawdown and taking an associated lump sum will not, on their own, trigger the money purchase annual allowance rules);
- an uncrystallised funds pension lump sum;
- a payment from a flexible lifetime annuity contract under which the amount of the annuity could decrease other than as allowed by regulations;
- a payment from a scheme pension under a money purchase arrangement on or after 6 April 2015 when fewer than 11 other individuals were entitled to a scheme pension (or dependant’s scheme pension); or
- certain stand alone lump sums.
- An individual subject to the money purchase annual allowance rules will have a reduced annual allowance for money purchase savings of £10,000.
- An individual subject to the money purchase annual allowance rules may also accrue defined benefits without triggering an annual allowance charge. The rules setting out the amount of the remaining annual allowance are complex but, broadly:
- where money purchase savings in the tax year are £10,000 or less, the individual will retain a total annual allowance of £40,000 plus any unused annual allowance carried forward from the previous three tax years;
- an individual whose money purchase savings in the tax year exceed £10,000:
- will be subject to the annual allowance charge on the excess money purchase savings over £10,000;
- will have a reduced annual allowance of £30,000 (the “alternative annual allowance“) for his/her non-money purchase pension savings, plus any unused annual allowance carried forward from the previous three tax years.
- Special rules will apply where an individual subject to the money purchase annual allowance rules is accruing benefits in a hybrid arrangement (for example one providing defined benefits with a money purchase underpin) made on or after 14 October 2014 (the date the Bill was introduced in Parliament).
Trivial commutation lump sums
- From 6 April 2015, it will no longer be possible to take a trivial commutation lump sum from a money purchase arrangement. Instead, it will be possible to withdraw all the funds from a money purchase arrangement as a UFPLS.
- It will still be possible to take a trivial commutation lump sum from a defined benefits arrangement, where the value of the individual’s total benefits in registered schemes does not exceed £30,000. From 6 April 2015, a trivial commutation lump sum may be taken from normal pension age (55), rather than from age 60 as at present.
Dependants’ benefits
On a member’s death, death benefits may be paid as a dependant’s pension and/or as a death benefit lump sum. Similar changes will be made to the rules for dependant’s annuities and dependant’s drawdown arrangements as for member’s annuities and drawdown funds. However:
- payment from a dependant’s flexi-access drawdown fund will not cause the money purchase annual allowance rules to apply to the dependant;
- any unused funds in a flexi-access drawdown fund at the member’s death may be paid as a “flexi-access drawdown fund lump sum death benefit“;
- a UFPLS may not be paid as a death benefit (a UFPLS may only be paid to a member).
Restriction and reduction of tax charges on certain lump sums
- the special lump sum death benefits charge reduces from 55% to 45% where certain lump sums are paid by a registered pension scheme “in respect of a member who had reached the age of 75 at the date of the member’s death” and the lump sum is paid on or after 6 April 2015. For those who have not reached age 75 at date of death, the charge is reduced to 0%.
Transfers where member has a protected pension age
- New provisions not included in the consultation on draft legislation will allow a member with a protected pension age of less than 55 to retain the protected pension age following a recognised transfer made on or after 6 April 2015, provided certain conditions are met.
Taxation of Pensions Act: amended reporting requirements
Summary
Following criticism of new reporting requirements to be imposed on members who flexibly access pension savings, the Government tabled amendments to make the requirements less onerous. As amended:
- a member who flexibly accesses pension benefits must give notice to the administrator of every other scheme in which they are accruing cash balance, hybrid or money purchase benefits (at that time and in the future), rather than to the administrator of every scheme of which they are a member; and the period in which the member must give notice has been extended from 31 days to 91 days.
Background
The Schedule to the Taxation of Pensions Bill (now the Taxation of Pensions Act 2014) includes new reporting requirements relating to flexible access to pensions and the application of the new money purchase annual allowance rules. A member will be taken to flexibly access pension rights when:
- the member takes income withdrawal or buys a short term annuity from a flexi-access drawdown fund;
- the member draws an uncrystallised funds pension lump sum; or
- certain standalone lump sums are paid.
On first flexibly accessing pension rights
- The administrator must give the member a statement with the date of the flexible access and an explanation of how the member will in future be subject to the money purchase annual allowance rules.
- The statement must be given to the member within 31 days of the flexible access first occurring.
- The administrator is not required to give the statement where it has previously been informed by the member (or administrator of another scheme) that the member had already flexibly accessed pension rights.
- The member must pass on the information in the statement to the administrator of each other registered pension scheme in which s/he is accruing cash balance, hybrid or money purchase benefits, within 91 days of receiving the statement.
On transferring between schemes
- Where the administrator of a transferring scheme has reason to believe that a transferring member has previously flexibly accessed pension rights, it must give notice to the administrator of the receiving scheme within 31 days of the transfer.
On joining a new scheme
- A member subject to the money purchase annual allowance rules who joins a new cash balance, hybrid or money purchase scheme (other than by transferring to the scheme) must give specified information to the scheme administrator of the new scheme within 91 days of joining.
Member with a flexible drawdown arrangement before 6 April 2015
- If the member starts to accrue cash balance, hybrid or money purchase benefits after 6 April 2015, the member must give a statement to the administrator of each registered scheme in which s/he is accruing cash balance, hybrid or money purchase benefits, within 91 days of the start of accrual.
Member with a capped drawdown fund before 6 April 2015
- If the member’s capped drawdown fund converts to a flexi-access drawdown fund, the member must give a statement to the administrator of each registered scheme in which s/he is accruing cash balance, hybrid or money purchase benefits, within 91 days of conversion.
Annual pension savings statements
- Where a member has previously flexibly accessed pension rights, a scheme administrator must give the member an annual pension savings statement where the member’s accrual in money purchase or hybrid arrangements under the scheme exceeds £10,000 in the relevant pension input period.
- Other members must be supplied with the information contained in an annual pension savings statement on request.
Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.
