With less than a month until A-Day, the Association of British Insurers (ABI) is lobbying the Government to release final details and clarification on a number of outstanding issues and regulations.
Although there is a large list of issues from the Finance Act, which need clarification, the ABI has been focusing most of its attention on the rules covering the recycling of tax-free cash, how Inheritance Tax (IHT) rules will apply to pensions, particularly the Alternatively Secured Pension (ASP), and the relationship between enhanced protection and life cover contributions.
On the issue of tax free cash, the ABI has asked Her Majesty’s Revenue and Customs (HMRC) to either remove or fundamentally change the proposed rules, as it raises major concerns over excessive liabilities and burdens placed on providers and scheme administrators.
It has also been in contact with HMRC to try and flesh out the likely direction of IHT rules on pensions, although it says the position still remains unclear, as in its latest Tax Simplification Newsletter stated “We cannot be precise about timing but Ministers are aware of the Industry’s wish to have clarity as soon as possible, and we will do our best to meet that.“
And although HMRC last week published an extension to the original rules relating to enhanced protection and life cover contributions, the ABI has asked the Revenue for firm clarification on the relationship, as the extension only specifically mentions regular premium term assurance life policies.
But apart form these three key issues, the ABI has also been lobbying the Government on the following outstanding issues:
- The classification of Money Purchase Pensions: where a member decides not to choose an insurance company, so the scheme administrator selects one for them. The Finance Act is unclear on whether the resulting pension is a “scheme pension” or “lifetime annuity”.
This needs clarification, as scheme pensions and lifetime annuities are treated very differently in terms of their value for lifetime allowance (LTA) purposes and also in the amount that can be taken as a pension commencement lump sum (PCLS).
- Unauthorised Payments: Pre-A-Day entitlements: The Act still needs to expressly say pensions and other benefits which became payable before A-Day are authorised payments, as long as they comply with the pre-6 April 2006 Revenue limits applicable to them.
At the moment, the Finance Act requires trustees to review all existing pensions in payment with a view to stopping or restructuring all those that do not fit the new statutory framework.
The ABI suggests there is no justification for this, as these benefits were built up entirely by contributions paid before 6 April 2006 and both the contributions and the benefits complied with the Revenue’s requirements at that time.
- Ill-health pensions: The Act, firstly, needs to authorise the payment of ill-health pensions which can be reduced (rather than only stopped or suspended) on an improvement in health.
Many schemes already provide for a reduction of this kind as part of their existing benefits structure, particularly if the scheme’s incapacity rule provides for varying levels of pension depending on the degree of ill-health.
Secondly, the ABI has asked for the Act to be amended so a pension paid to a member - who had previously drawn an ill-health pension which has now been stopped or suspended - is not treated as an entirely new pension. This is so the member doesn’t have two benefit crystallisation events (BCEs) and therefore is allowed two PCLSs for what is basically the same pension.
- State pension integration: It has asked for an amendment to permit any reduction in pension, as long as it does not exceed the rate of basic state pension at that time, while also allowing the scheme to make the deduction at any point during payment, as long as it is made only once. At the moment, the current wording does not correctly describe the way schemes adjust pensions at state pension age.
To satisfy the Act as it presently stands, schemes would need to either increase their liabilities (incurring extra expense for employers) or to reduce the pensions members thought they had already accrued.
Otherwise, both the scheme and its members will suffer the pension being classed as an unauthorised payment, which would expose some members to 40% or 55% tax on their PCLSs, and this would tend to hit the poorest pensioners hardest.
- Definition of “dependant”: Although this is assumed to be a drafting error, the ABI has asked for clarification on this as the current definition does not automatically treat any stepchild under the age of 23 as a dependant, unlike the member’s own child. And the definition also does not cover a member’s child over the age of 23, even if it is financially dependent on the member, except for reasons of physical or mental impairment.
- Short service refund lump sums: it is asking for an extension to allow interest or investment returns to be added to the refund, as practically any scheme which refunds contributions will provide this. HMRC has indicated in its guidance the interest or investment returns would normally be permitted as a scheme administration member payment (SAMP).
But the definition of a SAMP cannot be read in this context, otherwise all benefit payments under the scheme rules which are not classed as authorised payments could be SAMPs.
Secondly, the ABI points out the Act should also be amended to allow contracted-out money purchase schemes to pay a refund covering everything except for the members’ protected rights.
As these schemes are prevented by contracting-out legislation from refunding the member’s protected rights assets, they retain these within the scheme when a refund of contributions is paid. But this is a problem under the Act, as it requires the refund to “extinguish the member’s entitlement to benefits”.
- Trivial commutation: First of all, the ABI says the wording needs to be amended to make it clear whether the consent of the individual is required for a trivial commutation lump sum, and/or a trivial commutation lump sum death benefit.
Secondly, as it stands, the rules state the trivial commutation lump sum should extinguish the member's entitlement to benefits under the scheme. But there is confusion over the payment of further contributions or accrual of further rights after the nominated date for commutation.
The ABI is asking for clarification as the Registered Pensions Scheme Manual (RPSM) says any further contributions or benefit accrual cannot be included in the trivial commutation lump sum, but this is not clear from the Act.
- Serious ill-health lump sums: currently these schemes are prevented by the contracting-out legislation from commuting Guaranteed Minimum Pensions (GMPs) and protected rights for serious ill-health.
This is a problem as the Finance Act requires the refund “extinguishes the member’s entitlement to benefits”. The ABI would like to qualify the Act to allow contracted-out schemes to commute everything except GMPs and/or protected rights.
- Trivial commutation lump sum death benefit : The Act requires the payment to extinguish the dependant's entitlement under the pension scheme to all pension death benefit and lump sum death benefit in respect of the member.
But another part of the Act states if a trivial commutation lump sum payment exceeds 1% of the lifetime allowance then the excess over 1% is not a trivial commutation lump sum death benefit.
The ABI has two questions on this issue: how is this intended to be measured and payments taxed, and if that part of the payment is not a trivial commutation lump sum death benefit, what is it?
- Meaning of “extinguishes the member’s entitlement to benefits”: Under the rules for trivial commutation, serious ill-health lump sums, and short service refund lump sums, the definition of this is open to interpretation, and should be amended to clarify whether benefits payable on the future death of the member are also required to be extinguished.
- Assignment of Term Insurance Policies (S226A and Personal Pension): Many existing contracts will have been assigned to provide security for a mortgage etc. Section 172 treats these assignments as unauthorised member payments (other than in specified circumstances).
As permitted assignments made now should not have any adverse tax advantages after A-Day, the Act needs to clarify whether a transitional provision is necessary to avoid existing assignments being regarded as unauthorised payments?
- Taxation of PCLS where pension reduced: The current draft retrospectively taxes a member’s entire PCLS in the event of a subsequent reduction in pension. The problem is it taxes the whole of the PCLS and is not necessarily linked to abuse.
For instance, a scheme might (quite innocently) reduce pensions at state pension age in a way which does not fit the new tax regime. If this brings a pension down to less than 80% of its previous level, the member would become subject to a 40% or 55% tax charge on the whole PCLS already paid (and not just the part of it attributable to the reduction).
The ABI claims this is most likely to hit those members with the smallest pensions (as a small pension is more likely to be reduced to below 80% of its previous level if the state pension is deducted from it), and these members will not normally have the resources to pay the tax liability which is then triggered.
- Calculation of the Initial Member Pension Limit for Dependants’ Pensions: The rules of most occupational pension schemes provide for dependants’ pensions up to a limit of 100% of the member’s pre-commutation pension, as indexed.
Unless the Act is amended, unauthorised dependants’ pensions will be paid, and it will result in considerable extra administration in checking compliance, reporting and payment of unauthorised payment charges and scheme sanction charges, not just once but for every year the dependants’ pensions are in payment.
- Calculation of increases for Dependants’ Pensions: As with the calculation of the initial member pension limit for dependents, certain sections of the Act need to be amended, otherwise unauthorised dependants’ pensions will be paid, and it will result in extra administration and payment of unauthorised payment charges and scheme sanction charges, for every year the dependants’ pensions are in payment.
- Calculation of Pension Input Amount following a transfer from a DB scheme: The calculation required under the Act will not be possible in many cases, while in others it will result in excessive taxation or the effective loss of transfer options.
This is because under block transfers following sales and mergers, the block transfer amount is not normally broken down into individual amounts. Individuals will therefore be unable to complete their self-assessment tax returns. So the ABI is suggesting an exemption for block transfers.
- Five-year guarantees: It is not yet clear whether a pension put into payment on or after A-Day which includes provision, on death before age 75, for commutation of any remaining instalments within a guaranteed period will constitute an authorised benefit. Although the pension would appear to comply with the requirements, along with any resulting lump sum, it is not clear that HMRC agrees.
- Surrender of excess rights before registering for enhanced protection: If the value of a member's uncrystallised benefits in an occupational scheme on 5 April 2006 exceeds the maximum which could be paid under existing rules without HMRC withdrawing approval, the excess ("the relevant excess") must be surrendered before the member may register for enhanced protection.
Draft regulations have been published explaining what constitutes, and how to determine the value of, relevant excess. They also confirm, provided the relevant excess has been determined and valued correctly, payment of an amount equalling the value of the excess would not constitute an unauthorised payment.
But where a member’s rights include benefits attributable to Additional Voluntary Contributions (AVC), it is not clear what is being surrendered. The ABI suggests it would be fair to assume AVC benefits are refunded in preference to other benefits, but as the surplus AVC regulations are removed from A-Day, scheme rules are unlikely to have anticipated such scenarios.
- Existing Income Withdrawals which will become Designated for Unsecured Pension: One of the draft Transitional Orders deals with existing funds from which income withdrawals are being taken, or which are in income drawdown or annuity deferral, on 5 April 2006. The Order immediately classes these funds as member-designated funds available for unsecured pension on 6 April 2006, but the designation does not give rise to a Benefit Crystallisation Event.
When a BCE occurs at age 75 - assuming this is the first since 5 April 2006 - as the unsecured pension fund is a "relevant existing pension", a notional BCE is considered to have happened immediately before the BCE at age 75.
Although the notional BCE will not give rise to a Lifetime Allowance Charge, it will use up some or all of the member's LTA before the real BCE occurs at age 75. But if this unsecured pension fund is first used after A-Day, the amount would be offset against the crystallisation value at age 75.
This means a member with an income drawdown fund of £1.6m who had purchased an annuity with their income drawdown fund on 5 April 2006 would have no potential liability to a lifetime allowance charge on or after A-Day.
But if the same fund was used to purchase a lifetime annuity on 6 April 2006 there would be an immediate LTA charge on the whole of the lifetime annuity purchase price.
Although the member could apply for Primary Protection before purchasing the lifetime annuity the ABI claims there should either be an offset in these cases or an exemption from the lifetime allowance charge.
- The requirements for unsecured pension are modified for existing income withdrawal cases by draft Transitional Orders. But these do not clearly show how the rules apply and the ABI has requested clarification on whether the requirement for a minimum withdrawal of 35% of the maximum has been removed.
Under the draft Order, the first reference period for an unsecured pension begins on 6 April 2006 and can last up to 6 April 2008. The first unsecured pension year commences on 6 April 2006 and ends at the earliest of 5 April 2007 or the date set out in the rules for the maximum to be assessed.
But the Act does not make it clear whether the second unsecured pension year can be less than 12 months, if the first reference period extends beyond 5 April 2007 but ends before 6 April 2008, and if this is the case whether the maximum amount can be taken in this shortened unsecured pension year.
- Transitional protection of lump sums exceeding 25%: The Finance Act 2004 gives transitional protection for lump sums exceeding 25% of pre-A Day uncrystallised rights. But the amount of the lump sum rights under an arrangement is the amount an individual would have been entitled to under the arrangement on 5th April 2006.
It does not simply refer to the "maximum permitted lump sum", which is the maximum permitted under the current tax regime. So it can be interpreted as meaning lump sum rights could be different from the maximum permitted lump sum, which means lump sum rights could depend on the type of scheme a member is in.
The problem is many DB schemes have rules which give members an option to commute pension for lump sum but only with the consent of the trustees or employer, while other schemes allow members to take a lump sum up to a specified maximum, without having to obtain consent. If they want to take a larger amount up to the full maximum permitted, they have to obtain consent.
Therefore, members of a DB scheme may have no entitlement to a lump sum and cannot benefit from transitional protection. There is nothing in the legislation to say it must be assumed consent would be given, while for other schemes, the legislation gives transitional protection for the specified maximum in the scheme rules at A-Day. It is not clear whether members could claim protection for the full maximum permitted.
But as the RPSM states "the value of the member's uncrystallised lump sum rights include rights to take a lump sum benefit with the consent of the trustees/employer/any other party", the ABI wants the legislation to confirm transitional protection will apply to the full maximum permitted lump sum for both types of schemes, and not limited to the maximum which can be taken without consent.
- Treatment of reducing pensions: The draft Pension Schemes (Modification of Rules of Existing Schemes) Regulations (the “Modification Regulations”) do not allow schemes to deal with the problem of pensions which, under the scheme’s rules, are required to be reduced in a way which would make them unauthorised payments.
This requires a change either to those regulations or to the Act itself. As it stands, the HMRC’s interpretation of the Act is if a pension reduction of this kind occurs, it is only the pension instalments paid after the time of that reduction which are unauthorised payments.
The difficulty this creates for a scheme is the Modification Regulations cannot be used to justify not paying the pension in the first place (because the pre-reduction instalments are required to be paid under the scheme rules and are authorised payments).
The only way the scheme can avoid the pension payments later becoming unauthorised is by not making the reduction, which effectively means increasing the scheme’s (and therefore the employer’s) liabilities beyond the level which was ever intended when the scheme rules were agreed. This increase in scheme’s liabilities would also place an additional strain on the Pension Protection Fund.
- “Relevant benefit accrual” for defined benefit members with enhanced protection: In DB schemes, the question of whether a member has had “relevant benefit accrual” is tested by comparing the LTA value of their benefits on 5 April 2006 – assessed by reference to the earliest age (the “nil-reduction age”) at which they would be paid without actuarial reduction – with the LTA value of his benefits when they eventually crystallise.
But scheme rules sometimes provide, in specified contexts (usually ill-health, redundancy or death in service), for a different “nil-reduction age” from the normal one, or for no actuarial reduction to be applied at all in those contexts, with the LTA value of the member’s benefits when they eventually crystallise varying depending on the nature of the benefit crystallisation event.
As the Act stands, this would produce unintended results, as the variation in the type of BCE which may occur is not reflected by an ability to calculate the LTA value as at 5 April 2006 in different contexts.
The ABI suggests it should reflect the presumed policy intention of enhanced protection, and instead enable the LTA value as at 5 April 2006 to be assessed in a way which allows for the fact there may be different nil-reduction ages in different contexts.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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