Pension flexibility 2016
Published 16 March 2016
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Who is likely to be affected
Members of registered pension schemes who have a life expectancy of less than 12 months.
Members of registered pension schemes who have money purchase pensions in payment and their total pension wealth does not exceed £30,000.
Individuals with dependant’s drawdown or flexi-access drawdown pensions who will cease to be a dependant on reaching age 23.
Scheme administrators of registered pension schemes.
General description of the measure
A number of minor changes are being made to the pensions tax rules to ensure that they operate as intended following the introduction of pension flexibility in April 2015. The changes will:
- remove the requirement that a serious ill-health lump sum can only be paid from an arrangement that has never been accessed
- replace the 45% tax charge on serious ill-health lump sums paid to individuals who have reached age 75 with tax at the individual’s marginal rate
- enable dependants with drawdown or flexi-access drawdown pension who would currently have to use all of this fund before age 23 or pay tax charges of up to 70% on any lump sum payment, to continue to access their funds as they wish after their 23rd birthday
- remove the rule on paying a charity lump sum death benefit out of drawdown pension funds and flexi-access drawdown funds where the member dies under the age of 75 because the equivalent tax-free payment may be made as another type of lump sum death benefit
- enable money purchase pensions in payment to be paid as a trivial commutation lump sum
- enable the full amount of dependants benefits to be paid as authorised payments where there are insufficient funds in a cash balance arrangement when the member dies
Policy objective
These measures make the tax system fairer and ensure that pension flexibility is working as intended.
Background to the measure
At Budget 2014, the government announced the introduction of pension flexibility. These allowed individuals aged 55 and above to access their money purchase pension savings as they wish, subject to their marginal rate of tax.
In September 2014 the government made a further announcement in relation to the taxation of pension death benefits.
These changes were set out in the Taxation of Pensions Act 2014 which took effect from 6 April 2015.
Detailed proposal
Operative date
These measures will have effect on the day after the date of Royal Assent to Finance Bill 2016.
Current law
Registered pension schemes are tax-advantaged vehicles intended to encourage saving for retirement. The current law is mainly included in Part 4 of Finance Act (FA) 2004. Schedule 28 FA 2004 provides the rules for authorised pensions and Schedule 29 FA 2004 provides the rules for authorised lump sums.
Serious ill-health lump sums can be paid only out of funds that have not been accessed. If a serious ill-health lump sum is paid to an individual who has reached age 75, it is taxed at 45% (section 205A FA 2004). Dependant’s drawdown pension and flexi-access drawdown pension may be paid following the death of a member to the member’s child who has not reached age 23.
Where the member has no dependants a charity lump sum death benefit may be paid out of their drawdown or flexi-access drawdown pension funds irrespective of their age at death.
Trivial commutation lump sums can be paid out of defined benefits funds whether or not the funds have been accessed.
An uncrystallised funds lump sum death benefit must be paid out of money purchase funds valued at the member’s death. Cash balance benefits are money purchase benefits that are not calculated on the basis of contributions to the scheme (section 152 FA 2004). They may be paid as an uncrystallised funds lump sum death benefit but the payment according to the scheme rules will be the amount promised to fund the benefits of the beneficiary.
Proposed revisions
Legislation will be introduced in Finance Bill 2016 to amend FA 2004.
Serious ill-health lump sums
If an individual would meet the requirements to take a serious ill-health lump sum but for the fact that they have accessed their pension, they will be able to take the remaining funds that have not been accessed as a serious ill-health lump sum.
Where a serious ill-health lump sum is paid to an individual who has reached age 75, it will be taxable at that individual’s marginal rate rather than at a flat rate 45%.
Dependant’s drawdown and flexi-access drawdown
Where an individual has a dependant’s drawdown pension fund or dependant’s flexi-access drawdown fund because they are a child under the age of 23 of the member who has died, they will be able to continue to receive drawdown pension or flexi-access drawdown pension as authorised payments after reaching age 23. This would ensure that a child dependant who continues to draw down from their fund when they have reached age 23 does not have tax charges of up to 70% on any payments received from that date, and aligns their tax treatment with that of a nominee of the member.
Charity lump sum death benefit
A change is made to align the tax treatment of a charity lump sum death benefit after a member has died under the age of 75 whether paid out of drawdown pension funds and flexi-access drawdown funds or out of funds that have not been accessed (uncrystallised funds). The need to pay an uncrystallised funds lump sum death benefit a drawdown pension fund lump sum death benefit or a flexi-access drawdown fund lump sum death benefit within two years when it is paid to a charity is also removed.
Trivial commutation lump sum
A change is made so that a trivial commutation lump sum may be paid out of a money purchase scheme pension that is already in payment.
Cash balance
Where a member dies and the scheme must top-up the remaining funds to meet the entitlement of the member’s beneficiaries to an uncrystallised funds lump sum death benefit under the scheme rules, the full amount of the lump sum death benefit will be an authorised payment.
Summary of impacts
Exchequer impact (£m)
| 2016 to 2017 | 2017 to 2018 | 2018 to 2019 | 2019 to 2020 | 2020 to 2021 |
|---|---|---|---|---|
| negligible | negligible | negligible | negligible | negligible |
These measures are expected to have a negligible impact on the Exchequer.
Economic impact
These measures are not expected to have any economic impact.
Impact on individuals, households and families
This measure is not expected to have an impact on individuals, households or on family formation, stability or breakdown. These are minor measures to ensure that pensions legislation is working as originally intended.
Equalities impacts
These measures are expected to have minimal impacts on the legally protected equality groups. There may be slight positive impacts on younger people and spouses from changes to dependants’ Flexi-Access Drawdown and top ups to fund dependants’ death benefits.
Impact on business including civil society organisations
These measures will not significantly impact on businesses or civil society organisations.
Operational impact (£m) (HM Revenue and Customs (HMRC) or other)
There will be no significant operational cost for HMRC.
Other impacts
Other impacts have been considered and none have been identified.
Monitoring and evaluation
These measures will be monitored on an ongoing basis, through monitoring tax receipts.
Further advice
If you have any questions about this change, please contact Beverley Davies on Telephone: 03000 512336 or email: pensions.policy@hmrc.gsi.gov.uk.