Guidance

Taxation of Pensions Bill: briefing note

Updated 10 December 2014

Clause 1 of the bill introduces the schedule.

Clause 2 of the bill reduces the tax charges that apply to certain lump sums paid by registered pension schemes on an individual’s death or in the case of serious ill-health and removes the tax charge for certain lump sum death benefits paid where the deceased did not reach age 75.

Clause 3 of the bill introduces schedule 2.

Clause 4 of the bill contains the definitions used in the bill, providing interpretation and provides the power for the Commissioners of Her Majesty’s Revenue & Customs to make regulations appropriate to the changes in this bill.

1. Schedule 1

1.1 Part 1: drawdown pensions

This part creates “member’s flexi-access drawdown funds” and provides that all new drawdown arrangements set up after 6 April 2015 are flexi-access drawdown funds. Flexi-access drawdown is a new form of accessing a pension, with no cap on the amount that can be withdrawn each year and no minimum income requirement. This will replace flexible drawdown, which people can access only if they have a guaranteed minimum retirement income of £12,000 a year.

It distinguishes between flexi-access drawdown and “drawdown pension funds”, which were set up before 6 April 2015. These can remain as drawdown pension funds after 6 April if the individual wishes, but will be subject to the existing annual cap on withdrawals. Alternatively they can be converted to flexi-access drawdown, either by the individual notifying the scheme that they would like to convert, or by the individual withdrawing more than the maximum amount permitted and therefore breaching the cap.

This part also creates “dependant’s flexi-access drawdown funds”, in order to mirror the new member’s flexi-access drawdown and provides for the conversion of existing dependants’ drawdown to dependants’ flexi-access drawdown. This broadly mirrors the changes described above.

It also makes a number of consequential changes, making the new flexi-access drawdown an authorised pension which can be paid without incurring an “unauthorised payment” tax charge.

It sets out when a lump sum death benefit can be paid from a member’s or dependant’s flexi-access drawdown fund (a “flexi-access drawdown fund lump sum death benefit”), and applies the appropriate tax charges.

It removes the requirement for pension scheme administrators to report a payment from a flexible drawdown arrangement.

It includes a number of consequential changes to ensure existing regulation-making powers that apply to existing types of drawdown also apply to flexi-access drawdown.

1.2 Part 2: annuities

This part changes the rules to allow annuities to be more flexible products. It introduces a further category of annuity (those sold after 6 April 2015).

It removes a number of requirements which will not apply to annuities sold after 6 April 2015 (although they will continue to apply to existing annuities). It allows that these annuities can decrease, which existing annuities cannot usually do.

It also removes the upper limit of the guarantee period for guaranteed annuities[^1] of 10 years so that any term can be specified in the contract – a ‘term certain’.

It removes the requirement from the tax legislation that annuitants must have first been given the opportunity to select the insurance company in order for the annuity to be an authorised payment (so that the funds are not subject to a 55% tax charge where the individual was denied this opportunity). The Open Market Option, which encourages shopping around for retirement products, will, however, continue to be highlighted in the information pension schemes provide to their members at retirement.

It also applies these changes to:

• dependant’s annuities
• short-term annuities
• dependant’s short-term annuities

It includes a number of consequential changes (under “Further annuities amendments”) to ensure these changes are reflected elsewhere in the legislation.

1.3 Part 3: pensions payments out of uncrystallised funds

Part 3 creates the Uncrystallised Funds Pension Lump Sum (UFPLS). This is a lump sum which will be payable from funds which are “uncrystallised” , that is, have not yet been used to pay a scheme pension, annuitised or designated to a flexi-access drawdown fund or a drawdown fund.

The creation of the UFPLS will provide an additional option for flexible access to a pension.

It sets out that this kind of lump sum is an authorised payment, and how each such lump sum will be taxed (normally 25% tax-free and 75% taxed as pension income, to mirror the tax in place on other pension withdrawals or pension payments).

It explains when the UFPLS can be paid (on or after 6 April 2015; when the individual has reached normal minimum pension age (currently age 55); when the individual has Lifetime Allowance^{[footnote 2]} remaining).

It sets out how the UFPLS is to be taxed when the individual has reached age 75 and has less Lifetime Allowance available than the amount of the UFPLS. In this case, the tax-free part of the payment is restricted to 25% of their remaining Lifetime Allowance.

It prevents individuals with both a) primary or enhanced protection and b) protected rights to a tax-free lump sum of more than £375,000 from taking UFPLSs. Primary and enhanced protection allow people who had built up greater amounts of pension saving/entitlement to tax-free cash at A-day^{[footnote 3]} than they would be entitled to under the post A-day regime to maintain their rights to this. Allowing these people to take UFPLSs would potentially allow them to take more tax-free cash than they are entitled to.

Individuals with protection for rights built up before A-day to a tax-free lump sum that was more than 25% of their pension rights will still be able to take an UFPLS, but only 25% of this will be tax-free.

1.4 Part 4: annual allowances

This part amends the existing Annual Allowance^{[footnote 4]} provisions to introduce a reduced Annual Allowance of £10,000 for defined contribution (“money purchase”) pension savings for individuals who access their defined contribution pension flexibly. The following are counted as “flexible access”: taking a cash amount over the tax-free lump sum from a flexi-access drawdown account; taking an UFPLS; purchasing a flexible annuity; taking a scheme pension from a defined contribution scheme with fewer than 12 pensioner members or taking a stand-alone lump sum^{[footnote 5]} where the individual has primary but not enhanced protection)

Where an individual has flexibly accessed their pension savings in one of the ways described above, then the amount subject to the Annual Allowance charge will normally be based on any defined contribution savings in excess of £10,000, plus any defined benefit savings in excess of £30,000.

Where the money purchase savings are less than £10,000, all savings are tested against the normal £40,000 Annual Allowance. For those who haven’t flexibly accessed their pension savings, the amount subject to the Annual Allowance charge will continue to be the excess of their pension savings over £40,000.

It sets out that the new Annual Allowance for money purchase savings will apply to individuals in the tax year when they first access their pension savings flexibly as well as any subsequent tax year. It also sets out how to determine when pension rights are first flexibly accessed.

It specifies that it will not be possible to carry forward any unused money purchase Annual Allowance to test against a future year’s money purchase savings.

It sets out how the amounts of defined benefit and money purchase savings are calculated for the purposes of testing against the Annual Allowance and how this works for hybrid schemes set up on or after 14 October 2014, which may have elements of both defined benefit and money purchase savings.

It sets out how to test savings against the money purchase Annual Allowance when an individual first flexibly accesses their savings during a “pension input period” (period of time used for the purposes of calculating the value of savings to be tested against the Annual Allowance) and has made pension savings in that pension input period before flexibly accessing their pension.

It removes the current rule that accessing your pension flexibly results in an Annual Allowance of zero, for the tax year 2015-16 onwards.

1.5 Part 5: miscellaneous amendments

This part makes various amendments to tax and pensions legislation in order to give effect to the announced policy.

It amends the existing rules on tax-free lump sum recycling to ensure they remain effective under the new system.

It removes trivial commutation^{[footnote 6]} for defined contribution savings and, for defined benefit, removes the requirement that it must use up all benefits under the scheme.

It makes a number of alterations to the age at which various payments can be made from pensions, to ensure everything is aligned. It reduces the age at which you can trivially commute defined benefit savings from 60 to 55 (the normal minimum pension age) or earlier if the ill-health condition is met. It reduces the age at which you can access small pots to 55 from 60 or earlier if the ill-health condition is met.

It increases trivial commutation lump sum death benefit to £30,000 to match the trivial commutation lump sum limits introduced in Finance Act 2014.

It increases the number of circumstances in which a trivial commutation lump sum death benefit can be paid, by making guaranteed annuity/scheme pension guarantees payable as trivial commutation lump sum death benefits.

It removes the winding-up lump sum death benefit as it is no longer needed due as the changes to the trivial commutation lump sum death benefit limit mean that all winding-up lump sum death benefits will also qualify to be trivial commutation lump sum death benefits.

It sets out how drawdown pensions that were in existence prior to A-day should be tested against the Lifetime Allowance.

It ensures that individuals with a protected pension age and a pension in payment will be able to transfer their pensions to a different scheme and the pension will remain an authorised payment without the need for the transfer to be a block transfer^{[footnote 7]}.

It introduces a provision (a “permissive statutory override”) which will allow schemes to ignore their rules and instead follow the tax rules if they would like to offer flexibility but would otherwise have to go through a complex process of changing their rules.

It sets out that “relevant withdrawals” (essentially the same withdrawals that constitute flexible access for the purposes of triggering the reduced Annual Allowance and equivalent payments to dependants) from pensions which are made while an individual is temporarily non-resident for UK tax purposes will be treated as arising when in the year that individual returns to the UK and subject to normal UK tax rules, unless these withdrawals have been less than £100,000 in total. This applies to relevant withdrawals from registered pension schemes and from relevant non-UK schemes.

1.6 Part 6: provision of information

This part sets out the requirements on scheme administrators and individuals with regards to the information they are required to provide, when they are required to provide it and to whom. This is intended to make sure that where an individual has flexibly accessed their pension, they can meet the requirements outlined in Part 4, concerning Annual Allowances.

It requires that scheme administrators must provide a statement to individuals who access their pension flexibly, saying that they have done so and when the flexible access occurred. They must do this within 31 days of the flexible access.

It also places a requirement on individuals who flexibly access their pensions to inform other schemes to which they are accruing rights or actively contributing, or to which they contribute in the future, that they have done so. It introduces the term “accruing member” to describe such individuals.

It requires that scheme administrators who are transferring an individual’s pension out to another scheme tell the receiving scheme administrator if that individual has flexibly accessed their pension.

It requires individuals who are currently in flexible drawdown and who will therefore be deemed to have flexibly accessed their savings from 6 April 2015 to inform schemes that they have flexibly accessed their pension if and when they make any further pension contributions.

It requires individuals who convert a drawdown fund to a flexi-access drawdown fund to inform schemes that they have flexibly accessed their pension if and when they make any further pension contributions.

It also requires that scheme administrators must provide a pensions savings statement to an individual who has flexibly accessed their pension savings if their money purchase savings in that scheme exceed £10,000 for a tax year. They must also report to HMRC when they provide a pensions savings statement to an individual.

1.7 Part 7: overseas pensions

This part makes changes to non-UK pensions to ensure that the new UK pensions system is reflected in the treatment of overseas schemes which consist of or contain UK tax-relieved funds. Broadly speaking, this ensures that for UK tax purposes these funds will be treated as if they were in a UK registered pension scheme.

To ensure that the information required under Part 6 is available it extends powers to make regulations about the information that:

• scheme managers of qualifying recognised overseas pension schemes (QROPS) must provide to other QROPS scheme managers, scheme administrators of UK registered pension schemes and to members
• scheme administrators of UK registered pension schemes must provide to scheme managers of QROPS
• individual members of overseas schemes must provide to scheme administrators of UK registered pension schemes and to scheme managers of other overseas schemes

It also requires scheme managers of qualifying overseas pension schemes to provide information on when someone first flexibly accesses their pension rights (as required under Part 4 of Schedule 1) when reporting information relating to access to pension rights.

It ensures that the new flexibilities also apply to overseas schemes in the same way that they apply to registered schemes. This includes, for example, ensuring that payments from funds within overseas schemes that have received UK tax relief and would be UFPLS payments created by Part 3 of Schedule 1 if paid from a registered scheme, can be taxed as an authorised payment, and that the £10,000 reduced annual allowance described in Part 4 of Schedule 1 also applies in respect of certain overseas schemes.

It also amends the mechanism for calculating an individual’s remaining lifetime allowance when they have transferred pension rights to a QROPS or elected for their rights under an overseas scheme to be tested against their lifetime allowance, to take account of a subsequent payment of an UFPLS.

2. Schedule 2

2.1 Part 1: death benefits, nominees and successors

This part extends the categories of person who can inherit a drawdown fund. Currently pension death benefits can be paid only to dependants (normally a spouse or child under 23). This amends the rules so a ‘nominee’ or a ‘successor’ can also inherit a flexi-access drawdown fund.

A nominee can be anyone who has been nominated by the individual other than a dependant. If the deceased has made no nomination and there are no dependants, the scheme administrator can nominate an individual to become entitled to the funds.

A successor can be anyone nominated by the previous beneficiary, or, if no nomination has been made by the beneficiary, by the scheme administrator.

The changes in Part 1 of Schedule 1 for flexi-access drawdown funds are subsequently mirrored for new nominees’ and successors’ flexi-access drawdown funds.

2.2 Part 2: lump sum death benefits

This part ensures that the appropriate tax charges apply to lump sum death benefits.

Where certain lump sum death benefits are paid, a tax charge - the special lump sum death benefit charge - arises if the member has reached age 75 at the time of their death. In clause 2 of this bill we are reducing the rate of tax that applies to these lump sums from 55% to 45%.

This part provides that this charge also applies where a flexi-access lump sum death benefit is paid from the newly-introduced nominees’ or successors’ flexi-access drawdown fund and the nominee or successor had reached age 75 at the time of their death. This aligns the position with that for dependants’ flexi-access drawdown funds.

This part also applies the lifetime allowance charge where certain lump sums are paid tax-free as a result of the changes made by clause 2.

2.3 Part 3: uncrystallised rights at member’s death

This part introduces a new test against the lifetime allowance to ensure that uncrystallised funds that are then used to provide a drawdown pension for a dependant or a nominee are tested against the original (deceased) individual’s lifetime allowance. The beneficiary is liable to any lifetime allowance charge arising.

2.4 Part 4: income tax on beneficiaries’ income withdrawal

This part ensures that payments from inherited drawdown funds can be paid tax-free where the person from whom it was inherited died before the age of 75.

It also ensures that these tax exemptions that apply in respect of registered pension schemes also apply to foreign pensions.   [^1]: Guaranteed annuities are lifetime annuities which must be paid out for a specified period of time - so even if the annuitant happens to die within that time period, payments will continue to be made to their beneficiary. However, if the annuitant outlives the guarantee period, payments continue to be made as they would with a normal annuity.

1. Although you can save any amount into your pension, there is a limit to the amount of pension savings on which you can receive tax relief over your lifetime. The Lifetime Allowance is currently set at £1.25 million. ↩

2. On 6 April 2006 – “A-day‟ – the government implemented a new, simplified tax regime for pensions to replace the eight existing regimes. ↩

3. Although you can save any amount into your pension, there is a limit to the amount of pension savings on which you can receive tax relief. The Annual Allowance is the maximum amount of tax-relieved pension saving you can build up over one year. ↩

4. A lump sum relating to pre A-day where the whole amount can be taken as a lump sum without a connected pension. The requirements are set out in articles 25 to 25D in the Taxation of Pension Schemes (Transitional Provisions) Order 2006 (SI 2006/572). ↩

5. If an individual has less than £30,000 of pension wealth in total, they may take this as a lump sum. This is known as trivial commutation. ↩

6. A transfer where more than two or more members of a pension scheme transfer their rights to the same scheme. This usually occurs where an employer wants to transfer the rights of a group of employees from one pension scheme to another. ↩