Changes relating to age 75 and flexible drawdown

Transcription

1 October 2011 Registered pension schemes: Changes relating to age 75 and flexible drawdown This year s Finance Act makes a number of changes from 6 April 2011, concerning the impact that reaching age 75 has on the benefits which a registered pension scheme may pay (and the way in which those benefits are taxed). This newsletter summarises these changes, and then goes on to describe the new facility from 6 April 2011 for schemes to provide flexible drawdown. Lump sums paid to members Until 6 April 2011, many types of lump sum payable to a member from a registered pension scheme could only be paid before age 75. A lump sum paid on or after that age would be an unauthorised payment, leading to adverse tax consequences for both the member and the scheme. The Finance Act 2011 lifts this restriction in most cases. 1 The main type of lump sum that this change applies to is a pension commencement lump sum (being the main form of retirement lump sum), but the age 75 restriction is also lifted from the payment of trivial commutation lump sums, stand-alone lump sums, serious ill-health lump sums and winding-up lump sums. Contents Lump sums paid to members... 1 Lump sum death benefits. 1 Consequential changes to tax treatment... 2 Capped drawdown (previously unsecured pensions )... 3 TABLE 1: Lump sums payable to member ( LSs ) 4 TABLE 2: Lump sum death benefits ( LSDBs )... 5 Flexible drawdown... 6 Specific issues... 7 Lump sum death benefits A similar relaxation is introduced in relation to lump sum death benefits. Those lump sum death benefits that are permitted by the legislation can now be paid regardless of the member s age at death, whereas previously most of them could only be paid if the member had died before age 75 (and one type of lump sum a charity lump sum death benefit could previously only be paid if the member had died on or after that age). 1 The only exceptions are short service refund lump sums and lifetime allowance excess lump sums. These can still only be paid before age 75 (although this continuing restriction is rarely likely to become an issue in practice). 1 Registered pension schemes: Age 75

2 Consequential changes to tax treatment New benefit crystallisation event at age 75 It remains the case that a member s prospective defined benefits will be tested against his available lifetime allowance on reaching age 75, if he has not yet started to draw them. This principle is now extended to money purchase benefits too. Taxation of lump sum death benefits There are two main forms of tax treatment which apply to lump sum death benefits, depending on the type of benefit concerned. Until now, the position has been as follows: > Lifetime allowance test. Some lump sum death benefits are tested against the deceased s available lifetime allowance at the point of payment, which may (depending on the numbers) lead to a lifetime allowance charge. This applies to the main types of defined benefit lump sums (except for a pension protection lump sum death benefit see next point) and money purchase lump sums where the member had not started to draw his benefits when he died. > Special tax charge. Other lump sum death benefits are subject instead to a special lump sum death benefits charge 2. This applies if the benefit relates to a money purchase pension (or annuity) to which the member had become entitled before he died. It also applies to a defined benefit pension protection lump sum (which is a lump sum death benefit that can arise if the member had become entitled to his pension before he died and specified that the lump sum death benefit be treated as such). There are two changes from 6 April 2011: > The first is that the rate of the special tax charge is raised from 35% to 55%. > The second change arises from the fact that, for the first time, lump sums of the kind described in the first category above (under the subheading Lifetime allowance test) may be paid on or after reaching age 75. As (subject to one exception 3 ) the legislation provides that no lifetime allowance test should occur after a member has reached 75, the special lump sum death benefits charge will now apply to these benefits (instead of the lifetime allowance charge) where a member dies having reached that age. 2 3 This is payable by the scheme administrator (which generally means the trustees, in the case of an occupational pension scheme). Usually the scheme rules will allow the trustees to deduct the tax charge from the lump sum giving rise to it. The exception is the situation where there is a substantial increase to a pension in payment. 2 Registered pension schemes: Age 75

3 Taxation of serious ill-health lump sums These are already subject to the lifetime allowance regime, and so are tested against the member s available lifetime allowance at the point of payment. This may (depending on the numbers) lead to a lifetime allowance charge. This is another area, however, where the new ability to pay the benefit after the member has reached age 75 complicates the existing position. As (subject to one exception 4 ) a lifetime allowance test cannot be carried out once a member has reached age 75, a new 55% tax charge 5 now applies to those serious ill-health lump sums paid after the member has reached age 75 (even though the member s benefits will already have been tested against the lifetime allowance when he reached that age). The effects of these various changes are shown in the coloured areas of the tables on the next two pages. Capped drawdown (previously unsecured pensions ) Payments from money purchase arrangements which previously came under the label of unsecured pensions are now called drawdown pensions instead. HMRC are using the term capped drawdown for the drawdown regime that replaces unsecured pensions (to distinguish it from flexible drawdown, an entirely new facility which we outline from page 6). In some respects, the capped drawdown regime differs from the unsecured pensions system which it replaces: > Short-term annuities (i.e. the kind that cannot be paid for more than 5 years) may now continue to be paid after reaching age 75. > Income withdrawal is subject to changes too: - The maximum amount of pension is now 100% of an equivalent annuity (the basis amount ). Previously the percentage was 120% of the basis amount before reaching age 75 and 90% of the basis amount after that. - The period for reviewing the amount of pension is reduced from five years to three years before reaching age 75, and is annual from then on. 4 5 The exception is the situation where there is a substantial increase to a pension in payment. This is payable by the scheme administrator (which generally means the trustees, in the case of an occupational pension scheme). Usually the scheme rules will allow the trustees to deduct the tax charge from the lump sum giving rise to it. 3 Registered pension schemes: Age 75

4 TABLE 1: Lump sums payable to member ( LSs ) Type of LS Pre-6 April 2011 age 75 restriction Is restriction lifted now? Pre-6 April 2011 treatment of LS Any changes to tax treatment from 6 April 2011 Pension commencement LS Serious ill-health LS Tested against lifetime allowance (unless member has reached 75). New 55% tax charge on scheme administrator if member has reached Trivial commutation LS Winding-up LS LS up to 2,000 Payable only before age 75 YES Taxed as income, but with scope for up to 25% of payment to be taken tax-free. Stand-alone LS Lifetime allowance excess LS Tested against lifetime allowance (unless member has reached 75). Short service refund LS NO Scheme taxed 20% on first 20k and 50% on excess. Refund of excess contributions LS No age 75 restriction Any excess relief provided is deducted from LS. 6 Calculated on the amount of the lump sum payment. Most occupational pension schemes rules will enable the trustees to deduct the tax from the benefit. 4 Registered pension schemes: Age 75

5 TABLE 2: Lump sum death benefits ( LSDBs ) Type of LSDB Pre-6 April 2011 age 75 restriction Is restriction lifted now? Pre-6 April 2011 treatment of LSDB Any changes to tax treatment where death is on or after 6 April 2011 Defined benefit LSDB Uncrystallised funds LSDB Tested against lifetime allowance (unless member had reached 75). 55% tax charge on scheme administrator if member died having reached age Pension protection LSDB Annuity protection LSDB Drawdown pension fund LSDB Payable only on death before age 75 YES Special 35% tax charge on Rate of tax charge has gone up to 55%. scheme administrator. 7 LSDB up to 2,000 Trivial commutation LSDB Taxed as income. Winding-up LSDB No age 75 restriction Charity LSDB NOT payable on death before 75 YES (if in drawdown) 7 Calculated on the amount of the lump sum payment. Most occupational pension schemes rules will enable the trustees to deduct the tax from the benefit. 5 Registered pension schemes: Age 75

6 Flexible drawdown Overview Flexible drawdown is a new facility that lets money purchase schemes provide a drawdown pension which, unlike capped drawdown (see page 3), is not capped at a maximum (or minimum) amount. Flexible drawdown applies if: > a member meets the flexible drawdown conditions (outlined below); > he makes a valid declaration to the scheme to that effect; and > that declaration is accepted by the scheme. A member meets the flexible drawdown conditions if: > he satisfies the minimum income requirement (see next sub-heading) on the day when he first makes that declaration; > no relevant money purchase contributions are paid by or on behalf of him under a registered pension scheme in the tax year in which the declaration is made; and > at the time of the declaration, he is not an active member of any registered pension scheme which has a defined benefits or cash balance arrangement relating to him. There are corresponding rules relating to dependants. Minimum income requirement A person satisfies the minimum income requirement at a given time in a tax year if the relevant income payable to him for that tax year is not less than 20,000. Relevant income comprises a wide variety of different types of pension payments, including some overseas pensions, certain social security pensions, and payments under the financial assistance scheme (but not from the Pension Protection Fund). Drawdown pensions, however, do not count. Adverse annual allowance consequences We have mentioned the need: > for the member not to be an active member of a defined benefits or cash balance arrangement under a registered pension scheme at the time when the declaration is made; and > for there to be no relevant money purchase contributions to or in respect of him during that tax year. 6 Registered pension schemes: Flexible drawdown

7 The member may subsequently recommence such contributions or accrual (either to his original scheme or another one), but after the first tax year following that in which flexible drawdown commences he will be treated for annual allowance charge purposes as if the annual allowance were nil. Specific issues Flexible drawdown raises a number of issues: > Flexible drawdown may only be provided from money purchase arrangements. Even money purchase schemes do not have to provide it, but some may wish to do so (even if only indirectly, by allowing transfers to another scheme see next point). > The administrative aspects of operating drawdown may be of concern to some trustees who would otherwise like to make flexible drawdown available. In these cases the scheme could allow transfers, during the period approaching retirement, to another money purchase scheme (which would have the necessary systems for flexible drawdown in place). The member may need to leave enough of his benefits behind in the transferring scheme in order for him to satisfy the Minimum income requirement (see page 6), in which case it would need to be a partial transfer. > It may also be possible for a defined benefits scheme to transfer the member s accrued rights into a money purchase scheme in this way (or even to convert those rights into money purchase benefits within the same scheme), so opening the way to flexible drawdown for members who ask for this. Some care would be needed to comply with all the legislative requirements, given that this would involve switching from defined benefits to money purchase. One advantage for a scheme of providing this facility is the possibility of closing off some of the defined benefit funding risks. > Schemes that make flexible drawdown available should communicate this, at least to those members whose benefits from the scheme indicate that they would be likely to be able to benefit from it. Members expressing an interest in flexible drawdown should however be warned of the tax implications (see the paragraph at the top of this page) and advised to seek independent financial advice. > Whether a rule amendment is needed will depend on what the existing rules say and what is proposed. Basic provision of flexible drawdown from a money purchase arrangement will typically be possible under the scheme s discretionary powers. However, a different approach to making flexible drawdown available (for instance, by means of partial transfers to another scheme) may require a rule amendment depending on how wide the scheme s existing powers are. 7 Registered pension schemes: Flexible drawdown

8 For further information please speak to your usual Linklaters pensions contact. Contacts For further information please speak to your usual Linklaters pensions contact. Author: This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2011 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP together with a list of those non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ or on and such persons are either solicitors, registered foreign lawyers or European lawyers. Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. One Silk Street London EC2Y 8HQ Telephone (+44) Facsimile (+44) Linklaters.com 8 Registered pension schemes: Flexible drawdown