Flexible access and the annual allowance: How does it work? www.allenovery.com

Flexible access and the annual allowance: How does it work? www.allenovery.com

2 DCHQ Freedom and choice series: briefing 3 Flexible access and the annual allowance how does it work? Certain methods of flexible access for example, taking a cash lump sum from a DC pot worth more than GBP10,000 or taking a payment from a flexi-access drawdown fund will trigger changes to an individual s annual allowance, restricting their ability to make tax-relieved contributions to a DC arrangement to GBP10,000. This briefing looks at how the restriction works, what actions trigger it, and the tax planning implications for individuals.

3 HOW THE ANNUAL ALLOWANCE WORKS Normally, an individual has an annual allowance (AA) of GBP40,000 for making tax-relieved contributions to any type of arrangement, whether defined benefit or defined contribution. That may be increased by carrying forward any unused AA from the previous three tax years. In the year in which an individual flexibly accesses DC pension rights for the first time, and in later years, things get more complicated. You have to see whether the individual s non-tax-relieved contributions would be greater under the default AA or the new alternative basis. This alternative basis looks separately at defined benefit accrual (if the individual has any) and DC contributions. In relation to DB accrual, the AA is the default amount (the same amount as on the standard basis, including any carry forward) less GBP10,000. For DC contributions, there s a separate allowance, which is GBP10,000. This is a fixed allowance each year, with no carry-forward and no cross-over with the allowance for DB inputs. ACCESSING SAVINGS WITHOUT TRIGGERING THE ALTERNATIVE AA The alternative AA basis doesn t apply in every situation. For example, from April 2015 an individual can: cash out a DC pot of up to GBP10,000 under the small lump sum rules; buy an annuity; continue in capped drawdown; or designate funds for flexi-access drawdown and take a 25% tax-free lump sum; all without any impact on their AA.

4 EVENTS WHICH TRIGGER THE ALTERNATIVE AA If a member: takes a cash lump sum from a DC pot which is worth more than GBP10,000, or takes a payment from a flexi-access drawdown fund which is created from 6 April 2015 onwards, or which is converted from capped drawdown, then they need to bear in mind that their future DC contributions will be restricted to GBP10,000. There could also be an impact in relation to any ongoing DB accrual. The same rules apply immediately from 6 April 2015, to members with existing flexible drawdown funds which convert to flexi-access on that date that s the case whether or not a payment is taken from the fund. It s important to remember that this alternative AA basis only makes a difference to members who are still accruing DB pension rights, or making DC contributions for example, if they are using their DC access to fund reduced working hours. In addition, it only applies if a series of conditions is met: First, the member has to have undertaken flexible access in one of the ways we ve just seen. Even then, if the member makes DC contributions of less than GBP10,000 in the relevant pension input period, the default annual allowance applies. If the member makes DC contributions of more than GBP10,000 in an input period, then this alternative basis may apply. Tax will only be charged on the alternative AA basis if the tax charge would be higher on this basis than on the basis of the default annual allowance. To recap, individuals can cash out any number of small pots worth up to GBP10,000 each from occupational pension schemes, and up to three from personal pension schemes, without any impact on the annual allowance at all. Members can also designate funds for flexi-access drawdown after 6 April 2015 (or for capped drawdown before 6 April 2015) and take a tax-free pension commencement lump sum without triggering these new rules unless and until they take a payment from a flexi-access fund. However, accessing DC savings through lump sum cash withdrawal (from a pot worth more than GBP10,000) or through a payment from a flexi-access drawdown fund or a converted capped drawdown fund will trigger a restriction on DC contributions and different annual allowance calculations. These will also apply to members who are in flexible drawdown before 6 April 2015.

5 IMPLICATIONS FOR MEMBERS In practice, individuals who don t have ongoing DB accrual are likely to want to use up any rolled-forward annual allowance which they haven t used in previous years before triggering the new rules it s a case of use it or lose it. In contrast, individuals who are already in flexible drawdown currently have a nil annual allowance. If they are still working, they may want to restructure their benefit arrangements to take advantage of the new GBP10,000 annual allowance which will apply to them from 6 April. Members with multiple DC pots from previous employment may want to consider carefully the order in which they access their DC savings - for instance, if an active member has several DC pots elsewhere worth less than GBP10,000 each, it may make sense to cash those out under the small lump sum rules before accessing funds from larger pots which would trigger the alternative annual allowance rules. IMPLICATIONS FOR TRUSTEES AND ADMINISTRATORS For trustees and administrators, there will obviously be a need to update systems to address the new rules. Many schemes have previously incorporated provisions addressing the annual allowance into their rules and these will need to be reviewed to make sure they are still appropriate. The trustees of an individual s active scheme will need prompt information about the member accessing DC rights under other schemes, as this will affect annual allowance calculations. Regulations will require members to inform their current scheme about this, but members will need to understand their responsibilities in this area, and the information they provide will have to be processed promptly and correctly so that pension savings statements can be issued. Members may also need more help understanding their annual allowance and keeping track of contributions against the changed limits, and their current scheme is likely to be the first port of call for queries on these issues. For all these reasons, schemes may need to plan for an increased administration workload in the run-up to the changes and possibly on an ongoing basis. To find out more about the detail and implications of the April 2015 changes, visit our DC resource base, www.allenovery.com/dchq. SEPTEMBER 2014

FOR MORE INFORMATION, PLEASE CONTACT: Maria Stimpson Tel +44 20 3088 3665 maria.stimpson@allenovery.com Däna Burstow Tel +44 20 3088 3644 dana.burstow@allenovery.com Neil Bowden Tel +44 20 3088 3431 neil.bowden@allenovery.com Helen Powell Tel +44 203 088 4827 helen.powell@allenovery.com GLOBAL PRESENCE Allen & Overy is an international legal practice with approximately 5,000 people, including some 526 partners, working in 44 offices worldwide. Allen & Overy LLP or an affiliated undertaking has an office in each of: Abu Dhabi Amsterdam Antwerp Budapest Casablanca Doha Jakarta (associated office) London Luxembourg Prague Riyadh (associated office) Rome Athens (representative office) Bangkok Dubai Düsseldorf Madrid Mannheim São Paulo Shanghai Barcelona Frankfurt Milan Singapore Beijing Hamburg Moscow Sydney Belfast Hanoi Munich Tokyo Bratislava Ho Chi Minh City New York Warsaw Brussels Hong Kong Paris Washington, D.C. Bucharest (associated office) Istanbul Perth Yangon Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP s affiliated undertakings. CS1409_CDD-40046_ADD-47113_Briefing3 www.allenovery.com