PENSIONS PROFILE MARCH 2011 REMOVING THE REQUIREMENT TO ANNUITISE BY AGE 75 Summary From 6 April 2011, the requirement to buy an annuity by age 75 will be removed. Alternatively Secured Pensions (ASPs) will cease to exist and drawdown can continue past age 75. For those wishing to take drawdown there will be two options: Capped drawdown with income falling between a minimum of nil and 100% of the equivalent annuity; or Flexible drawdown with the ability to draw down unlimited amounts provided the individual is in receipt of a minimum income of 20,000. The maximum capped amount that may be withdrawn will be set at least every three years until age 75 and then annually thereafter. Updated GAD tables have been issued for calculating maximum income from drawdown funds. The tax rate for all lump sum death benefits is to be set at 55%, apart from death benefits for those who die before age 75 without having taken any benefits, which will remain tax-free. The age 75 ceiling will be removed for pension commencement lump sums. Background In the Emergency Budget on 22 June 2010, the coalition government announced that changes would be made to end the obligation to purchase an annuity by age 75 with effect from 6 April 2011. In addition, this Budget introduced transitional measures for those turning 75 in the meantime and confirmed that the changes would be a matter for consultation amongst the industry (which was launched on 15 July 2010 and closed on 10 September). The government considered 185 responses (on subjects including taxation of death benefits, the design of capped drawdown and flexible drawdown, and the impact on providers) and on 9 December 2010 published draft legislation for the Finance Bill 2011: http://www.hmtreasury.gov.uk/d/pensions_annuitisation.pdf The government s response to the consultation paper is found on: http://www.hm-treasury.gov.uk/d/consult_age_75_annuity_responses.pdf; This legislation will fundamentally change the current annuitisation requirements and pensions tax treatment and rules applicable to income drawdown arrangements. = ANY QUESTIONS? If you have any questions or comments in relation to this article, please email pensions.technical@landg.com
2 PENSIONS PROFILE Removal of the age 75 rule Under the new proposals, from 6 April 2011, an individual will be able to purchase an annuity with all or part of their pension fund without any age restrictions. The legislation will enable individuals with DC pension savings, from which they have not yet taken a pension, to defer a decision to take benefits from their scheme indefinitely on and after 6 April 2011. Furthermore, the age 75 restrictions on value protection, short-term annuities and trivial commutation will be removed. Under the new rules, the concepts of Unsecured Pensions (USP) and Alternatively Secured Pension (ASP) will disappear and there will only be one alternative to an annuity - a drawdown pension. Existing USP and ASP members will automatically become subject to the new drawdown rules from 6 April 2011, including those for death benefits (see later). Importantly, pension commencement lump sums will be able to be paid at any time after age 55 (in most cases), even past the age of 75. Continuing significance of age 75 All drawdown and uncrystallised benefits will be still subject to lifetime allowance testing at age 75. Furthermore, tax relief will only continue to be available on contributions paid before age 75. New income limits Capped drawdown From 6 April 2011, the maximum withdrawal of income that an individual will be able to take will be 100% (currently 120%) of the equivalent annuity that could have been brought with the fund value (the minimum withdrawal will continue to be zero). This maximum capped amount will be reviewed at least every three years (changed from the current five year reviews) until the member attains age 75, after which annual reviews will determine the level of income. As all existing ASP holders are over 75, they will continue to have annual investment reviews. The Government Actuary s Department (GAD) has issued recently updated tables extended beyond age 75 as the basis for calculating the annual capped drawdown limit. Under the new tables, drawdown rates will generally be lower for example for a male aged 60 with funds designated to drawdown of 100,000, the maximum level of income on the 120% basis and present GAD table would be 7,440. On the new 100% basis on the new revised table, maximum income would drop to 6,100. There will be an interim period (until 6 June 2011) where both new and old tables will be in use. Full details can be found on: http://www.hmrc.gov.uk/pensionschemes/gad-tables.htm In addition, dependants drawdown pensions may continue after age 75. There are transitional rules for those members with unsecured pensions fund arrangements and were under the age of 75 before 6 April 2011. As an easement to providers, the government proposes that the new withdrawal limits and triennial reviews of capped drawdown pensions should apply only from the date of their next review. In practice, this will be the earliest of the following events: the fifth anniversary of the most recent review; following a 75 th birthday: the first anniversary of the most recent review; or following a transfer to another drawdown provider, the first anniversary of the most recent review. For drawdown pension arrangements made before 6 April 2011, the altered withdrawal limits will have effect for individuals whose 75 th birthday is or was: on or after 6 April 2011, from the start of their next reference period to begin on or after that date; before 6 April 2011, from the start of the drawdown pension year in which 6 April 2011 falls (with one exception see next bullet); and
3 PENSIONS PROFILE from 22 June 2010 through to 5 April 2011, the changes will have effect from the start of their next drawdown pension year to begin on or after 6 April 2011. Flexible drawdown If an individual wishes to draw down more than the capped limits, then they can consider flexible drawdown (subject to the provider offering this facility) from their non-protected rights funds (note that protected rights are excluded). This offers unlimited taxable amounts (up to the remaining value of the fund) providing they produce evidence that they have secured a sufficient minimum income to prevent them from exhausting their savings and becoming reliant on the state. This minimum income requirement (MIR) has been set at a non age-related figure of 20,000 p.a., and will be set by Treasury Order at least every five years. The MIR must provide a secure income for life, which includes: State pensions Lifetime annuity or dependant s lifetime annuity Scheme pension or dependant s scheme pension Overseas pension payment equivalent to a lifetime annuity or scheme pension The MIR cannot be satisfied by drawdown payments, dependant drawdown payments or overseas pensions equivalent to drawdown. In addition, income from purchased life annuities (PLAs) will not count towards the MIR. The government will keep under review pension income that can count towards the MIR. Due to the high level of the MIR, the flexible drawdown option will effectively only be available to relatively wealthy individuals (the government s report has indicated that approximately 50,000 individuals currently in a drawdown arrangement could initially benefit from flexible drawdown). An individual making a withdrawal from a flexible drawdown pension fund during a period when they are resident outside the UK for a period of less than five full tax years will be liable to UK income tax on that withdrawal for the tax year in which they become UK resident again. At the point of election, there must have been no contributions made to a money purchase scheme in that same tax year, and the member must have ceased being an active member of a defined benefit scheme. Once in flexible drawdown, to prevent future income recycling, an individual will be liable to the annual allowance charge on all pension input amounts to any registered pension scheme. This will therefore prevent any further pension contributions being made to any pension scheme and individuals must cease any active membership of a defined benefit scheme. Once the MIR has been satisfied and the declaration accepted, there will be no further retesting. Death benefits Crystallised pension funds in drawdown can currently be passed on tax-free after death, provided that they are used to provide a dependant s pension. This will continue to be the case after 6 April 2011. However, draft legislation provides a fundamental change to the tax treatment of lump sum death benefits. The tax rate for all lump sum death benefits is to be set at 55%, with the exception of death benefits for those who die before age 75 with uncrystallised funds, which will remain tax-free. This 55% recovery charge will apply in respect of deaths on or after 6 April 2011. For those individuals in drawdown, this charge on their crystallised funds will be a significant increase from the current rate of 35%. This higher tax charge will undoubtedly increase the attractiveness of phased drawdown (where uncrystallised funds will not be subject to any tax charges on death). Conversely, for those in ASP, the 55% tax charge will be a marked decrease from the current level of 82%. The rationale behind this is that because tax relief is given on pension contributions and investment growth and 25% of the pension pot can still be taken tax free, the government considers that it is important for pension benefits be taxed at this higher rate, which reflects the value of relief given. Any
4 PENSIONS PROFILE unused funds in drawdown will be taxed at this new rate of 55% to recover past relief given (unless they are used to provide a dependant s pension). Importantly, lump sums paid as serious ill-health lump sum will also be taxed at 55% after age 75. However, serious ill-health lump sums will continue to be tax-free when paid to a member who has not yet reached the age of 75. In cases where there are no dependants, it will still be possible for individuals to pass on unused pension savings to a nominated charity upon death free of tax. Inheritance tax Currently there is an omission to act clause within the Inheritance Tax Act 1984 that generally means, that if certain conditions are met, pension funds could potentially be added to an individual s estate on death where they had not been fully crystallised by the selected retirement date. In order to accommodate the forthcoming removal of the age 75 ceiling from 6 April 2011, the IHTA 1984 will be amended to remove this clause. From 6 April 2011: IHT will not typically apply to drawdown pension funds (this includes death from age of 75). The current IHT anti-avoidance rules applying where the individual fails to take their pension benefits (e.g. a failure to buy an annuity) will be removed. Conclusion The new draft legislation will introduce some radical pensions changes from 6 April 2011 such as the removal of the age 75 ceiling, drawdown of the entire pension fund after income tax (provided the MIR is met), tax-free cash payments after age 75, and the increase in tax charge from 35% to 55% on crystallised funds lump sum death benefits. For those currently in ASP, the reduction of 82% tax charge to 55% is a significant improvement in terms. The A-Day concepts of USP and ASP will be consigned to the history books. The new rules will give investors far more control and flexibility over their retirement options, although the vast majority of people will continue to choose an annuity in exchange for their retirement fund.
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