Back in June, I wrote about the Chancellor’s announcement in his emergency budget that the Government would look at overhauling legislation that would restrict pensions tax relief from April 2011. The Chancellor said at the time that he would assess the possibility of reducing the level of the annual allowance instead of implementing the previous Government’s plans to introduce a high income excess relief charge, which industry and employers’ bodies complained were too complicated and could deter pension saving.
Action has now been taken.
On 27 July 2010, HM Treasury published a discussion paper outlining its proposals for an alternative means of restricting pensions tax relief. The main proposals for discussion are as follows:
1. Reducing the annual allowance
The discussion paper says that the reduced level of the annual allowance would depend on how the restriction is designed, but it was likely to be between £30,000 and £45,000. The main points raised for discussion are:
a) A tailored annual allowance charge. Instead of the current flat-rate 40 per cent charge, contributions exceeding the annual allowance would be treated as the top slice of an individual’s income and subject to a recovery charge that would vary according to whether income is taxed at the higher rate or the additional rate;
b) Valuing defined benefit accruals. For valuing deemed contributions to defined benefit pension schemes, the Government proposes using a flat-rate factor in the region of 15-20 (the current factor being 10.) The Government Actuary’s Department suggests that a factor of 15-20 could lead to an annual allowance of £40,000 being needed;
c) Treatment of deferred members. Carving out deferred members from the annual allowance test would ease administrative burdens on schemes, but could raise potential fairness issues over the treatment of active members;
d) Exemptions from the annual allowance test. The Government proposes that contributions or accruals would not be tested against the annual allowance on death or when a serious-ill-health lump-sum is paid; and
e) Reducing the lifetime allowance. To maintain cohesion between the annual allowance and the lifetime allowance, the Government proposes reducing the latter from its current £1.8m level. Consequently, it seeks views on whether the value of rights receiving primary or enhanced protection should be frozen.
2) Managing the impact of the annual allowance charge in defined benefit schemes
The discussion paper identifies a number of issues that may arise in defined benefit schemes, particularly unusual ‘spikes’ in accruals by individuals who are not normally subject to an annual allowance charge. The paper offers several suggestions for dealing with such situations, including capping or smoothing accruals so they do not exceed the annual allowance, or redesigning or removing benefit elements that may cause spikes. The Government has said that it will look out for actions that try to take advantage of the flat-rate valuation of defined benefit accruals, such as awarding large pension increases or bringing forward the normal pension age.
3) Paying the annual allowance charge
A revised annual allowance would still be assessed and collected through the self-assessment tax return. However, the Government has asked for views on whether the pension input period for the purposes of the annual allowance should be aligned with the tax year. Transitional measures will be included in legislation to cover those people who have already exceeded their reduced annual allowance by April 2011, but where their input period does not end until 2012.
4) Informing scheme members and HM Revenue & Customs
The Government suggests there is a case for requiring defined benefit schemes to inform members about their pension input amounts. Views are sought on whether schemes should be required to notify members specifically if their pension input amounts exceed the annual allowance.
What happens next?
All submissions to the discussion paper must be received by 27 August 2010. The Government will then decide by the end of September 2010 whether to proceed with reducing the annual allowance. If it does, the measures in the Finance Act 2010 to bring in a high income excess relief charge will be repealed.
However, this discussion paper shows that reducing the level of the annual allowance is potentially problematic for the Government. For example, there are fairness issues that need to be properly considered, particularly in relation to the comparative treatment of active and deferred members. Consequently, unless anti-avoidance provisions are included in any new legislation, it is possible that high-earners with substantial pension entitlements could manipulate the new regime to their advantage.
The Government has much to consider…