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Taxation of Pensions Bill 2014-15 Bill No 97 of 2014-15 RESEARCH PAPER 14/57 23 October 2014

This paper has been prepared for Second Reading of the Taxation of Pensions Bill 201415, scheduled for 29 October 2014. At present, most people with defined contribution (DC) pension savings use them to buy an annuity. This is because pension tax legislation allows lump sum or flexible withdrawals only in limited circumstances. In Budget 2014, the Government announced that from 6 April 2015, people aged 55 and over would be able to access their DC pension savings when and how they choose, subject to their marginal rate of income tax. The Bill would make changes to pension tax legislation to implement this. It would also restrict and reduce certain tax charges applying to death benefits. Related changes, such as providing for a guidance guarantee and a prohibition on transfers from unfunded public service defined benefit schemes to DC schemes, are in the Pension Schemes Bill 2014/15.

Djuna Thurley Roderick McInnes

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Research Paper 14/57 Contributing Authors:

Djuna Thurley, Policy, Business and Transport Section Roderick McInness, Statistics, Social and General Statistics Section

This information is provided to Members of Parliament in support of their parliamentary duties and is not intended to address the specific circumstances of any particular individual. It should not be relied upon as being up to date; the law or policies may have changed since it was last updated; and it should not be relied upon as legal or professional advice or as a substitute for it. A suitably qualified professional should be consulted if specific advice or information is required. This information is provided subject to our general terms and conditions which are available online or may be provided on request in hard copy. Authors are available to discuss the content of this briefing with Members and their staff, but not with the general public. We welcome comments on our papers; these should be e-mailed to [email protected]. ISSN 1368-8456

Contents 1

2

3

4

Summary

1

Background

2

1.1

The pension tax framework

3

1.2

Current options on retirement

4

Pensions from money purchase arrangements

5

Lump sum payments

8

Attitudes to and awareness of the different options

9

1.3

The requirement to annuitise

10

1.4

Problems in the annuities market

13

Financial Services Consumer Panel report

13

The FCA’s Thematic Review

14

Annuity rates

15

Current reform proposals

17

2.1

Budget 2014

17

Responses

19

2.2

Queen’s Speech 2014

21

2.3

Finance Act 2014

21

2.4

Freedom of choice in pensions

22

The guidance guarantee

22

Prohibition on transfers from defined benefit schemes

24

Minimum pension age

24

Interaction with other forms of support for pensioners

25

Expected impact

27

3.1

Exchequer

27

3.2

Individuals

28

3.3

The market

29

The Bill

32

4.1

Overview

32

4.2

Initial responses

33

4.3

How the Bill will change options at retirement

34

4.4

Flexi-access drawdown

34

Members

34

4.5

4.6

4.7

4.8

4.9

Dependants

35

Annuities

36

Comment

38

Uncrystallised pension fund lump sums

38

Comment

39

Money purchase annual allowance rules

40

Current rules

40

The Bill

42

Comment

44

Miscellaneous amendments

45

Pension commencement lump sum - recycling

45

Trivial commutation lump sum

45

Small pots

46

Other provisions

46

Permissive statutory override

47

Provision of information

48

4.10 Overseas pensions

49

4.11 Restriction and reduction of tax charges on certain lump sums

49

The Bill

51

Comment

52

Glossary

54

RESEARCH PAPER 14/57

Summary Individuals with defined contribution (DC) pensions build up a pension fund using contributions, investment returns and tax relief. At present, most people with DC pension savings use them to buy a lifetime annuity – a financial product which provides a regular income throughout retirement. The pension tax system has strongly encouraged this outcome, prescribing the payments that can be made from a pension scheme and providing for tax charges on payments that are unauthorised. Under current rules, an individual can take their pension savings as a lump sum if they are below set limits. Income drawdown (where the individual can make withdrawals while leaving the rest of their fund invested) is an option, but the amount an individual can withdraw is capped unless they have other pension income above a set amount. Pension income is taxed at the individual’s marginal rate, with the option of a 25% tax-free lump sum at the time of taking the pension. In Budget 2014, the Government announced that from April 2015, individuals aged 55 and over would be able to choose when and how to access their DC pension savings, which would be subject to their marginal rate of income tax. This Bill sets out the changes to pensions tax legislation needed to implement this. Under its provisions, the main options available to people from 6 April 2015 would be to: -

Purchase a lifetime annuity that would provide an income throughout retirement (with some current restrictions removed);

-

Designate funds to a ‘flexi-access drawdown fund’, with no restrictions on the amount of withdrawals that can be made; and

-

Take an ‘uncrystallised funds pension lump sum’ (UFPLS), which means individuals would be able to make withdrawals from money purchase pension savings that haven’t yet come into payment, without first creating a flexi-access drawdown fund.

People already in a ‘capped’ drawdown on 6 April 2015 could convert to flexi-access drawdown. Existing flexible drawdown funds would become flexi-access drawdown funds. In the case of a lifetime annuity or flexi-access drawdown, there would normally be the option of a 25% tax-free lump sum at the time of taking the pension. For UFPLS, 25% of each withdrawal would be tax free. Where an individual has accessed their DC pension savings ‘flexibly’, the amount they can contribute annually to a money purchase scheme would reduce to £10,000. To help people navigate the options available, people would be offered guidance at the point of retirement. This is to be provided for in the Pension Schemes Bill 2014/15. Responses to the proposals have been mixed: while some have welcomed the new flexibilities, others have expressed concern that increased choice will bring a significant burden of responsibility for individuals to understand the choices they are making. The proposals would not apply to defined benefit (DB) pension schemes, although individuals in private sector DB schemes who want to draw their savings flexibly would be able to transfer out, having first taken advice. The Pension Schemes Bill 2014/15 would provide for a prohibition on transfers from unfunded public service schemes to DC schemes. Other changes in the Bill would restrict and reduce certain tax charges applying to death benefits and reduce the age limit for taking small amounts of savings as a lump sum from 60 to 55, or earlier in cases of ill-health.

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Research Paper 14/57

1

Background

Individuals with defined contribution (DC), pensions build up a pension fund using contributions, investment returns and tax relief. At present, most people (75%) with a DC pension use it to buy an annuity – a financial product which provides a regular income, usually until death.1 The pensions tax legislation has strongly encouraged this outcome. The rationale has been that because individuals receive tax relief on pension contributions to encourage them to save for an income in retirement, it is reasonable to expect them to turn their savings into an income stream at some point.2 Increasing flexibility has been introduced into the rules over time. Under current rules, the main alternatives to purchasing an annuity under current rules are: 

Those with small amounts of overall pension saving (under £30,000), or very small individual pots (under £10,000), may have the option from age 60 to take it as a lump sum;3 and



Income drawdown, which allows the individual to draw an income from their fund while leaving the rest of it invested. However, except where the individual can show that they have other pension income over a set amount, there is a cap on the amount they can draw down each year (150% of a comparable annuity).

‘Unauthorised payments’ from a pension scheme have an extra tax charge on them, such that HMRC does not expect many to be made.4 The Government proposes to introduce more flexibility into the rules from 6 April 2015, allowing people aged 55 and over to choose when and how to draw their pension savings, subject to their marginal rate of income tax. It said the introduction of the single-tier pension from April 2016 enables it to be less prescriptive: The single-tier pension provides a game-changing opportunity to rethink this model. With people receiving a full single-tier pension already clear of the basic means test, the state need be much less prescriptive about how people use their accumulated pension savings.5

However, it would also take steps to ensure that the new flexibilities could not be exploited to achieve tax advantages that were not intended: […] from next year the tax rules will be drastically simplified. However, it is important to ensure that these rules cannot be exploited by individuals to achieve tax advantages that are not intended. If the government were to take no action against such behaviour, an individual over the age of 55 could divert their salary each year into their pension, take it out immediately and receive 25% of it tax-free, thus avoiding income tax and National Insurance Contributions on their employment income. This is not the intention of the reforms, and the government has previously said that measures would be put in place to prevent this. As set out above, the government spends £22.8 billion a year on

1 2 3

4 5

HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 2.17 DWP and Inland Revenue, Modernising annuities. A consultation document. February 2002 Finance Act 2004 (FA 2004), s 164 and Sch 29 para 7 to 9; The Registered Pension Schemes (Authorised Payments) Regulations 2009 (SI 2009/1171); HMRC Registered Pension Schemes Manual (RPSM), RPSM09104905 RPSM09200030 HC Deb 20 March 2014 c950-1 [Steve Webb]; HC Deb 19 March 2014 c792 [George Osborne]

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pensions tax relief and has a responsibility to ensure that this money is used for genuine pension saving.6

This paper looks at the current arrangements before going on to consider the changes to be introduced in the current rules. 1.1

The pension tax framework

The UK tax treatment of pensions follows an “exempt, exempt, taxed (EET) model”: 

(Exempt). Pension contributions by individuals and employers receive tax relief and employer contributions are exempt from national insurance contributions;



(Exempt). No tax is charged on investment growth from pension contributions; and



(Taxed). Pensions in payment are taxed as other income, but individuals are able to take up to 25% of their pension fund as a lump sum on retirement.7

The main pension tax legislation is set out in Part 4 of the Finance Act 2004 (as amended). Legislation relating to the taxation of pension income is in the consolidated Income Tax (Earnings and Pensions) Act 2003. The last major reform of the system was the introduction of the pension tax simplification regime from 6 April 2006 (‘A day’) under the Finance Act 2004 (FA 2004). This replaced eight different tax regimes governing pensions with a single set of rules applying to saving across pension schemes and rules as to how pension savings are turned into benefits.8 Previously, there had been a range of limits on annual contributions and final benefits in pension schemes. Under FA 2004, there are no limits on the amount of pension savings an individual can have, instead there are limits on the amount of tax relief available. These are: the annual and lifetime allowance. Briefly: 

The annual allowance (AA) limits the amount of annual pension savings that benefit from tax relief. It is £40,000 from 2014/15 onwards, with provision for an individual to carry forward unused allowances from the previous three years.9 There is a tax charge, at the individual’s marginal rate for income tax, if contributions or the value of benefits accrued in a year exceed the AA.10



The lifetime allowance (LTA) limits the amount of pension saving over an individual’s lifetime that can benefit from tax relief. It has been set £1.25 million from 2014/15 onwards.11 Pension savings are tested against the LTA at ‘benefit crystallisation events’, for example, when an individual becomes entitled to a lifetime annuity.12 Funds above the LTA paid to the member would be taxed at 55%.13

6

HM Treasury, Freedom and choice in pensions: Government response to consultation, Cm 8901, July 2014, para 2.27 7 HM Treasury, Removing the requirement to annuitise by age 75, July 2010, para 2.3; Bill 97-EN, page 2 8 HM Treasury, Simplifying the taxation of pensions: increasing choice and flexibility for all, December 2002; For more detail, see The background to the reforms are discussed in more detail in Library Note SN 2984 Pension tax simplification (11 December 2008) 9 FA 2004 chapter 5, as amended by Finance Act 2013, s49 10 FA 2004, s227; HMRC, Registered Pension Schemes Manual, RPSM06100000 11 FA 2004, chapter 5. Protection arrangements have been put in place when the LTA was introduced and when it was reduced in 2012 and 2014 – see SN 5901 Restricting pension tax relief (April 2014) 12 FA 2004, s216; RPSM11200000 13 RPSM11201030

3

Research Paper 14/57 Another change introduced by the FA 2004 was to categorise payments from pension schemes as authorised or unauthorised.14 Unauthorised payments attract a tax charge (of up to 55%). The charge is intended to recover the tax relief previously given, as a payment which does not meet the purpose for which the tax relief was given.15 The amount and type of benefit an individual can actually receive will depend on the rules of the scheme they belong to.16 1.2

Current options on retirement

The Government has said that the new flexibilities to be provided under the Bill will apply to ‘defined contribution pension’ savings – which should be taken to mean both money purchase and cash balance: 2.9 In deciding who should have direct access to flexibility, the government has been guided by the principle that if an individual would previously have had to purchase an annuity or enter drawdown to access their pension savings, they should be able to access their pension flexibility. 2.10 Thus, those with a money purchase, cash balance or other arrangements which typically would have required the individual to purchase an annuity will be able to directly access their pension flexibility from April 2015, should they wish to do so. […] Those with Additional Voluntary Contributions (AVCs) will also be able to access these flexibly, subject to their pension scheme rules. Those with a hybrid arrangement may be able to access their pension flexibly without the need for a transfer to a money purchase arrangement, but this will depend on the nature of their arrangement at the time they take their pension. 17

Section 152 FA 2004 defines pension arrangements as either money purchase or defined benefit. 18 HMRC’s Registered Pension Schemes Manual (RPSM) explains: An arrangement is a money purchase arrangement if, at that time, all the benefits that may be provided to or in respect of the member under the arrangement are cash balance or other money purchase benefits.19

Money purchase benefits are: Benefits provided under a pension scheme, the rate or amount of which is calculated by reference to an amount available for the provision of benefits to or in respect of the member (whether the amount so available is calculated by reference to payments made under the scheme by the member or any other person or employer on behalf of the member, or any other factor).20

A cash balance arrangement is a type of money purchase arrangement where: […] the member will be provided with money purchase benefits, but where the amount that will be available to provide those benefits is not calculated purely by reference to payments made under the arrangement by or on behalf of the member. This means that in a cash balance arrangement, the capital amount available to provide benefits

14 15 16 17

18 19 20

FA 2004, chapter 3 Bill 97-EN, para 19; FA 2004, s208, 209 and 239 RPSM09200030 HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 1.3 RPSM20000000 - Glossary; FA 2004, s152 (2) Ibid; FA 2004, s152 (4)

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(the member's "pot") will not derive wholly from any actual contributions (or credits or transfers) made year on year.21

A defined benefits (DB) arrangement is one where benefits provided are not money purchase benefits but are calculated by references to fixed factors. A DB scheme is: […] typically, a ‘final salary’ scheme, that is, one where the level of benefits paid is calculated by reference to the member’s final salary and length of service with the employer.22

A hybrid arrangement is one where the benefits provided may be one of any two or three of cash balance, money purchase or defined benefit: An arrangement where only one type of benefit will ultimately be provided, but the type of benefit that will be provided is not known in advance because it will depend on certain given circumstances at the point benefits are drawn. For example, a hybrid arrangement may provide the member with other money purchase benefits based on a pot derived from the contributions that have accrued over time, but subject to a defined benefit minimum or underpin.23

The Pension Schemes Bill 2014/15 would introduce new definitions in pension legislation, based on the type of promise the scheme offers members during the accumulation phase about their retirement benefit.24 As well as creating new definitions of defined benefit and defined contribution schemes, there is to be a new category of ‘shared risk’ scheme - one which would offer a pension promise, but not a full pension promise, during the accumulation phase in relation to at least some of the retirement benefit that members might receive. The Bill would also legislate to enable the provision of schemes providing pension benefits on a collective basis. The Government has said it will consider how collective schemes would operate within the pension tax regime.25 For more detail, see Library Research Paper RP 14/44 Pension Schemes Bill (21 August 2014). Pensions from money purchase arrangements Section 165 and Schedule 28 (Part 1) FA 2004 currently provide that no payment of pension may be made from a money purchase arrangement other than: 

a scheme pension – pension paid by the scheme administrator, or an insurance company selected by the scheme administrator, payable for life and except in certain specified circumstances cannot reduce;



a lifetime annuity – an annuity paid for life or, if greater, a guaranteed period of up to 10 years, for which the member had the opportunity to select the insurance company and which except in certain specified circumstances cannot reduce; or



a drawdown pension – there are two types of drawdown pension, capped drawdown and flexible drawdown.26

Detailed guidance is in the Registered Pension Schemes Manual.27 The different options are discussed in more detail below. 21 22 23 24 25

26

Ibid, FA 2004, s152 (5) Ibid; FA 2004, s152 (6) and (7) Ibid, FA 2004, s152 (8) Bill 12 EN, para 31 DWP, Reshaping pensions for future generations: Government response to consultation, June 2014, Cm 8883, p22 See also, HMRC, Tax Impact and Information Note – Pension Flexibilities, August 2014

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Research Paper 14/57

Annuities Current legislation enables money purchase schemes to pay a pension in the form of a lifetime annuity. However, certain conditions must be met: (1) For the purposes of this Part an annuity payable to the member is a lifetime annuity if— (a) it is payable by an insurance company, (b) the member had an opportunity to select the insurance company, (c) it is payable until the member's death or until the later of the member's death and the end of a term certain not exceeding ten years, and (d) its amount either cannot decrease or falls to be determined in any manner prescribed by regulations made by the Board of Inland Revenue. 28

An annuity is an insurance contract that guarantees to pay annual amounts for a fixed period. A lifetime annuity can either be single life (providing payments for the lifetime of the scheme member) or joint life (in which case payments would continue for the lifetime of the surviving partner).29 Lifetime annuities with a guarantee period (which can be no more than ten years under current rules) continue to pay a pension in full for the duration of the guarantee period and therefore provide some protection for dependants). Although under current rules payments cannot decrease except in limited circumstances, they can increase. So a member could opt for a level annuity (which pays the same income each year) or an escalating annuity (which would pay a lower level of annuity but then increase each year). If they are in poor health or with lifestyle conditions that mean they might die earlier than average, they may qualify for an enhanced annuity, which can provide a higher annuity income than standard annuities for those who qualify. The payouts from investment-linked annuities are linked partly or wholly to the stock market, so the amount they pay can vary depending on the success of underlying investments. Some pension contracts include a ‘guaranteed annuity rate’ from the pension provider, which may be higher than prevailing rates offered on the open market or standard internal rates for that pension provider.30 People do not have to purchase an annuity from the provider with whom they saved. They must be given the opportunity to choose who they purchase their annuity from.31 Once they have purchased an annuity they are “locked into the annuity rates offered at that time.”32 The Open Market Option (OMO) has been available since 1978 and firms have been obliged to inform their customers of this since 2002.33 A report for the Financial Services Consumer Panel explained that the technical definition of exercising the OMO is to buy an annuity from a provider other than the original pension provider. However, to achieve the best outcome, the process involved four stages:

27

For lifetime annuity See RPSM09101700; for scheme pension, see RPSM09101400; for drawdown pension, see RPSM09103500 28 FA 2004, S165 (rule 4); Schedule 28, Part 1 (3) 29 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 2.20 30 Jackie Wells, Pension Annuities: A review of consumer behaviour, January 2014, glossary 31 Finance Act 2004, Schedule 28, paragraph 3 (1) (b); HMRC’s Registered Pension Schemes Manual, paragraph RPSM09101760 32 FSA Moneymadeclear, Retirement options – its time to choose, November 2008 33 David Blake, Pension schemes and pension funds in the United Kingdom, Second Edition, p252-3; DWP and Inland Revenue, ‘Modernising annuities. A consultation document. February 2002; FSA, Disclosure: Trading an endowment policy and buying a pension annuity August 2001Consultation Paper 106; Financial Services Authority, Disclosure: Trading an endowment policy and buying a pension annuity, Feedback on CP106, April 2002

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RESEARCH PAPER 14/57 

Making the purchase or purchases at the right time; this might not be the same date that the DC customer retires and it might involve multiple pots.



Checking older DC pension contract terms: for example the pension provider might offer a guaranteed annuity rate. Such features might mean that the customer would not benefit from shopping around.



Selecting the right type of annuity and the right features from a complex range which requires a careful weighing up of costs and benefits in order to make an informed decision.



Securing a competitive rate using a whole-of-market search.34

Steps have been taken to improve the operation of the OMO over time. In 2007, the Labour Government announced a number of actions to improve it.35 More recently, the Pensions Regulator has reminded trustees that: “the right to shop around should be prominent in all retirement-related member communications.”36 The ABI launched a code of conduct, effective from 1 March 2013, with the aim of ensuring that customers have “access to information to enable them to make an informed decision about annuities appropriate to their needs and lifestyle in retirement.37 According to the Association of British Insurers (ABI), in 2013 there were 353,000 annuities sold by ABI members in the UK, worth £11.9bn in total. The average (mean) annuity in 2013 was bought with a pension fund of around £35,600; but the median was around £20,000, so half of people buy an annuity with less than this.38 Scheme pension Money purchase schemes may pay a scheme pension direct from the scheme or secure it with an insurance company. The member must first be given the opportunity to use the funds held in the arrangement to purchase a lifetime annuity contract on the open market.39 Schedule 28 (3) FA 2004 provides that a scheme pension must: 

be paid for the life of the member ;



be paid at least annually,



not be capable of being reduced year on year; and



be paid by the scheme administrator (or by an insurance company chosen by the scheme administrator).40

Drawdown pension A drawdown pension comes in two basic forms: income withdrawal (where the pension is paid direct from the scheme) and a short-term annuity (where the individual uses some of

34

35 36 37

38 39 40

Annuities and the annuitisation process: the consumer perspective. A review of the literature and an overview of the market, December 2013, section 1.3 HM Treasury, ‘Outcome of the Review of the Operation of the Open Market Option’, 9 October 2007 TPR, Defined contribution schemes – regulatory guidance, November 2013, para 77 ABI, ‘Insurance industry takes big steps to help customers make the most of their pension savings,’ 5 March 2012; ABI, ‘Consumers in the Retirement Income Market,’ March 2012; ABI, Consumers in the Retirement Income Market, Consultation document, December 2011 ABI, The UK Annuity Market: Facts and Figures, February 2014 FA 2004, s 165 (pension rule 4) FA 2004, Sch 28 (2)

7

Research Paper 14/57 their fund to buy an annuity for a fixed period of up to five years). 41 Under current rules, there are two types of drawdown arrangement: capped and flexible: 

An individual is eligible for flexible drawdown if they can show they satisfy the minimum income requirement (MIR) i.e. have other pension income of at least £12,000 a year (down from £20,000 in 2013/14).42



In other cases, there is a cap on the amount they can draw down each year of 150% of the value of an annuity that could have been brought with a fund of the same value (up from 120% in 2013/14).43 Investment reviews must take place every three years before the age of 75 and every year after that. At these reviews the maximum amount the individual can drawdown annually is reassessed, based on tables produced by the Government Actuary’s Department.44

Income drawdown is a smaller share of the market than annuity purchase, although it is increasing in popularity. According to the Financial Conduct Authority (FCA): In 2012 420,000 annuities were sold, 16 times more than income drawdown products, with a premium value of £14bn compared to £1.2bn for income drawdown. 45

It poses additional and different risks for individuals than traditional annuities and has therefore generally been considered suitable for people with higher amounts of DC pension saving. In November 2012, the Government said: […] in general, a substantial fund value is needed to make income drawdown costeffective and there is a risk to retirement income if investment returns are poor and the level of income is reduced below what an individual had planned – the income is not guaranteed as with an annuity.46

In 2011, the Pensions Policy Institute reported the views of independent financial advisers that people needed a minimum pension pot of between £100,000 and £250,000, as well as other income and assets, in order to ensure they could “bear the investment risk and longevity risk associated with drawdown.”47 The website of the Money Advice Service says that “because of the increased charges and investment risk associated with income drawdown, it is generally not used for pension pots smaller than £50,000”.48 Lump sum payments Section 166 FA 2004 provides for lump sum payments to be made by registered pension schemes to members. Schedule 29 (Part 1) provides for the details. The circumstances in which they can be paid are summarised below. Lump Sums Authorised payments of lump sums to members are set out under section 166 FA 2004 and to dependants in section 168 FA 2004.

41 42 43 44 45 46

47 48

FA 2004, Sch 28 (5) and (6) FA 2004, section 165 (rule 7);Schedule 28; HMRC’s Registered Pension Schemes Manual, RPSM09103590 FA 2004, section 165 (rule 5); RPSM09103530 FA 2004, Schedule 28 (10); RPSM09103550 FCA, Thematic Review of Annuities, TR14/2, February 2014 DWP, Reinvigorating workplace pensions, Cm 8478, December 2012, p27, para 58; See also FSA, Retail conduct risk outlook 2012 PPI, The implications of ending the effective requirement to annuitise by age 75, December 2011 Money Advice Service website – income drawdown

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Trivial commutation A trivial commutation lump sum can be paid when the member is 60 or over and the total value of their pension rights under all registered pension schemes is less than the commutation limit, and the lump sum extinguishes all of the rights the member has under the scheme. The current trivial commutation limit is £30,000. Small pots The Registered Pension Schemes (Authorised Payments) Regulations 2009 (SI 2009/1171) allow for up to three small personal pension funds of £10,000 or less to be paid out as lump sums. Also a lump sum can be paid where, were it not for the fact that the lump sum would not extinguish all of the rights under the scheme because of an annuity in payment, the lump sum could have been paid as a trivial commutation lump sum. There is no limit on the number of lump sums up to £10,000 that may be paid out of an occupational pension scheme. Pension commencement lump sums A tax-free lump sum known as the pension commencement lump sum (‘PCLS’) can be paid only in connection with the member becoming entitled to a pension. Aside from the temporary changes mentioned below, the PCLS must be paid no more than six months before they become entitled to the associated pension and no more than 12 months after the entitlement to the associated pension arises. The PCLS must be paid from the same scheme as the associated pension. Paragraphs 1 to 3A of Schedule 29 to FA 2004 set out the conditions for a lump sum to be a PCLS. Schedule 5 of FA 2014 introduced a number of temporary changes to the PCLS rules where the intended PCLS is paid before 6 April 2015. These changes allow for a lump sum to be an authorised PCLS where entitlement to the associated pension occurs more than six months after payment of the PCLS, provided the entitlement to the associated pension arises by 5 October 2015. The changes also allow for the associated pension to be paid from a scheme other than the scheme from which the PCLS is paid.49

Detailed guidance can be found in HMRC’s Registered Pension Schemes Manual RPSM09204000. Attitudes to and awareness of the different options The DWP Attitudes to Pensions Survey 2012 asked respondents what would be their preferred use of pension savings – whether to provide a regular income, a lump sum, or a mix of regular income and tax-free lump sum. A majority (63%) said that they wanted a regular income of some sort in retirement – this was either a reduced regular income alongside a tax-free lump-sum payment (31 per cent) or entirely as a regular income throughout retirement (32 per cent). Only 8% said they favoured receiving their entire pension savings as a lump sum.

HM Treasury, Pension Flexibility 2014 – Tax Information and Impact Note, 14 October 2014; RPSM 9100330; FA 2004, s166 and Sch 29 (Part 1) 49

9

Research Paper 14/57 Views on the best way to use a pension, 2012

Source: DWP Attitudes to pensions Survey 2012, fig 8.11 p. 117

The survey report also noted that these preferences tended to be linked to age and income level: Those favouring receiving all of the money as a regular income throughout retirement tended to be younger, have never had a private pension and have a household income of less than £44,000. Respondents in favour of receiving some of the payment as a lump sum and some as a regular income tended to be older, have multiple sources of income for retirement (including a pension) and had ever had a private pension. This group was also more likely to say they were willing to take calculated risks with money as long as there was the potential for a good return, which was strongly correlated with household income of £44,000 or more.

The report also notes that that half of respondents (49 per cent) had no prior knowledge of annuities when answering this question. However, this represents an improvement compared with the 2009 survey, when only 21 per cent of respondents were aware of the need to annuitise.50 1.3

The requirement to annuitise

A ‘requirement to annuitise’ tax-relieved savings dates back almost a century to the Finance Act 1921.51 The Finance Act 1956 made it a requirement to annuitise between the ages of 60 and 70.52 The upper age limit was increased to 75 by the Finance Act 1976.53

50 51

DWP Attitudes to pensions Survey 2012, fig 8.11 pp. 117-18 Section 32; Mamta Murthi, J. Michael Orszag and Peter R. Orszag, The Value for Money of Annuities in the UK: Theory, Experience and Policy (1999)

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The last Labour Government supported the continuation of this policy for three reasons: 

tax relief on pension contributions is provided so people can save for an income in retirement, not for other purposes;



annuities pool people’s risk, ensuring that they are the most financially efficient way of turning capital into an income stream; and



annuities make sure that people continue to receive an income from their savings no matter how long they survive, thus reducing their possible future need for income-related support from the Government.54

However, it saw merit in introducing flexibility to the rules. An ‘unsecured pension’ (from which withdrawals could be made while leaving the fund invested) was already an option up until age 75. In April 2006, it introduced the ‘Alternatively Secured Pension’ for those aged 75 and over. This was in response to the concerns of some religious groups who had principled objections to the pooling of mortality risk through annuities. It did not expect the option to be widely used.55 There were limits on the amount that could be drawn down each year.56 Critics of the ‘requirement to annuitise’ argued that people should be able to exercise choice over their pension funds, provided they did not fall back on means-tested benefits. In opposition, a number of Conservative backbenchers introduced Private Members Bills with the aim of providing for an alternative. These stated that people with pension funds large enough to buy an annuity providing a minimum retirement income above the level of meanstested support, should be able to re-invest any residual funds in a “Retirement Income Fund” which they could use as they liked. 57 Before the 2010 General Election, both Conservative and Liberal Democrat parties had argued for a change in the rules.58 The Conservative-Liberal Democrat Coalition Government’s Programme for Government included a commitment to “end the rules requiring compulsory annuitisation at 75”.59 In July 2010, the Government launched a consultation on proposals for reform to support is objective to “re-invigorate private pensions saving, by giving people greater flexibility to choose the retirement options that are best for them.”60 It proposed to reform the pension tax framework in line with the following principles: 1 The purpose of tax-relieved pension saving is to provide an income in retirement. 2 Any changes to the pensions tax rules should not incur Exchequer cost and should not create any opportunities for tax avoidance.

52 53 54

55

56 57

58

59 60

Section 22 (2) Section 30 DWP and Inland Revenue, Modernising annuities. A consultation document. February 2002; See also HM Treasury, ‘Simplifying the taxation of pensions: increasing choice and flexibility for all’, December 2002, para 5.45 HM Treasury and Inland Revenue, Simplifying the taxation of pensions: the Government’s proposals, December 2003 FA 2004, section 165 ; HM Treasury, Removing the requirement to annuitise by age 75, July 2010, para 2.5-7 These included David Curry’s Pension Annuities (Amendment) Bill 2001/02, Edward Garnier’s Retirement Income Reform Bill 2002/03 and Adrian Flook’s Retirement Income Reform Bill 2003/04 See, for example, Theresa May, Providing for Pensions. Principles and Practice for Success , Politeia, 2010; The Liberal Democrat Manifesto 2010 The Coalition: our programme for government, 20 May 2010 HM Treasury, Removing the requirement to annuitise by age 75, July 2010, para 2.1

11

Research Paper 14/57 3. Individuals should have the flexibility to decide when and how best to turn their pension savings into a retirement income, provided that they have sufficient income to avoid exhausting savings prematurely and fall back on the state. 4. In line with the EET model, pension benefits taken during an individual’s lifetime should be taxed at income tax rates. The tax-free pension commencement lump sum will continue to be available. 5 On death, pension savings that have been accumulated with tax relief should be taxed at an appropriate rate to recover past relief given, unless they are used to provide a pension for a dependant.61

It proposed that from April 2011, there would “no longer be a specific age by which people effectively have to annuitise”. The option of income drawdown would be available throughout retirement, rather than just to age 75. Except for those who could show they had secured a sufficient minimum income to prevent them from “falling back on the state,” there would be a cap on the amount that could be drawn down each year: 2.15 The Government will go further than capped drawdown by creating additional flexibility for individuals who wish to draw down more than the capped annual limit. Under this flexible drawdown model, individuals will be able to draw down unlimited amounts from their pension pot, provided that they can demonstrate that they have secured a sufficient minimum income to prevent them from exhausting their savings prematurely and falling back on the state. The requirement to demonstrate a minimum income will apply at the point at which an individual wants to exceed the annual capped drawdown limit. The Government wants to ensure that the requirement to secure a minimum income is transparent and fair and can be implemented without undue complexity or burdens on individuals or business.[…] 62

The level of the existing cap on withdrawals (120% of the value of an equivalent annuity) would be reviewed to see whether it remained appropriate in an environment where income drawdown remained an option throughout retirement.63 To ensure that people did not use pension saving as a “tax-privileged means for passing on wealth” any unused funds remaining on death at age 75 or over would be taxed at a rate designed to reflect the value of the tax relief received.64 The Government published its response to this consultation in December 2010.65 It proposed that, to be eligible for flexible drawdown, people would need to be able to show they had at least £20,000 other secure pension income per year.66 For those not eligible for flexible drawdown, the cap on the amount they could withdraw each year would be set at 100% of a comparable annuity. Investment reviews would take place every three years before age 75 and annually after that. This was to “further mitigate” the risk of individuals exhausting savings in later life.67 In response to widespread concern among respondents to the consultation that the new rules might increase the likelihood of individuals seeking to enter drawdown products without

61 62 63 64 65

66 67

Ibid p8, Box 2A Ibid p9 Ibid, para 2.16-7 Para 2.9 and 2.22 HM Treasury, Removing the requirement to annuitise by age 75. A summary of the consultation responses and the Government’s response, December 2010, para 1.2 and 1.6-8 Ibid, para 3.44-54 Ibid, para 3.9-10

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a full understanding of the risks involved, the Government said it was committed to ensuring consumers had access to financial advice: 3.68 The Government is committed to ensuring that consumers have access to financial advice to enable them to make appropriate choices. The rollout by the [Consumer Financial Education Board] of the free and impartial national financial advice service will help consumers understand these choices and will signpost consumers in the direction of specialist advice where appropriate. 3.69 The Government recognises the concerns raised about individuals entering drawdown without a full understanding of the risks involved. It is right that individuals who wish to benefit from the flexibility offered by capped drawdown pensions are able to do so but this product inevitably carries exposure to investment risk that annuities do not. The associated risk of depleting funds prematurely cannot be entirely mitigated without imposing undesirably restrictive withdrawal limits that would undermine the flexibility that drawdown arrangements provide.68

The Government said it was difficult to give a precise estimate of the numbers who might be able to take advantage of flexible drawdown. However, of some 450,000 people who purchased annuities in 2009, it estimated that less than 1% had a pension fund large enough to do so.69 The changes were legislated for in the Finance Act 2011 (section 65).

In April 2013, the limit on annual withdrawals applying to those in capped drawdown was increased from 100% of a comparable annuity to 120%. 70 This was in response to concern from individuals in capped drawdown, who had found the maximum amount they were able to withdraw reduced when this came up for review. Reasons included low gilt yields and investment returns.71 The rules were changed again in Budget 2014 (see section 2.1 below). 1.4

Problems in the annuities market

Two influential reports in 2013/14 drew attention to ways in which the annuities market was not working well for consumers. Financial Services Consumer Panel report The Financial Services Consumer Panel (FSCP) published a report in December 2013 showing that the “market does not work well for the majority of consumers.” One of its key findings was that consumers were poorly placed to drive effective competition amongst providers and distributors of annuities. It said: There are many barriers inhibiting consumers’ full engagement when they decide to annuitise: low financial capability; fear of product complexity and of making an irreversible, high-cost mistake; general distrust of professional advisers, and inability to find appropriate advice at acceptable cost. 72

A literature review highlighted the complexity of the process for consumers. It said: 

68 69

70 71 72

Annuitisation was a very complex process for most DC consumers;

Ibid HM Treasury, Consultation on draft legislation - removing the requirement to annuitise from age 75, December 2010 HC Deb, 5 December 2012, c878; HM Treasury, Autumn Statement, Cm 8480. December 2012, para 2.58 HC Deb 20 Mar 2012 c618W; For more detail, see Library Note SN 712 Pensions: income drawdown FSCP, Annuities: Time for Regulatory Reform, December 2013, para 3.1

13

Research Paper 14/57   

A ‘good annuity outcome required expert help in most cases; A high proportion of DC customers did not shop around for the best deal; and Many consumers did not understand the differences between advice channels or know where to go for professional help.73

The FSCP recommended regulatory and structural reform: Recent initiatives, such as the Code of Conduct introduced by the Association of British Insurers (ABI), and market developments, such as the online automation of the annuity purchase process, may prove helpful, but rely on effective enforcement by the ABI and may overload consumers with information. The chances of mass consumer detriment are, in our judgement, too high to trust to current market-driven solutions alone: hence our recommendations for further regulatory and government-led structural reform.74

The FCA’s Thematic Review The Financial Conduct Authority (FCA) announced the findings of its Thematic Review of Annuities in February 2014. It emphasised the complexity of the decisions consumers are required to make at retirement: There are a number of decisions that consumers must engage with to make a wellinformed decision about buying an annuity. Alongside the timing of their retirement, they must also consider whether or not to take benefits through income drawdown, and if they choose an annuity, the ‘shape’ of annuity to purchase. Consumers often have not engaged in building up their pension savings and this affects how they engage with their retirement income choices. Once consumers are confronted with annuity choices they are faced with decisions that require them to consider their future circumstances, and attribute a future value to options such as joint versus single life, guaranteed periods, inflation protection and death benefits. These decisions all require making judgements about what will happen in the future and the relative values placed on protecting their income against uncertain events. This is something that is very challenging, even for consumers with high levels of financial capability.75

It recognised that most consumers found it “difficult to assess risk and uncertainty in financial products”. This resulted in a “general lack of engagement in the annuity purchase, with many consumers struggling to evaluate the options to find the best deal at retirement.”76 The FCA concluded that “some parts of the market were not working well for the majority of consumers” and identified the following concerns:

73

74 75 76



The majority of consumers (60%) do not switch providers when they buy an annuity, despite the fact that we estimate 80% of these consumers could get a better deal on the open market, many significantly so.



We estimate that the aggregate benefits that consumers miss out on by not shopping around and switching is the equivalent of between £115m and £230m of additional pension savings. We recognise that this may not be

Annuities and the annuitisation process: the consumer perspective – A review of the literature and an overview of the market, December 2013, Summary of findings, paras 1.2-5 Ibid, para 3.13 FCA, Thematic Review of Annuities, TR 14/2 February 2014, p26 Ibid

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RESEARCH PAPER 14/57

realisable, as changes in switching behaviour would be likely to result in changes within the market. 

In part consumers miss out on the benefits available from shopping around and switching due to their lack of engagement in pensions and annuities, the confusing trade-offs they face and the impact of behavioural biases that makes it difficult for consumers to make the right choices and may result in many of them not shopping around effectively.



There is also an incentive on providers to retain their existing pension customers, as overall the estimated levels of expected profitability of standard annuity business sold to existing pension customers is more than the expected profitability of annuity business sold on the open market.



The differences in retention rates (i.e. proportion of pensions annuitising with their pension provider rather than switching) between firms varies widely and some firms have relatively high retention rates and have active retention strategies that may increase customer loyalty and reduce the propensity to shop around.



There are particular groups of consumers where it appears that the market is not working well. There is an apparent lack of choice and ability to switch for those with small pension funds and lower annuity rates available to these consumers generally, which is likely in part to be due to the fixed costs of providing an annuity representing a larger proportion of the customer’s funds.



There is also a lack of access to enhanced annuity rates for some consumers annuitising with their existing pension provider and not shopping around.77

It decided to conduct a competition market study on products for retirement income.78 The terms of reference for this study were revised following the March 2014 Budget. The FCA said: The market study into retirement income will consider products such as annuities and income drawdown. These are products purchased by individuals with their accumulated pension pot that provide an income during retirement. We will also be considering new financial products which might be offered to those approaching retirement. We will examine competition and choice in the context of the various options open to consumers when retiring. As part of this work we will assess the value for money associated with different at-retirement products in the future landscape.79

Annuity rates The literature review conducted for the FSCP found that a perceived barrier to DC customers’ engagement with the annuitisation process was that they believed the product did not offer sufficiently good value to justify the effort of shopping around. This negative view had been exacerbated by annuity rates, which had steadily fallen over the past 20 years, due to increasing longevity and falling gilt yields, among other factors. 80 An annuity rate is the level of income that is guaranteed in return for a DC fund. It can be expressed as a percentage, or as so many £x of income for each £10,000 invested in a 77 78 79 80

Ibid p29 Ibid p30 FCA, Retirement income market study: revised terms of reference, 9 June 2014 Financial Services Consumer Panel, Annuities and the annuitisation process: the consumer perspective. A review of the literature and an overview of the market, January 2013, p2-6

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Research Paper 14/57 pension fund. For example, an annuity rate of 6% is the same as £600 a year income for every £10,000 in a pension fund.81 Trends in annuity rates are closely related to the yield on UK gilts, which form a major part of the investment portfolio of the insurance companies which sell lifetime annuities. The yield on the 15-year gilt serves as a generally accepted benchmark for annuities.82 Strong demand for gilts following the financial crash in 2008 – driven by increased investor preference for safer assets and also by the Bank of England’s quantitative easing programme – has seen gilt yields fall to historic lows in recent years (see the chart below): Yields on UK gilts with 15-year maturity (nominal and real spot rates) 12.00 10.00

Yield (per cent)

8.00

nominal

6.00

real 4.00 2.00 0.00

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

-2.00

Source: Bank of England yield curves data

Note: the real yield is the nominal yield minus an implied inflation rate. Subtracting the real from the nominal yield gives the portion of the nominal yield which compensates the investor for the erosion of the purchasing power of the gilt by inflation.

The actuarial calculation of annuity rates also takes account of changes in life expectancy. All other things being equal, increases in remaining life expectancy at retirement tend to reduce annuity rates, as retirement savings have to provide an income over a longer retirement period. According to ONS life expectancy data, over the period 1985-2014 the remaining life expectancy of 65-year-olds increased by 7 years for men (from 80 to 87) and 6 years for women (from 83 to 89). From 2015 onwards, the remaining life expectancy of people reaching 65 years of age is projected to increase by a further 1.2 years per decade on average:

81 82

Money Advice Service, Your retirement options, August 2011 The 15-year gilt yield is used by the Government Actuary’s Department to calculate the annual withdrawal limit from pension scheme savings under capped drawdown rules.

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Cohort life expectancy for women and men reaching 65 years of age, UK Whole life expectancy for those reacing 65

95 93

Women

91 89

Men

87 85 83 81

historic

projection 2060

2057

2054

2051

2048

2045

2042

2039

2036

2033

2030

2027

2024

2021

2018

2015

2012

2009

2006

2003

2000

1997

1994

1991

1988

1985

79

Source: ONS, Period and cohort life expectancy tables, 2010-based, reference table D1 Notes: Based on historical rates from 1985 to 2010 and assumed calendar year mortality rates from the 2010-based principal projections. Cohort life expectancy is calculated using age-specific mortality rates which allow for known or projected changes in mortality throughout a person’s life.

2

Current reform proposals

2.1

Budget 2014

In Budget 2014, the Government announced short-term changes to pension rules, increasing the size of pension that could be taken as a lump sum and introducing more flexibility into the income drawdown arrangements from 27 March 2014: 1.164. As a first step towards this reform, the Budget introduces a number of immediate changes, to allow people greater freedom and choice now over how to access their defined contribution pension. From 27 March 2014 the government will:

-

reduce the amount of guaranteed pension income people need in retirement to access their savings flexibly, from £20,000 to £12,000

-

increase the capped drawdown limit from 120% to 150% to allow more flexibility to those who would otherwise buy an annuity

-

increase the size of a single pension pot that can be taken as a lump sum, from £2,000 to £10,000

- increase the number of pension pots of below £10,000 that can be taken as a lump sum, from 2 to 3

- increase the overall size of pension savings that can be taken as a lump sum, from £18,000 to £30,000. 83

It also announced that from April 2015, there would be more radical reforms: 1.165. Under the current tax system, people are charged 55% if they choose to withdraw all of their defined contribution pension savings at the point of retirement. 83

HM Treasury, Budget 2014, HC 1104, March 2014, para 1.164-5

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Research Paper 14/57 This means the majority of people instead purchase an annuity and receive taxable income over the course of their retirement. Under the new system, an individual will be able to withdraw their savings at a time of their choosing subject to their marginal rate of income tax. The government anticipates that under these circumstances some people will choose to draw down their pension sooner in order to suit their personal situation. This will increase income tax revenue in the short to medium term.84

On the longer-term, radical reforms, Chancellor of the Exchequer, George Osborne, said: […] We have introduced flexibilities, but most people still have little option but to take out an annuity, even though annuity rates have fallen by half over the last 15 years. The tax rules around these pensions are a manifestation of a patronising view that pensioners cannot be trusted with their own pension pots. I reject that. People who have worked hard and saved hard all their lives, and done the right thing, should be trusted with their own finances, and that is precisely what we will now do: trust the people.[…] I am announcing today that we will legislate to remove all remaining tax restrictions on how pensioners have access to their pension pots. Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want: no caps; no draw-down limits. Let me be clear: no one will have to buy an annuity.85

On 20 May 2014, the Pensions Minister, Steve Webb, made a statement framing the new proposals in the context of the Government’s pensions strategy. He explained that the Government had taken steps to reform the state pension, was implementing auto-enrolment and introducing measures to improve value for money in DC schemes. So, there was now an opportunity to think about the choices people had in retirement: In the past, retirement was often a relatively short period of time, and the priority for most was to turn their pension savings into a regular income for as long as they lived. But in a world where people will routinely live for 25 years in retirement, we need to think more creatively and give people new options about what they will do with their own money. In the past, Governments were concerned that if people had freedom over their pension pots, they would run them down too quickly and then depend on state support in later life. The single-tier pension provides a game-changing opportunity to rethink this model. With people receiving a full single-tier pension already clear of the basic means test, the state need be much less prescriptive about how people use their accumulated pension savings. That is why the Government have announced a plan for radical liberalisation of the retirement savings market with effect from April 2015. Gone will be the detailed rules on how quickly people can turn their pension pot into annual income. Instead, for the first time, we will treat people as adults, giving them the flexibility to choose how best to use their hard-earned savings in the way that suits their personal circumstances. People will still be free to take a tax-free lump sum and turn the balance of their pension pot into an annuity, providing a guaranteed income for life, but they will also be able to withdraw the whole of their pension pot as cash to spend as they see fit, subject only to taxation on the balance in excess of the tax-free lump sum. Or they can decide to allow their money to go on growing, drawing cash as and when they wish, perhaps as part of a phased retirement—something that we have talked about for years and are now delivering. By lifting the rules, we anticipate that industry will

84 85

Ibid HC Deb 19 March 2014 c793

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RESEARCH PAPER 14/57 respond with new products that meet consumers’ income needs in new and innovative ways.86

Responses In the debate on the Budget on 25 March 2014 Shadow Work and Pensions Secretary, Rachel Reeves, said the Opposition would judge the reforms against three tests: First, is there robust advice for people who are saving for their retirement? Secondly, is the system fair to those on middle and lower incomes who want a secure retirement income? Thirdly, are the Government sure that the changes will not result in extra costs to the state, either through social care or by increasing housing benefit bills? We will continue to push for the reform of pensions, but it must be reform that works for people who have saved all their lives, who deserve security and confidence in retirement.87

The flexibility for people to choose their own vehicle to finance their retirement income was welcomed by Sir Edward Garnier, who had sponsored one of the Private Members’ Bills on retirement income funds in the previous Parliament.88 Other Conservative MPs welcomed the increased choice and thought it would act as an incentive to save.89 Crispin Blunt thought financial services companies would innovate in response to the announcement. The challenge was to “ensure the spirit of the reforms develops into a well-governed and safe experience to deliver good customer outcomes”.90 Chair of the Work and Pensions Committee, Dame Anne Begg, asked about the future for annuities: Annuities are an excellent principle—someone saves into a pot and then buys something that lasts them to the end of their life. We do not know how long we will live after reaching pension age, so an annuity provides insurance: we know it will not run out before we reach the end of our life. It insures against old age. All of that is right. However—this is the big but—what if there is no annuity market? What will the many people for whom an annuity is the right choice do then?91

Responding to the Statement on the Government’s pensions strategy, the Shadow Pensions Minister, Gregg McClymont, welcomed the increase in the limits applying to small pots that would take effect from March 2014. Regarding the longer term changes, he asked about the implications for the development of risk-sharing schemes: How can one develop the collective pensions to which he subscribes when they depend on intergenerational risk-sharing? As we understand it, intergenerational risksharing becomes extremely difficult, if not impossible, if people exit the system at the age of 55.92

In a debate on 2 July, he further questioned the basis for the policy, given the rationale for auto-enrolment and evidence on customer experience of the annuities market: […] the Pensions Minister, has developed a whole pensions policy based on the notion that inertia has to be harnessed for the public good, meaning that, as a rule, people are 86 87 88 89 90 91 92

HC Deb 20 March 2014 c950-1 HC Deb 25 March 2014 c177 HC Deb 24 March 2014 c84; see Library Note SN 712 Pensions: income drawdown (May 2014) HC Deb 25 March 2014 c 185 [Margot James; Charlie Elphicke]; HC Deb 24 March 2014 c96 [Caroline Nokes] Ibid c197 Ibid c237 HC Deb 20 March 2014 c953

19

Research Paper 14/57 not aware of the complexities of pensions and there therefore needs to be a system in place so that those who do not exercise a choice still get a good outcome. Is the hon. Gentleman really that confident that we will very quickly reach a situation in which there will be informed consumers across the board who can make the kinds of investment decisions to which he is referring? […] Would he care to comment on why the existing annuities market was not working? My understanding of the analysis is that the default position of individuals was simply to accept what they were offered and not to get involved in the type of process to which he refers. If that means that the annuities market was a failure because people were not getting value for money as a result of not shopping around, what confidence does he have that there will be an overnight revolution in people’s engagement with the type of guidance he suggests? 93

Outside Parliament, responses to the proposal were mixed. Pensions expert Ros Altmann said the message of the Budget was that the Government “does believe in the value of saving and wants to trust people who have put money into pensions to manage their money for themselves in retirement, with far fewer rules and restrictions”.94 Michelle Cracknell of the Pensions Advisory Service (TPAS) welcomed the fact that individuals would have greater choice, although they would need help in making decisions.95 Other reactions were more sceptical. The Institute for Fiscal Studies said there were number of reasons why compulsory annuitisation might be a good thing. It could:   

reduce moral hazard (i.e. the risk that individuals exhaust their pension pots knowing they could receive means-tested benefits in retirement); help to prevent individuals exhausting their savings prematurely, for example, because they underestimate how long they are going to live;and reduce the risk of ‘adverse selection’, whereby there is an increase in the price of annuities because those still wanting to purchase one are disproportionately those who expect to live a long time.96

The National Association of Pension Funds (NAPF) was concerned that increased choice would bring a significant burden of responsibility for individuals to understand the choices they were making: Automatic Enrolment, one of the largest and most successful reforms of workplace pensions ever seen, was introduced to encourage people to make good financial decisions about their retirement, because experience tells us that people are often illinformed and make poor decisions about financial planning for old age. On the one hand the idea that savers can take their pension as a lump sum, albeit subject to tax, may be an incentive to save. However, this choice brings with it a significant burden of responsibility for individuals to understand the choices they are making. We know this is not always the case as people often underestimate how long they will live and overestimate how long their pot will last. There is a recognised problem with the lack of financial literacy in the UK and there is a distinct lack of detail in today’s announcement

93 94

95 96

HC Deb 2 July 2014 c916-7 Ros Altmann, ‘UK Budget 2014: A watershed moment for pensions and savings’, Financial Times,19 March 2014 (£) The Pensions Advisory Service, ‘Budget 2014’, 19 March 2014 IFS, ‘Budget 2014: pensions and savings policies’, 20 March 2014

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on how the Government will ensure people have access to good impartial advice so they make the right decisions about their income for retirement.97

Some organisations were optimistic about the effect on the market. The Low Income Tax Reform Group, welcomed the fact that the reforms “should force providers to be more competitive in what they are prepared to offer pension savers”.98 The ABI said the insurance industry looked forward to playing a key role in ensuring the reforms delivered better outcomes for customers, but that they represented a “significant challenge for everyone involved in helping people secure their retirement income.”99 On the other hand, the TUC feared that the reforms would not deliver a decent income in retirement: […] the main thrust of the Chancellor’s policy goes against what most people want from the pension system – a decent income in retirement. As no-one can know how long they will live, this is best achieved by sharing risk in collectively organised pension schemes.100

2.2

Queen’s Speech 2014

In the May 2014 Queen’s Speech, it was announced that there would be a Pension Tax Bill to give effect to the changes to pension tax legislation needed to introduce the flexibilities for accessing DC pension savings announced in Budget 2014.101 A separate bill would make related changes to pensions legislation (for example, to provide for the guidance guarantee and to implement a ban on transfers from unfunded public service DB schemes).102 These measures are the Pension Schemes Bill 2014/15 was published on 26 June 2014.103 2.3

Finance Act 2014

The short-term changes announced in Budget 2014 – to the rules about small pots and income drawdown – were legislated for in the Finance Act 2014 (section 41 and 42).104 The Government also made a temporary change to the rules when the legislation was at its Report Stage so that people would not lose the advantage of a tax-free lump sum if they did not decide what to do with their savings within six months. Financial Secretary to the Treasury, David Gauke, explained: Usually people lose the advantages of a tax-free lump sum if they do not decide what to do with the rest of their pension savings within six months of taking the lump sum. On 27 March, the Government announced that those who had already taken a tax-free lump sum from their defined contribution pension savings, but had not yet secured their pension, would be given more time to decide what they wished to do with the rest of their retirement savings. We also did not think it would be fair to prevent people from taking their tax-free lump sum now simply because they wished to wait to access their pension savings more flexibly from next April, so the Government promised to introduce new provisions in the Bill to ensure that people do not lose their right to a taxfree lump sum if they would rather use the new flexibility this year or next. The provisions are technically quite detailed, but their purpose is not. Full pension flexibility for defined contribution savings will be introduced in April 2015, and until that

97 98

99 100 101 102 103 104

‘NAPF comments on 2014 budget’, 19 March 2014 LITRG, ‘Pensioners put in greater control over their own cash’, 20 March 2014; ‘A brave new work for Britain’s savers, Financial Times, 21 March 2014 (£) ‘Budget 2014: ABI comments on changes to pensions, 19 March 2014 TUC, ‘Pension changes go in wrong direction’, 20 March 2014 Gov.UK – Queen’s Speech – what it means for you? Pensions Tax Bill Gov.UK – Queen’s Speech – what it means for you? Private Pensions Bill For more detail, see Library Research Paper RP 14/44 Pension Schemes Bill (21 August 2014) HM Treasury, Budget 2014, HC 1104, March 2014, para 1.164

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Research Paper 14/57 happens we want people to be able to take their tax-free lump sum and to have until October 2015 to make their pension choices without tax consequences. The changes made in new clause 13 and new schedule 5 will enable people to take a tax-free lump sum and to wait until April 2015 to decide how they want to access their pension savings: by transferring the rest of their pension savings to another pension provider to enable them to access them more flexibly; by repaying the lump sum when the scheme that paid it will accept it in order to access the whole of their savings more flexibly; or by receiving the rest of the pension savings as a lump sum under the higher limits that clause 40 provides. Those changes also ensure that people who have the right to receive a tax-free lump sum at an earlier age, or of a larger amount than is normally allowed, can use the new flexibility and keep those rights. 105

2.4

Freedom of choice in pensions

A consultation on the Government’s proposals – Freedom and choice in pensions – was published on 19 March 2014 with responses requested by 11 June.106 The Government published its response on 22 July 2014.107 This section looks at some of the consultation issues that are not included in the current Bill. For those in the Bill, see section 4 below. The guidance guarantee In the 2014 Budget, the Government said that it recognised the importance of equipping people to make decisions that best suited their personal circumstances and would therefore introduce a new guarantee that from April 2015 “everyone who retires with a defined contribution pension will be offered free and impartial face-to face guidance on their choices at the point of retirement”.108 In the consultation document it proposed that guidance would be: 

impartial and of consistently good quality;



cover the individual’s range of options to help them make sound decisions and equip them to take action, whether that is seeking further advice or purchasing a product;



free to the consumer; and



offered face to face.109

The Government said it recognised that people would need help navigating the expanded range of choices available “so that they can make good decisions which suit their needs and circumstances”.110 Outside commentators have stressed the importance of people being able to make informed decisions. Age UK said: Giving people a real choice about how and when to use their pension savings is the right approach, but it must be an informed choice so the advice available to them when they make this crucial decision needs to be first rate. 111

105 106 107

108 109 110

HC Deb 2 July 2014 c902; FA 2014, section 42 and Schedule 5 HM Treasury, Freedom and Choice in Pensions, March 2014, Cm 8835 HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, 22 July 2014 HM Treasury, Budget 2014, HC 1104, March 2014, para 1.160 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 4.11 Ibid

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Some questioned whether guidance would be sufficient. The TUC said: Independent guidance is clearly better than that provided by company sales teams, but half an hour of the best possible advice will not equip people for what could be thirty years of managing their pension pot. […] Expecting the market to deliver retirement income solutions that work for the great majority is unrealistic.112

In its response to consultation, the Government announced that guidance would be delivered by independent third parties, building on capability in existing organisations: 3.5 Almost every respondent agreed with the government’s central policy goal that guidance must be trusted by consumers. The vast majority, including most financial services industry respondents, said that consumers would not trust guidance given by a person or organisation with a vested interest in selling a financial product or service. The government has therefore decided that the guidance guarantee will be provided by organisations which are independent and have no actual (or potential) conflict of interest. […] 3.8 As noted by many respondents, the government has set a challenging timetable for delivering guidance by next April. It agrees that a clear strategy and forward plan which sets out clear roles and responsibilities is vital to ensure the service is up and running effectively in good time. The government has therefore decided that, until the service has reached maturity, overall responsibility for service design and implementation will remain within the Treasury, which will work with a range of organisations (including [the Pensions Advisory Service] and [Money Advice Service]) to deliver guidance to individuals. .113

The purpose of guidance would be to: […] equip and empower people to make confident and informed choices on how they put their pension savings to best use; it will help people to ask the right questions, but will not itself make specific recommendations. 114

The Government would legislate to require pension providers and schemes to signpost individuals to the guidance service as they approach retirement and to establish a levy on regulated financial services firms to fund its cost.115 On 18 October 2014, the Government announced that the providers of the guidance guarantee: People who wish to access their defined contribution pension flexibly will be able to go to a local Citizens Advice Bureau across the UK for expert face to face guidance, or receive telephone guidance from the Pensions Advisory Service. An online service will also be designed by the government as part of the scheme.116

The FCA is to be responsible for setting standards for guidance and monitoring compliance with them. It has consulted on what these should be.117

111

112 113

114 115 116 117

See, for example, Age UK, ‘Welcome help for savers but no gains for the poorest pensioners’, 19 March 2014; ABI, ‘Budget 2014: 11 thoughts on George Osborne’s pension plan’, 20 March 2014 TUC press release, 21 July 2014 HM Treasury, Freedom and choice in pensions: government response to the consultation, Cm 8901, July 2014 Ibid Ibid p19 HM Treasury, ‘Pension guidance providers unveiled’, 18 October 2014 Cm 8901, para 3.28-9; FCA, Retirement reforms and the Guidance Guarantee, CP 14/11, July 2014

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Research Paper 14/57 Provision for the guidance guarantee is to be made in the Pension Schemes Bill 2014/15. Government amendments relating to guidance have now been tabled but not yet debated. Details of the Bill’s progress can be found on the Pension Schemes Bill 2014/15 page of the Parliament website.118 Prohibition on transfers from defined benefit schemes In March 2014, the Government said that to protect the Exchequer from additional costs, it would legislate to prevent members of public service defined benefit schemes transferring their pension rights to a DC scheme to take advantage of the flexibilities for DC scheme members to be introduced from April 2015.119 In July 2014, it announced that this prohibition on transfers would not apply to funded public service schemes, such as the Local Government Pension Scheme. This was because such schemes held assets, which meant that transfers did not have the same implications for the Exchequer as in the case of unfunded schemes. It would consider whether safeguards should be put in place to protect the interests of both individuals and funds in cases of transfers out.120 For members of private sector DB schemes considering a transfer to a DC, the Government intends to introduce a requirement that they take advice: […] for the majority of people, but not all, it will remain in their best interest to stay in their defined benefit scheme. In response to stakeholder feedback, the government will introduce two new safeguards to protect individuals and pension schemes: a new requirement for an individual to take advice, from a professional financial adviser who is independent from the defined benefit scheme and authorised by the FCA, before a transfer can be accepted; and new guidance for trustees on the use of their existing powers to delay transfer payments and take account of scheme funding levels when deciding on transfer values.121

The Pension Schemes Bill 2014/15 contains regulation-making power for the Secretary of State to make regulations to prevent members from transferring out of public service DB pension schemes, except to other DB schemes.122 Minimum pension age The current pension tax rules set a minimum age at which a pension can generally be drawn, other than on ill-health grounds. The minimum pension age is currently 55.123 The Government proposed to increase this to 57 in 2028 and then to align it with the State Pension age so that it is always ten years below it.124 The State Pension age (SPA) is increasing. The SPA for women started to increase from 60 in April 2010 and will reach 65 in November 2018, bringing it into line with that for men. The equalised SPA will then rise to 66 by October 2020 and then to 67 between 2026 and 2028. For the future, there will be periodic reviews of the SPA.125 In its response to consultation, the Government said that:

118

For more detail, see Library Research Paper RP 14/44 Pension Schemes Bill (21 August 2014). HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 5.6-7 120 HM Treasury, Freedom and choice in pensions: the government’s response to consultation, Cm 8901, July 2014 121 Ibid p25; For more detail, see Library Note SN 6891 Flexibility for DC pension savers from April 2015 (October 2014) 122 Bill 12 2014-15; For more detail, see RP 14/44 Pension Schemes Bill (21 August 2014), p57 123 FA 2004, Part 4, section 279 (1) 124 HM Treasury, Freedom and Choice in Pensions, March 2014, Cm 8835, Chapter 4 125 Pensions Act 1995, Schedule 4 as amended by the Pensions Acts of 2011 and 2014. For more detail, see SN 6546 State Pension age 2012 onwards 119

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RESEARCH PAPER 14/57

Close to half of respondents agreed with the government’s proposal to raise the minimum pension age to align it 10 years below the State Pension age. However a significant majority opposed moving it to 5 years below126

It confirmed that it would increase the minimum pension age to 57 in 2028 and that it would remain 10 years below SPA thereafter.127 The change would apply to those public service pension schemes where the normal pension age is linked to the SPA. Further consideration would be given to the position of individuals who had a right to access those benefits from an earlier age: 2.38 The government received strong representations against applying the change to some public service pension schemes, in particular for those schemes that will not link their normal pension age with the State Pension age from 2015, namely the Firefighters, Police and Armed Forces pension schemes. Instead, these schemes’ normal pension ages reflect the unique nature of these occupations. Increasing the minimum pension age to 57 would have a more significant impact on these schemes, in reducing the gap between their minimum pension age and normal pension age to just three years – a much smaller timeframe than proposed for the gap between minimum pension age and State Pension age. 2.39 Therefore, the government does not intend to apply the minimum pension age increase to those public service schemes for Firefighters, Police and the Armed Forces. The government is clear that the change should apply to public service pension schemes, where pension ages are linked to State Pension age, and to those in the private sector 2.40 Some individuals have built up savings with a right to access those benefits from an earlier pension age. The government recognises that they will be affected by an increase in the minimum pension age, and is considering the nature and extent of any protection that might be required for those individuals. The government will be guided by simplicity and fairness, both for individuals and for schemes, in designing any protection that may be introduced. 2.41 Recognising that there are further issues to explore in designing an increase to the minimum pension age, subject to the will of Parliament the government will legislate for these changes in the next Parliament.128

Interaction with other forms of support for pensioners In April 2014, Financial Secretary to the Treasury, David Gauke, explained how pension savings are treated for means-tested benefit purposes: Under existing rules the capital value of pension investments is disregarded when assessing entitlement to working age income related benefits. Actual pension payments are deducted from both income-based and contributory benefits. When an individual is over the qualifying age for pension credit and has a pension fund that they have not yet accessed, a notional income is deducted from any benefit entitlement. 129

126

127 128 129

HM Treasury, Freedom and choice in pensions: the government’s response to consultation, Cm 8901, July 2014, para 2.3 Ibid, para 2.36 Ibid HC Deb 1 April 2014 c626W

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Research Paper 14/57 The rules are set out in the State Pension Credit Regulations 2002 (SI 2002 No. 1792), regulation 18 and the Housing Benefit (Persons who have attained the qualifying age for State Pension Credit) Regulations (2006 No. 214), regulation 41.130 The current rules reflect the options now available to people with savings in a defined contribution pension scheme. In evidence to the Work and Pensions Select Committee, Pensions Minister, Steve Webb said the Government would need to rethink how pension savings interact with means-tested benefits in the light of its proposed reforms.131 In evidence to the Work and Pensions Committee, he said the Government was not seeking to change the fundamental position with regard to help with the costs of social care: Just to be clear, the intention of the Budget reforms is not to change the fundamental position of someone who has saved for a pension. If I have saved for a pension and I have got a £50,000 pension pot, and I put it into a new flexible pension-type product that has got the capital and I draw some income from it, the intention is not to change the treatment of the capital in that product. If I can just quote what the Chancellor said: “I am absolutely clear that we want to make sure that this does not have an impact”. We are working through exactly how we do that, because the Department of Health have to do this; we have to do it for Pension Credit and so on, and the Treasury have to think this through, but the intention is the status quo ante. It is not that we have come up with this clever wheeze that suddenly everyone has got masses of capital so we can means-test them for social care and save some money. That is not the intention.132

In its response to the consultation, the Government said it would look further at the notional income rules for pension drawdown products (for both benefits and social care) to ensure these were consistent between drawdown products and annuities: The government wants to work closely with industry to ensure people have a range of options to access their money flexibly – and, as part of that, wants to ensure that the decisions people make between converting their pension savings into a regular income via an annuity and accessing their savings periodically (for example through a drawdown product) do not significantly impact how they are assessed for means tested welfare and social care support. The government expects a range of new products to emerge as a result of these reforms. Where possible, these products will be treated similarly to current drawdown products, which see any capital held in a drawdown product excluded from the respective capital means tests. Instead, that capital is treated as generating an appropriate notional income for the purposes of income means tests. This will preserve the important principle that everyone pays their fair share towards supporting themselves and paying for social care, with government support targeted where it is needed most. In light of these reforms, the government will look at the notional income rules for pension drawdown products (for both benefits and social care) to ensure these are consistent between drawdown products and annuities.[…] Those individuals who choose to draw down their full pension pot quickly and manage it directly, for example combining it with their other assets, will need to consider how this could affect their current and future entitlement to welfare and social care support

130 131 132

An explanation is in DWP, Decision Makers Guide, volume 14, chapter 85 Oral evidence: Pension reforms, HC 1248, 30 April 2014 Oral evidence: Pension reforms, HC 1248, 30 April 2014

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RESEARCH PAPER 14/57 – in the same way as those who choose to save for retirement outside of a pension do now. The government wants to ensure that individuals are able to make an informed decision that best suits their personal circumstances and risk appetite for the duration of their retirement. Welfare and social care will therefore be covered by the guidance service so people can, for example, take account of the likelihood that they may need to pay for social care in the future.133

3

Expected impact

3.1

Exchequer

In the March 2014 Budget, the Government said it expected the reforms to result in an increase in income tax receipts in each year until 2030, as a result of new and existing pensioners using the new flexibility to draw down their pension savings at a faster rate than via an annuity and paying income tax on these withdrawals at their marginal rate. This is partially offset by “higher costs of pensions tax relief to reflect the increased attractiveness of pension savings for some individuals.”134 After this initial boost to tax receipts, from the 2030s onwards the Government expects an ongoing structural reduction in tax receipts of around £300 million a year in steady state: “Because more people make withdrawals there will then be reduced income tax on annuity pension payments in later years.”135 Although the pensions flexibility measure is not fiscally neutral in the long run, the Government estimates that this cost “is small in comparison to the impact of all the government changes on pensions, designed to ensure pensions provision is sustainable with an aging population (notably the increase in State Pension age), which means by 2030 the government is saving around £17 billion a year in 2013-14 terms compared to previous policy. 136

HM Treasury, Freedom and choice in pensions: the government’s response to consultation, Cm 8901, July 2014; The Government has produced a factsheet on charging under the Care Act 2014 134 HM Treasury, Budget 2014 policy costings, March 2014, p11 135 Ibid 136 HM Treasury, Budget 2014 policy costings, March 2014, p12; see also HM Treasury Budget 2014 chart 1.12, page 45 133

27

Research Paper 14/57 Projected Exchequer impacts of pensions flexibility measures in Taxation of Pensions Bill, 2015/16 to 2040/41 (as announced at Budget 2014)

Source HMRC analysis published in Budget 2014 chart 1.11, page 45 Note: positive figures represent Exchequer gain (increased tax receipts)

Projected Exchequer impacts of pensions flexibility measures in Taxation of Pensions Bill, 2015/16 to 2019/20 (as announced at Budget 2014)

Exchequer impact (£ million)

2015-16

2016-17

2017-18

2018-19

2019-20

+320

+600

+910

+1,220

+810

Source: HMRC, Tax Information and Impact Note - Pension Flexibility 2015, 14 October 2014

These figures do not take account of decisions subsequently announced (such as allowing transfers from private sector DB schemes and funded public sector DB schemes and the introduction of a £10,000 money purchase annual allowance for those accessing their savings flexibly). These are expected to have an effect on the yield over the scorecard period. The final costing will be subject to scrutiny by the Office for Budget Responsibility. 137 3.2

Individuals

HM Treasury assumed that under the proposed changes around 30% of people (around 130,000 a year) in DC schemes would decide to drawdown their pensions at a faster rate than via an annuity.138. However, the extent of behavioural change is difficult to predict.139 It hopes the changes will stimulate innovation and new competition in the market:

137 138

139

HM Treasury, Pension Flexibility 2014 – Tax Information and Impact Note, 14 October 2014 HM Treasury, Budget 2014 policy costings, March 2014, p11; HMRC, Tax Information and Impact Note Pension Flexibility 2015, 14 October 2014 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 6.14

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[…] with providers creating new products to satisfy individual consumer needs and meet new social challenges such as funding care later in life […]. It will also expand the market to allow further development of existing products, such as deferred annuities. 140

In evidence to the Work and Pensions Committee, Pensions Minister, Steve Webb, said the take up of new flexibilities would partly depend on what other products became available: I am not sure there is much point in me guessing. As I say, HMRC assumed that about 30% would take the cash, for the sake of argument; some of the annuity providers are saying it might be 70%-odd. We do not know. The survey evidence puts it in that range, but we are all guessing, because it depends what other products become available, and I suspect that annuity-like products will become available that people will choose as well.141

Shadow Pensions Minister Gregg McClymont asked via a freedom of information request for the analysis underpinning the reforms, but this was refused. He said: The government needs to come clean on how they predicted savers’ behaviour would change under these reforms as this formed the basis of their estimates.[…] This has been such a radical change to the retirement income policy and usually with change of this sort would be published with a more detailed impact assessment.142

The Institute for Fiscal Studies found that a significant proportion of individuals would be entirely unaffected by the announcements: We estimate that about half of men and two-thirds of women (or six-in-ten of all) aged between 55 and 59 have no money currently held in DC pensions. There are two other smaller groups of individuals who are also likely to be unaffected by the Budget announcements – those whose DC pots are below the trivial commutation thresholds (8%) and those who we estimate will have at least £20,000 of secure income from state pensions, defined benefit (DB) pensions and already annuitised DC pensions (2%). This leaves just under four-in-ten men and just over two-in-ten women (or threein-ten of all those) aged between 55 and 59 who will experience greater flexibility as a result of the Budget changes.143

The Pensions Policy Institute found that the majority (90%) of those saving under automatic enrolment for the first time would already have access to these flexibilities via the existing trivial commutation rules, and by the increases to the trivial commutation limits from April 2014. However, it considered that the high profile of the Budget 2014 announcements might make individuals more likely to take the route of a lump sum withdrawal rather than buying an annuity.144 3.3

The market

The Government identified problems in the annuity market as one of the reasons for the reforms:

140 141 142

143 144

Ibid, para 3.19 Oral evidence: Pension reforms, HC 1248, Wednesday 30 April 2014, Q37 Josephine Cumbo, ‘Treasury refuses to reveal pension reform analysis’, Financial Times, May 2014 (£); HC Deb 2 July 2014 c903 IFS, ‘Budget 2014 pension reforms: increased flexibility, but for whom?’ 15 March 2014 Pensions Policy Institute, The benefits of automatic enrolment and workplace pensions for older workers, 20 May 2014, page 6

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Research Paper 14/57 Moreover, the annuities market is currently not working in the best interests of all consumers. It is neither competitive nor innovative and some consumers are getting a poor deal. It is time for a bold, modern and progressive reform.145

It hopes the reforms announced in the Budget will stimulate innovation and competition in the market: […] with providers creating new products to satisfy individual consumer needs and meet new social challenges such as funding care later in life […]. It will also expand the market to allow further development of existing products, such as deferred annuities. 146

Evidence to the Treasury Committee’s enquiry on the 2014 Budget suggested it was too early to predict how the market might respond: 138. David Geale from the FCA thought that it was "too early to tell" how the market might respond to the changes, but considered that there was the "potential […] for product innovation". Joanne Segars, of the NAPF, also saw this potential. She told us: What we would hope to see is more innovation in this market with products being developed that lead into long-term care products, for example, that are much more flexible and perhaps more accurately match the spending patterns that people face in retirement. I think there is potential here for more innovation and then it is for those pension providers […] to meet that new demand, to rise to that challenge. Chris Hannant, of APFA, expected to see "a market that generates products that are better tailored to the needs of the consumer". 139. The financial sector's past performance in meeting consumer need through innovation was criticised by the Parliamentary Commission on Banking Standards, which found that: Banks have incentives to take advantage of these customers by adding layers of complexity to products. A good deal of the innovation in the banking industry makes products and pricing structures more complex, hindering the ability of consumers to understand and compare the different products.147

The impact on the annuity market was also difficult to predict: 149. None of the evidence we received disagreed that these reforms would change the market, but as Joanne Segars of the NAPF pointed out to us, the effect of these reforms on the annuities market is not easy to predict. She said “the big unknown in all of this, of course, is how much demand there will still be for annuities in whatever form going forward”. Chris Woolard of the Financial Conduct Authority told us that predictions that the annuities market would effectively disappear due to the changes might be too pessimistic. He said: If you look at the experience of other countries, despite predictions there of markets sometimes disappearing on the back of certain changes, I think the case has often been that that is not what has happened. Switzerland is a very different regulatory environment. We ought to be careful about stretching the analogy too far, but if you look at Switzerland, they have gone through a very similar deregulation and still 80% of people who are retiring choose to buy an annuity there. I think we have to be very careful about predictions of doom 145 146 147

HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, Foreword Ibid, para 3.19 Treasury Select Committee, Budget 2014, 13th report 2013-14, HC 1189, May 2014

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RESEARCH PAPER 14/57

For his part, Otto Thoresen of the ABI expected that initial market contraction would be followed by recovery: In the next five to 10 years [you will see] lower levels of annuity take-up, but as people move through their retirement process, a recovery and growth again in the annuity market, because its positive aspects continue to be positive—the certainty it gives people and their ability to plan for the future, and they know that they will not run out of money.148

Otto Thoresen, Director General of the ABI, told the Committee that annuity rates might continue to worsen under certain circumstances: A number of factors could lead to rates being poorer, but I do not think it is contraction in the market so much. We are already on a path that was leading to a different annuity market, anyway. The advent of the enhanced annuity providers who effectively underwrite the client at the point of their taking their annuity meant that you were beginning to get a healthier pool of customers in the standard annuity market. If you have a healthier pool of customers, they will live longer. If they live longer, clearly the rate that the market as a whole can offer will become less attractive. One factor certainly could apply: if the only people who take annuities are a particular type of individual that will shape the annuity pool and the pricing. But I do not think contraction in itself is likely to be the issue.149

In its risk outlook for 2014, the FCA said that the reforms, combined with other factors, could encourage innovation in some retirement income products. However, it had concerns about the potential for complexity and opaque pricing making products difficult to compare: As firm and consumer balance sheets remain under pressure from external conditions the disparity between what firms can viably offer consumers and what consumers need from decumulation products may increase. To minimise the consequences of these disparities, increasing conflicts may materialise in product complexity and the accessibility of product terms and conditions. Risks that look to be on the rise in this area include the design and distribution of pension products and […] the design and development of products that capitalise on other stores of wealth (predominantly property, e.g. equity release). 150

In the Second Reading debate on the Pensions Schemes Bill 2014/15, Shadow Pensions Minister, Gregg McClymont, asked about the impact on schemes’ investment strategies: […] we need to know how the budget reforms will impact on the pension pots and retirement income of low and middle earners. That is important. One of the weaknesses of individual DC, from which the Minister is trying to move away, is that 10 years from any individual’s retirement, the pension fund has to move assets into lowyielding bonds to avoid any risks so close to the retirement age. There is less risk, but less return. The danger of the Government’s flexibility provisions on retirement is the interaction with pension fund asset management. It now becomes the norm that individuals will cash in their pension pot at 55, 56 or 57, which means that at the age of 45, 46 or 47 the pension fund will have to move into low-risk, low-yielding assets, reducing the pension pot when cashed in on retirement.151

148 149 150 151

Ibid Ibid, para 150 FCA, Risk Outlook 2014, p71 HC Deb 2 September 2014 c210

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Research Paper 14/57 Another question has been the possibility of schemes applying large exit fees to people wanting to transfer out to take advantage of the new flexibilities. In response to questions on this point, Pensions Minister, Steve Webb, said the Government was working with the industry to understand the extent of the problem: First, despite Opposition attempts to hype this up and overstate the case, the number of schemes with exit fees is very much in the minority. In other words, our 2013 pensions and charges landscape survey found that more than five in six trust-based schemes, and nine out of 10 employers with contract-based schemes, had no exit fees. We must therefore be clear that exit fees are exceptional. Secondly—I am generally talking about legacy schemes here—we are already considering charges, and a legacy audit is being undertaken of old and high-charging schemes. That is due to report by December and will provide additional information about existing fees. At the moment, we do not have full information with which to form policy, but the Government are working with the pensions industry to understand how common exit fees are, how large they are, and the terms under which they operate. Crucially, once the evidence is clearer, the Government will be able to decide whether additional measures are required to protect savers. At the moment we are gathering information, but we are determined to ensure that savers are protected. I hope that is helpful.152

4

The Bill

4.1

Overview

The Government consulted on draft legislation between 6 August and 3 September 2014.153 On 14 October 2014, the Taxation of Pensions Bill 2014/15 was presented to Parliament.154 The Bill and Explanatory Notes are on the Parliament website. The Tax Information and Impact Note and draft guidance are on Gov.UK. The Bill as introduced to Parliament has a number of changes compared to the draft Bill. It includes some new provisions, such as: 

Changes to the charges on unused funds on death;



Reporting requirements to enable the operation of the money purchase annual allowance rules;



Changes to the rules for individuals who receive UK tax relief for contributions to nonUK pension schemes, so that the flexibilities and restrictions to relief would apply equally to them; and



Miscellaneous changes made as a consequence of consultation responses, as well as technical improvements.

A summary of the changes is in chapter 2 of HMRC, Pension flexibility: draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014. The Bill has three clauses and a Schedule:

152 153 154

Ibid c204 See Gov.UK - (Draft) Taxation of Pensions Bill HM Treasury, ‘Government creates further choice on pensions as reforms start their legislative journey,’ 14 October 2014

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Clause 1 introduces the Schedule, which contains most of the detail;



Clause 2 restricts and reduces the tax charges that apply to certain lump sums;



Clause 3 contains definitions that apply to this Bill and a power to amend specified legislation in consequence of this Bill.155

The Bill applies to the whole of the United Kingdom.156 In general, its provisions would take effect from 6 April 2015: 

The new flexibilities will have effect for pensions to which individuals become entitled on or after 6 April 2015.



The changes relating to the annual allowance and trivial commutation lump sums will have effect from 6 April 2015.



The changes relating to lump sum death benefits will have effect in relation to lump sums paid on or after 6 April 2015.



The changes relating to individuals who were entitled to drawdown pension before 6 April 2006 and have not to date had any benefit crystallisation event occur in relation to them, will have effect for benefit crystallisation events occurring on or after 6 April 2015, and where the flexible drawdown nomination was made on or after 27 March 2014.157

The Bill makes many changes to provisions in the Finance Act 2004 (FA 2004), so unless otherwise stated, amendments referred to below are to this Act. 4.2

Initial responses

Responses to the Bill have tended to reflect the mix of support and concern that met the original announcement in the Budget. The Government’s Older Worker’s Business Champion Ros Altmann welcomed the reforms and called on providers to ensure the full range of options was available: It means people can use their pensions as a bank account. People will be free to access their money freely as they need to, rather than being forced to buy particular products. […] Most pension companies are not ensuring that their customers can take money out flexibly. I call on the industry to make sure that people can really benefit from the new pension changes as quickly as possible. 158

However, some industry representatives said that not all providers would be able to offer all the proposed options, at least in the first instance, and that there would be costs to doing so.159 Director General of the ABI Otto Thoreson was concerned that the focus should be on building an income for retirement rather than early access to cash:

155

Ibid, para 40-43 Ibid, para 52 157 HM Treasury, Pension Flexibility 2014 – Tax Information and Impact Note, 14 October 2014 158 Steven Swinford and Dan Hyde, ‘George Osborne: use your pension as bank account’, Daily Telegraph, 13 October 2014 159 Marek Handzel, ‘Pensions Industry urges caution as Taxation of Pensions Bill is published’, Pensions Age, 14 October 2014 156

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Research Paper 14/57 […] the objective of the reforms, to give people more choice in generating income from their retirement pots in a way which works for their personal circumstances, risks being lost under a weight of rhetoric which is focussed on access to pensions savings much earlier than the vast majority of British workers plan to retire. The consequences of this if no balance is brought to the discussion, could be significant for retirees and their families, for the pension reform agenda and for future governments struggling with continued austerity and an ageing population.[…] Automatic enrolment has seen millions more people saving for their retirement – we should be building on this success to increase their resilience in older age, not threatening this early success by breaking the link between saving and retirement completely. 160

4.3

How the Bill will change options at retirement

Until 6 April 2015, individuals with a DC pension may have the option of: 

A lifetime annuity;



A scheme pension;



Income drawdown, with a cap on the amount that can be withdrawn each year unless they can show they have secure other pension income above a set amount;



Taking a lump sum if they are at least 60 and their savings are below set limits.

For more detail, see section 1.2 above. From 6 April 2015, a scheme member coming to take their benefits would have the option of: 

Buying a lifetime annuity (with some of the current restrictions on lifetime annuities removed – for example, the annual rate will be able to go up as well as down);



Taking a scheme pension;



Designating some or all of their funds to a flexi-access drawdown; or



An uncrystallised funds pension lump sum (UFPLS), or series of lump sums.

4.4

Flexi-access drawdown

Members As discussed in section 1.2 above, current legislation allows income drawdown as an alternative to buying an annuity. There are two currently types of drawdown:

160 161 162



An individual is eligible for flexible drawdown if they can show they satisfy the minimum income requirement i.e. have other pension income of at least £12,000 a year (down from £20,000 on 27 March 2014).161



In other cases, there is a cap on the amount they can draw down each year of 150% of the value of an annuity that could have been brought with a fund of the same value (up from 120% on 27 March 14).162 Investment reviews must take place every three years before the age of 75 and every year after that. At these reviews the maximum

Otto Thoreson, ‘Greater Freedom must not become about early access’, ABI Blog, 14 October 2014 FA 2004, section 165 (rule 7);Schedule 28; HMRC’s Registered Pension Schemes Manual, RPSM09103590 FA 2004, section 165 (rule 5); RPSM09103530

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amount the individual can drawdown annually is reassessed, based on tables produced by the Government Actuary’s Department.163 Part 1 of the Schedule would make provision for flexi-access drawdown funds. Paragraphs 1 to 3 would provide for member’s flexi-access drawdown funds. Paragraph 1 would provide that the cap on the amount that can be taken each year only applies to a drawdown fund as defined in paragraph 8 of Schedule 28 (i.e. to an existing capped drawdown fund).164 Paragraph 2 would provide that a new capped or flexible drawdown arrangement, as provided for in the existing rules, cannot be created on or after 6 April 2015. Instead, newly designated funds on or after 6 April 2015 would be to a member’s flexi-access drawdown fund (new paragraph 8A (1) and (2) of Schedule 28).165 The effect on those in existing drawdown arrangements on 5 April 2015 would depend on whether they are in capped or flexible drawdown: 

An existing flexible drawdown arrangement would convert to flex-access drawdown funds on that date (new paragraph 8A(3) of Schedule 28).



An existing capped drawdown arrangements could continue and the member could designate additional funds to it. It would convert to a flexi-access drawdown fund if either: the individual’s withdrawals exceed the cap; or they notified the scheme administrator that they want to convert to flexi-access drawdown and the administrator accepted this notification; or they transferred drawdown funds to a new scheme and notified the administrator they wanted them to be newly-designated from the date of transfer (new paragraphs 8B and 8C of Schedule 28).

No limits would apply to withdrawals from a member’s flexi-access drawdown fund.166 The option of a ‘pension commencement lump sum’ (a tax-free lump sum of up to 25% of the value of the fund) would be available. Apart from this withdrawals would be taxed as pension income and would trigger the money purchase annual allowance rules provided for in Part 4 of the Schedule (see 4.7 below).167 Dependants Similar rules apply to dependants where pension funds have been passed to them on the death of the member i.e; they can currently be taken as a dependant’s scheme pension, a dependant’s annuity or a dependant’s drawdown pension. If an individual wants to take funds as a dependant’s drawdown pension, they must designate those funds to a dependant’s drawdown pension fund.168 As is the case for members there are limits on the amounts that can be draw down each year unless the dependent has pensions in payment from other sources of at least £12,000.169 A tax-free lump sum cannot be paid in connection with a dependent’s drawdown pension.170 Paragraph 4 of Part 1 of the Schedule would provide for a dependant’s flexi-access drawdown fund. The provisions in paragraph 4 broadly mirror the member changes under

163 164 165 166 167 168 169 170

FA 2004, Schedule 28 (10); RPSM09103550 Bill 97-EN, para 61 Bill 97-EN, para 62 Ibid, para 61 HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p15 FA 2004, s167; Bill 97-EN, para 14 FA 2004, section 167 (2A) and Schedule 28 (24C); RPSM10104940 FA 2004, section 167 and Schedule 28 (2); RPSM10104870; Bill 97-EN, para 14

35

Research Paper 14/57 paragraph 3 (regarding newly designated funds and conversion of existing fund).171 Draft guidance explains that that dependants will have the same options as members for drawdown pensions, as follows: 

Designations after 5 April 2015 under an arrangement where there is no pre April 2015 dependants' drawdown pension fund will be to a dependants' flexaccess drawdown fund;



Existing dependants' drawdown pension funds paying flexible dependants' drawdown pension will convert to a dependants' flexi-access drawdown fund on 6 April. Any designations to that pre-existing drawdown pension fund will be into the converted dependants' flexi-access drawdown fund;



Dependants may convert existing dependants' drawdown pension funds paying capped dependants' drawdown pension into dependants' flexi-access drawdown fund in a similar way to members. That is they either notify their scheme administrator they intend to convert the fund or take dependants' drawdown pension of more than the annual maximum amount for capped drawdown. Any designations to the fund after it has converted will be to a dependants' flexi-access drawdown fund;



Dependants can choose not to convert their existing capped dependants' drawdown pension funds. Any further designations under the arrangement will be to the existing capped dependants' drawdown pension fund. The cap on the maximum amount of dependants'' drawdown pension that can be paid will continue to apply. Scheme administrators will still need to carry out regular reviews and calculations of the maximum annual amount in line with the existing requirements. 172

Payment from a dependant’s flexi-access drawdown fund on its own would not trigger application of the money purchase annual allowance rules. Only if the individual had also either received an uncrystallised pension fund lump sum or member’s flexi-access drawdown benefits would the money purchase annual allowance rules apply.173 Unused funds in a member’s flexi-access drawdown fund could be paid as a flexi-access drawdown fund lump sum death benefit.174 Paragraph 7 adds ‘flexi-access drawdown lump sum death benefit’ to the list of authorised lump sum death benefits in section 168(1) FA 2004. Paragraph 13 adds it to the list of payments that would be subject to the special lump sum death benefits charge in section 206(1). Clause 2 of the Bill would reduce and restrict the charges on unused funds on death - see section 4.11 below.175 4.5

Annuities

Current rules enable a money purchase arrangement to pay a lifetime annuity, provided it meets certain conditions. These are that: (a) it is payable by an insurance company, (b) the member had an opportunity to select the insurance company,

171

Bill 97-EN, para 71 HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p20-21 173 Ibid 174 bid 175 Bill 97-EN, para 81 172

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(c) it is payable until the member's death or until the later of the member's death and the end of a term certain not exceeding ten years, and (d) its amount either cannot decrease or falls to be determined in any manner prescribed by regulations made by the [HMRC]c.176

One condition is that the individual must have been given the opportunity to select the insurance company (the Open Market Option) - the intention being to ensure that consumers are made aware of their right to shop around to get the best annuity deal on offer to suit their circumstances.177 Another is that the amount payable cannot decrease except in limited circumstances.178 HMRC’s Registered Pension Schemes Manual (RPSM) explains: Generous tax reliefs are given to encourage pensions saving, so it is important that the tax rules ensure that the pension funds are used for the intended purpose of funding pensions for the life of the member. A lifetime annuity contract provides a means of turning pension capital into an income that lasts for all of a pensioner’s retirement. To ensure that this continues to be the case, there are also some safeguards within the rules to ensure that a lifetime annuity contract provides a stable and predictable source of income. Any annuity contract where the amount of income payable from year to year either stays level or increases will come within the primary definition of a lifetime annuity. The regulations allow a lifetime annuity contract to provide, in very specific and controlled circumstances, for an income that from year to year stays level, increases or decreases. The amount of income provided by the contract may only be calculated by reference to a factor, or a mixture of factors, specifically provided for in the regulations (see RPSM09101750 for more details).179

Part 2 of the Schedule amends the requirements for lifetime and short-term annuities for members and dependants. 180 Paragraph would insert new paragraph 3(1A) into Schedule 28 of the 2004 Act to provide an additional definition of a member’s lifetime annuity where the member became entitled to it on or after 6 April 2015. This removes some of the restrictions that apply under current legislation, with the effect that:

176 177

178

179 180 181

-

The annual rate of the lifetime annuity will be allowed to go down as well as up;

-

There will no longer be a requirement that the member must have been given the opportunity to select the insurance company, although schemes may still offer the member this opportunity should they wish;

-

The current 10-year restriction on the period for paying the income from a lifetime annuity after the member’s death will be removed. A lifetime annuity may continue to be paid after the member’s death for any period that is set out in the annuity contract.181

FA 2004 section 165 (rule 4) and Schedule 28 David Blake, Pension schemes and pension funds in the United Kingdom, Second Edition, p252-3; DWP and Inland Revenue, Modernising annuities – a consultation document, February 2002, p32 FA 2004, Schedule 28, Part 1 (3); Finance Act 2005, para 13 and Schedule 10; Registered Pension Schemes (Prescribed Manner of Determining Amount of Annuities) Regulations 2006 (SI 2006/567) RPSM09101730 Bill 97, Schedule, Part 2 para 38-40 HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p13

37

Research Paper 14/57 The existing rules continue to apply where the member or dependant became entitled to the annuity before 6 April 2015.182 Comment In its response to consultation, the ABI called for more flexibility in the rules to encourage innovation: The tax rules act as limits on the shape of retirement income products and this is rightly recognised in the consultation paper. For instance, a lifetime annuity must be payable for the member’s life or up to a term of 10 years after death if a guarantee is purchased. The annual amount of the lifetime annuity payable is also limited in that it must not go down except in the specific circumstances prescribed by HMRC regulations. There are many possibilities for new retirement income products, such as an annuity that provides varying payments according to customer needs – these are currently not possible because current tax rules do not allow the annuity amount to decrease except in narrowly defined circumstances.183

Regarding the removal of the requirement that the member must have been given the opportunity to select the insurance company, the Government hopes that increasing the choice available and providing support to make those choices, will change consumer behaviour: 2.26 The current tax rules stifle innovation in the retirement income market, leaving pension savers with very little choice over how to spend or invest their defined contribution savings. This has contributed to consumer inertia and a lack of engagement. By increasing the choices people have at retirement, and providing them with the right support to make the choice that is right for them, consumer behaviour will change and a more competitive and dynamic retirement income market will emerge.184

Furthermore, it intends to require pension providers and schemes to signpost individuals to the guidance service.185 In its response to consultation, a firm of pension lawyers suggested that the requirement should be retained for DC schemes which do not adopt any of the new flexibilities within their benefit structure.186 4.6

Uncrystallised pension fund lump sums

Part 3 of the Schedule would introduce the option of an ‘uncrystallised pension fund lump sum’ (UFPLS). It would also provide that for a payment to qualify as a UFPLS, it must meet certain conditions:

182 183 184 185



It must be paid on or after 6 April 2015 from uncrystallised rights held under a money purchase arrangement;



The individual must have all or part of their lifetime allowance available;



It is not a pension commencement lump sum or trivial commutation lump sum;

Ibid, Schedule, Part 2 para 43, 45, 47 and 50 ‘ABI consultation response: HM Treasury’s Freedom and Choice in Pensions’, June 2014 HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014 HM Treasury, Freedom and choice in pensions: Government response to consultation, Cm 8901, July 2014,

p7 186

Draft Taxation of Pensions Bill – Sackers response to consultation, 3 September 2014

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The individual must be aged at least 55 or meet the ill-health conditions; and



Immediately before payment they represent rights that were uncrystallised (i.e. they are funds held in a money purchase arrangement that have not as yet been used to provide that member with a benefit under the scheme (so have not crystallised).187

To ensure than an individual cannot get a UFPLS that would give them a bigger tax-free amount than they could have been paid as a pension commencement lump sum, a UFPLS cannot be paid if they have: 

Primary or enhanced protection and a right to tax-free lump sum of more than £375,000 on 5 April 2006;188 or



A ‘lifetime allowance enhancement’ factor and the available portion of their lump sum allowance is less than 25% of the amount of the payment.189

Normally 25% of a UFPLS would be tax-free, with the remainder taxed as income. Exactly how the payment is treated would depend on whether the individual is under or over age 75: 

Where the member is under age 75, 25% of the amount of the UFPLS would be paid free of income tax, and the remainder taxed at the individual’s marginal rate;



Where the individual is aged 75 or over and has more lifetime allowance than the amount of the UFPLS, then the lump sum would be taxed in the same way as if the member was under age 75. If they have less lifetime allowance than the amount of the UFPLS, then an amount equal to 25% of their available lifetime allowance can be paid tax-free, with the remainder taxable at the individual’s marginal rate.190

The reason is that at age 75 all uncrystallised benefits would have been tested against the lifetime allowance already and any charge deducted at that time.191 The treatment of a payment in excess of the maximum that could be paid as a UFPLS would also depend on the individual’s age: 

If the member is under age 75 at the time of payment, it would be taxed as a lifetime allowance excess lump sum (at 55%);192



If they are over the age of 75, it would be taxed as income.193

Comment Some industry representatives have questioned whether providers would be able to offer this as an option, and the costs of doing so:

187

Para 57 For an explanation of these protection arrangements, see RPSM03105135 and RPSM03105185 189 HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 5 August 2014; Bill 97-EN para 117. A lifetime enhancement factor can be due to primary protection, pension credits from previously crystallised rights, non-residence, transfers from recognised overseas pension schemes or pre-commencement pension credits 190 Schedule, para 62 (2); HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p18 191 Bill 97-EN 192 FA 2004, s215 193 Bill 97-EN 188

39

Research Paper 14/57 Fidelity Worldwide Investment retirement director Alan Higham agreed […], saying: "Pensions were never set up to be bank accounts and the reality is that many can't and won't operate that way." He said that accessing the flexibility the government was offering would not always be straightforward, particularly as some people would have to move their pensions to do so, opening up margins for error and adding cost. Cost would also be a major factor for providers when offering further flexibility, said law firm Pinsent Masons’ pensions expert Simon Laight, who also questioned whether all providers would be able to deliver systems to complement the reforms. “Some of the complexity has been removed – no longer having to carry out regular maximum withdrawal checks – but not all. Running so called banking style pension accounts requires manual intervention or introduction of sophisticated new systems – both costly to implement," said Laight. “Pension providers [will] need expensive new systems and for that you need scale. We’ll see a land grab as providers rush to develop new banking style pensions and seek to capture market share. It’s a dash for cash,” he added.194

There were also concerns that appropriate regulatory rules were not yet in place. Otto Thoreson of the ABI said: The regulatory rules around ‘Uncrystalised Funds Pension Lump Sums’ (aka ‘the pensions bank account’) and drawdown in trust-based schemes don’t exist yet. The risk to savers of making decisions without the necessary information, or the potential for scammers to become active in this market, is clear. But the prospects of the government’s guidance guarantee being able to cover the gap, or the FCA being able to develop appropriate safeguards in time for next April, are virtually nil. 195

4.7

Money purchase annual allowance rules

Current rules An annual allowance tax charge arises where an individual’s total pension input amount for a year exceeds the amount of the annual allowance. The charge on the excess amount is at the individual’s marginal rate. From 2014/15 onwards the annual allowance is £40,000. Any unused annual allowance from the previous three tax years can be carried forward.196 How pension savings are measured against the annual allowance depends on the type of arrangement. The Explanatory Notes say: 24. For most money purchase arrangements the pension input amount is the total contributions made by the individual or anyone else on their behalf, including any made by any employer. The exception to this is where the arrangement is a cash balance arrangement where the pension input amount is the increase in the promised fund for the individual. For a cash balance arrangement the pension input amount could, for example, be the amount an employer has promised to provide for an employee, but without making a contribution to fulfil that promise until many years later. 25. However in defined benefit arrangements individuals accrue a right to an amount of annual pension from pension age based on a variety of factors, for example years of service or salary. To treat the two in a comparable way, a deemed notional contributions value is applied to the increase in value of pension rights between the start of the year and the end of the year. For defined benefit arrangements, the 194

Marek Handzel, Pensions Industry urges caution as Taxation of Pensions Bill is published, Pensions Age, 14 October 2014 195 Otto Thoreson, Greater Freedom must not become about early access, ABI Blog, 14 October 2014; See also See, for example, Peter Walker, Treasury set to confirm open access lump sum, FT adviser, 14 October 2014; Rachel Vahey, Better regulation please, NEST blogspot, 15 October 2014 196 FA 2004, s227, 228 and 228A

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pension input amount is therefore calculated by multiplying the increase in their expected pension over the course of the year by a factor of 16. This broadly means that an increase in annual pension benefit of £1,000 would be deemed to reflect a contribution of £16,000. 26. Where an individual has a hybrid arrangement, as defined in section 152 Finance Act 2004, it is more difficult to calculate a comparable contribution value because the type of benefits provided are not decided until they are taken. In the circumstances, the pension input amount is worked out by calculating what would be the value of the pension input amount for each type of benefit that could be provided from the hybrid arrangement, and taking the highest of these values. 197

When the current Government introduced the option of flexible drawdown in 2011, it provided that an individual in flexible drawdown would lose the right to receive tax relief on further contributions made to a pension. Effectively, they have an annual allowance of nil.198 The intention was to prevent “recycling” of tax relief.199 In its response to the Freedom and choice in pensions consultation in July 2014, the Government said it was important to ensure that the new flexibilities could not be exploited by individuals to achieve tax advantages that were not intended: If the government were to take no action against such behaviour, an individual over the age of 55 could divert their salary each year into their pension, take it out immediately and receive 25% of it tax-free, thus avoiding income tax and National Insurance Contributions on their employment income.200

However, it considered that introducing a nil annual allowance for all individuals accessing their pension flexibly after April 2015 would be “disproportionate” and therefore decided to introduce a new “money purchase annual allowance rule”. This would provide that: 

those currently in flexible drawdown who have an annual allowance of £0 will from April 2015 be subject to a new annual allowance limit of £10,000



those who choose to draw down more than their tax-free lump sum from a defined contribution pension will still be able to benefit from further tax-relived pension saving, and make further tax-free contributions to a defined contribution pension of up to £10,000 per year. This means that following their first flexible withdrawal, an individual will be able to contribute up to £10,000 a year with tax relief to a defined contribution pension. This covers 98% of pension savers over the age of 55.



this annual allowance will only apply if an individual accesses a defined contribution pension worth more than £10,000. Individuals can make withdrawals from three small personal pots and unlimited small occupational pots worth less than £10,000, without being subject to a £10,000 annual allowance on subsequent contributions



the current capped drawdown system will be grandfathered for those in capped drawdown on 5 April 2015. This means that those in capped drawdown at this

197

Bill 97-EN FA 2004, s227A; RPSM06105070; Cm 8901,para 2.28 199 HM Treasury, Removing the requirement to annuitise at age 75. A summary of consultation responses and the Government’s response, December 2010, para 3.30 200 HM Treasury, Freedom and choice in pensions: Government response to consultation, Cm 8901, July 2014 para 2.27 198

41

Research Paper 14/57 point will not have a £10,000 annual allowance. However, at the point that they withdraw more than the capped amount, they will have a £10,000 annual allowance. The government believes it would be unfair to apply the £10,000 annual allowance to this group of individuals as they entered capped drawdown without the knowledge that they would be subject to such a rule 201

The Bill Part 4 of the Schedule would insert several new sections into FA 2004. It would provide that the annual allowance position for someone who has not flexibly accessed their pension is unaffected.202 However, where an individual has ‘flexibly accessed’ their pension savings in a tax year on or after 6 April 2015, a £10,000 annual allowance would apply to future money purchase pension savings. The Government believes that this “covers 98% of pension savers over the age of 55.”203 Paragraph 65 of the Schedule would insert a new section 227G, to provide that an individual has ‘flexibly accessed’ their pension saving if in a tax year on or after 6 April 2015, when they: 

drawdown funds from a flexi-access drawdown fund, including receiving payments from a short-term annuity;



receive an uncrystallised funds pension lump sum;



receive payment of a lifetime annuity under a flexible annuity contract (one set up on or after 6 April 2015, where the terms of the contract would allow the payments to go down);



take more than the permitted maximum for capped drawdown from a pre-6 April 2015 drawdown fund;



receive payment of a scheme pension from a money purchase arrangement with are fewer than 12 members; or



receive a stand-alone lump sum and are not entitled to enhanced protection.

The rules will also apply from 6 April 2015 to an individual who was in a flexible drawdown arrangement before that date.204 An individual has not accessed their pensions flexibly, and so does not trigger the money purchase annual allowance rule, if they:

201 202 203

204



receive a pension commencement lump sum or ‘small pots’ lump sum;



are in receipt of a scheme pension or lifetime annuity (except in the circumstances referred to above); or



takes no more than the permitted maximum for capped drawdown from a pre-6 April 2015 drawdown pension fund.205

Ibid, para 2.31 Bill 97-EN para 122 HM Treasury, Freedom and choice in pensions: government response to consultation, Cm 8901, July 2014, p6 Bill 97-EN, para 143-151

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If the “money purchase annual allowance rule” is triggered, and an individual contributes more than £10,000 to their money purchase pension, they would be subject to an annual allowance charge on the excess over £10,000 and their annual allowance for the remainder of their pension saving would be reduced from £40,0000 to £30,000. Draft HMRC guidance explains: If you trigger the money purchase annual allowance rules and exceed the £10,000 money purchase annual allowance in any tax year, 

you will be subject to the annual allowance charge on the excess over £10,000, (see RPSM06105020), and



your annual allowance for the remainder of your pension savings will be reduced to £30,000 (the ‘alternative annual allowance’) plus any unused annual allowance you may carry forward from the three previous tax years. To ensure that the same savings are not subject to the annual allowance twice, any pension savings tested against the £10,000 money purchase annual allowance will not be tested against your reduced £30,000 annual allowance.

If you do not exceed the £10,000 money purchase annual allowance, 

your total annual allowance, including for money purchase and defined benefit arrangements, will continue to be £40,000 plus any unused annual allowance carried forward from the three previous tax years,



you will not be able to carry forward any unused money purchase annual allowance.206

If an individual has accessed pension savings flexibly and contributed more than £10,000 to a money purchase scheme, a tax charge would apply. This charge would be at the individual’s marginal tax rate and based on the higher of: 

The default chargeable amount - the amount by which the individual’s total pension input exceeds their annual allowance (£40,000), plus any available carry forward (new section 227ZA (3)); and



The alternative chargeable amount - the excess of any money purchasing savings over £10,000 plus the excess of any DB pension savings over £30,000 (new paragraph 227B).207

There are special rules for calculating the pension input amount for certain hybrid arrangements made on or after 14 October 2014. In this case, the pension input amount will be the amount that provides the highest tax charge rather than the highest input amount, the intention being to avoid tax avoidance.208 New sections 227E and 227F would provide for the details of how the rules work in the tax year in which the individual flexibly accesses their pension savings (“a trigger event”). This is important because, for the purposes of the annual allowance generally, pension savings in a particular arrangement count for the pension input period that ends in a particular tax year.

205 206 207 208

HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p25 Ibid p23 Bill 97-EN, para 124-5 New section 227D; Bill 97-EN para 135

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Research Paper 14/57 Each successive pension input period must end in a consecutive tax years, but pension input periods do not have to match tax years.209 New section 227E would provide that where a pension input period ends in the same tax year as the one in which an individual flexibly access their savings, but before the flexible access occurs, then for the purposes of the £10,000 money purchase annual allowance, the pension input amount for a money purchase arrangement would be treated as nil.210 New section 227F would apply to a pension input period during which an individual first flexibly accesses their pension rights. In this case, only contributions made after flexible access count.211 For more details, and examples, see HMRC’s Draft guidance on clauses for the Taxation of Pensions Bill, October 2014 (p26-7). Under current rules, an individual subject to an annual allowance charge of more than £2,000 may be able to ask the scheme to pay it in return for a reduction in benefits. Draft guidance explains that this would not change: There are in effect no changes to when you can ask your scheme to pay your annual allowance charge in return for an actuarial reduction in your benefits. Where your pension savings exceed £40,000 in a particular scheme and your annual allowance charge is greater than £2,000 (but based on the existing annual allowance calculation), you can require your scheme to pay the annual allowance charge in return for a reduction in your benefits. You will not be able to require your scheme to pay any annual allowance charge if your total pension savings are less than £40,000, although they may do so on a voluntary basis, in return for a reduction in your benefits.212

Provisions for the passing on of information, both to scheme administrators and members, when individuals have flexibly accessed their pension savings are in Part 6 of the Schedule (see section 4.9 below). Comment In its response to consultation on the draft legislation, the Association of Accounting Technicians (AAT) argued that although the new measures would reduce the potential for unforeseen tax leakage, they would not stop it altogether: We note that the consultation response states that the reduced annual allowance will not impact 98 percent of the population and are concerned that this highlights how minimal its deterrent effect will be.213

On the other hand, organisations such as the National Association of Pension Funds welcomed the rules as a pragmatic approach: We also welcome the pragmatic approach towards the risks of tax avoidance, which should enable to costs and burdens on schemes to be limited. To achieve this, the

209 210 211 212 213

HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p26 Bill 97-EN para 136 Ibid, para 137-8 HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p29 AAT, ‘Comments on the draft legislation on the Taxation of Pensions Bill published on 6 August 2014,’ 27 August 2014, para 1.7

44

RESEARCH PAPER 14/57 implementation of the reduced £10,000 ‘money purchase annual allowance’ and the £30,000 ‘alternative annual allowance’ must be kept as simple as possible. 214

The ABI said: Ministers have made the right decision on how to balance greater freedom and choice with the need to prevent tax avoidance. They are to be commended for listening to provider advice about how best to tackle the problem without creating new loopholes.215

4.8

Miscellaneous amendments

Pension commencement lump sum - recycling The pension commencement lump sum is a tax-free lump sum of up to 25% of the value of a pension fund, paid in connection with an individual becoming entitled to their pension.216 There are ‘recycling rules’ to prevent the exploitation of pension tax rules by using the lump sum to make further tax relieved pension contributions. HMRC’s Registered Pension Schemes Manual explains: The recycling rule will apply where an individual envisages recycling a pension commencement lump sum by any means; from simply reinvesting the lump sum back into a registered pension scheme by way of a relievable pension contribution paid by the individual, through to the use of any devices, schemes, arrangements and understandings of any kind, whether or not legally enforceable, that enable the effective recycling of a pension commencement lump sum. If a pension commencement lump sum is taken as part of a structured and pre-planned arrangement for paying significantly greater contributions to a registered pension scheme, the fact that the individual has other funds from which the significantly greater contributions are paid or could have been paid does not mean that the recycling rule is avoided. 217

Paragraph 70 of the Schedule reduces to £7,500 (from 1% of the lifetime allowance) the minimum aggregate value of pension commencement lump sums paid to the individual in a 12 month period that trigger the recycling rule.218 Trivial commutation lump sum Under current rules, people with small amounts of total pension saving may be able to take it all as a lump sum. The purpose of these rules is to ensure that members would not be forced to purchase an annuity with small amounts of pension saving “which could prove to be uneconomic and disproportionately bureaucratic for both schemes and members.” Under the FA 2004, provision was made for people aged between 60 and 75 to take their pension as a lump sum, where their pension benefits had a total capital value of less than 1 per cent of the lifetime allowance. 219 Initially, the ‘trivial commutation limit’ was set at 1% of the lifetime allowance. However, the two were decoupled when the lifetime allowance reduced from £1.8 million to £1.5 million from April 2012 and the trivial commutation limit was fixed at

214 215

216 217 218 219

NAPF, ‘Response to draft guidance on clauses for the Taxation of Pensions Bill’, 3 September 2014 ‘ABI response to HM Treasury Freedom and choice in pensions announcement on the Guidance Guarantee’ 21 July 2014 Provision for it is in s166 and Sch. 29 FA 2004. FA 2004, Sch 29 3A(3);RPSM04104925 Bill 97-EN, para 158; HM Treasury, Tax Information and Impact Note, 14 October 2014, p29 HC Deb 4 April 2005 c1174W; FA 2004, s166 and 29

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Research Paper 14/57 £18,000.220 It was increased to £30,000 from 27 March 2014 as part of the reforms announced in Budget 2014.221 Paragraph 71 of the Schedule would amend paragraph 7(1) of Schedule 29 FA 2004 to provide that from 6 April 2014, a trivial commutation lump sum can only be paid in respect of a DB arrangement. The provision is being removed for money purchase arrangements because “those with relatively small amounts of money purchase savings will be able to take a UFPLS from that date”.222 In addition: 

The age from which a trivial commutation lump sum can be paid would be reduced from 60 to minimum pension age (55).223 and



To qualify as a trivial commutation lump sum, a payment would only need to extinguish any DB rights relating to the member under that scheme.224

Small pots One effect of introducing a common set of rules across pension schemes in FA 2004 was that it was no longer possible to commute some small pots that could previously have been commuted. FA 2004 provided for trivial commutation where a person’s total pension saving was below a certain amount. However, it had previously been possible to commute a pension of less than £260 per annum and no account had to be taken of other pensions in payment.225 In Budget 2008 it was announced that changes would be made to help more members of occupational pensions with small pensions.226 Provision was made for some small ‘stranded pots’ and pension savings below £2,000 in occupational pension schemes to be taken as a lump sum. This was extended to personal pensions from 6 April 2012. An individual could only take a lump sum twice under this rule. The scheme member had to have reached the age of 60.227 In Budget 2014, the Government announced that it would increase the size of a single pension pot that can be taken as a lump sum from £2,000 to £10,000 and increase the number of pension pots of below £10,000 that can be taken as a lump sum, from two to three.228 Provision was made for this in the Finance Act 2014 (section 42). Paragraph 72 and 73 of the Schedule would reduce the age at which an individual could make use of these rules from 60 to 55.229 Other provisions Paragraph 74 provides for a new circumstances when a ‘trivial commutation lump sum death benefit’ can be paid. The Explanatory Notes say: A trivial commutation lump sum death benefit may be paid to an individual in respect of any entitlement they had to receive any guaranteed pension payments of a lifetime annuity or scheme pension payable after the member’s death. The lump sum must 220

HM Treasury, Restricting pensions tax relief through existing allowances: a summary of the discussion document responses, October 2010, para B.13 221 HM Treasury, Budget 2014, HC 1104, March 2014; Finance Act 2014, section 42. 222 Bill 97-EN, para 159 223 HM Treasury, Freedom and choice in pensions: Government response to consultation, Cm 8901, July 2014, para 4.38 224 Bill 97-EN, para 159 225 DWP, Deregulatory review – Government response, October 2007, para 2.10.2 226 HMRC, Budget 2008 Notes, BN 42, Pensions: Regulation making powers 227 Registered Pension Schemes (Authorised Payments) Regulations 2009 (SI 2009/1171); RPSM09105485 228 HM Treasury, Budget 2014, HC 1104, March 2014 229 HM Treasury, Freedom and choice in pensions: Government response to consultation, Cm 8901, July 2014, p25

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extinguish the individual's rights to receive the guaranteed pension payments under the scheme or contract concerned. This applies to payments made on or after 6 April 2015.230

The limit for the trivial commutation lump sum death benefit would increase to £30,000. Facility to pay a winding-up lump sum death benefit would be remove because such payments also satisfy the conditions to be a trivial commutation lump sum death benefit.231 Paragraph 76 deals with the valuation of a lifetime annuity when an individual becomes entitled to it before normal minimum pension age and the ill-health condition is not met, HMRC explains: […] where an individual becomes entitled to a lifetime annuity before the normal minimum pension age and without the ill-health condition applying, the amount treated as crystallised by that annuity at age 55 will be the higher of the annual rate of the annuity multiplied by twenty and the original value of the sums and assets used to buy the lifetime annuity.232

Paragraph 77 deals with the valuation of a pre-6 April 2006 drawdown pension for the purposes of the lifetime allowance. HMRC explains that this would: […] provide that where an individual became entitled before 6 April 2006 to what is now a capped drawdown pension and no benefit crystallisation event has yet occurred, the amount of lifetime allowance treated as used up by that pension when the first benefit crystallisation event occurs will be reduced to 80 per cent of the maximum drawdown pension payable under that arrangement.233

Paragraph 78 deals with transfers relating to individuals with a protected right to take their pension below the age of 55. HMRC explains: […] when an individual under age 55 with a protected pension age transfers benefits in payment as part of a recognised transfer, the transfer won't cause any pension payment made before the member's 55 th birthday to be unauthorised.234

Paragraph 81 deals with the taxation of pensions for individuals who are temporarily nonresident. An explanation is in HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill (21 October 2014), section 9.6 Permissive statutory override In its consultation document, the Government said it was keen that individuals who wanted to take advantage of the changes should not be prevented from doing so by scheme rules: When and how you are able to take your pension depends on the interaction between the tax rules and your pension scheme rules. Many pension scheme rules specify an age at which you are entitled to take your benefits, usually equal to or greater than the age specified in the tax rules (currently 55), and some currently place restrictions on whether you are able to take your pot under either the trivial commutation rules or small pot rules.

230 231 232 233 234

Bill 97-EN, para 164 bid para 165-6 HMRC, Pension Flexibility 2014 – Tax Information and Impact Note, 14 October 2014; Bill 97-EN, para 167 Ibid; Bill 97-EN, para 168 Ibid; Bill 97-EN, para 169

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Research Paper 14/57 If the age at which you are entitled to take your pension under your scheme rules is below age 55 (usually under older pension schemes) you may incur a tax charge of up to 55% when you take your pension, unless you have ‘protected rights’. You may have ‘protected rights’ if, as at 5 April 2006, your scheme rules entitled you to take your pension before age 55.235

It therefore sought views on whether a statutory override should be put in place “to ensure that pension scheme rules did not prevent individuals from taking advantage of increased flexibility.”236 The NAPF said it would support a permissive override to allow flexibility in how to accommodate the new rules: The NAPF believes that it is important to allow schemes flexibility in how they accommodate the changes introduced in the Budget and that changes to scheme rules should not be forced upon schemes and employers. We support a permissive override, by which schemes and their sponsors who choose to embrace the new flexibilities have an efficient means of incorporating these into their rules.237

In July 2014, the Government said that, given the concerns that had been expressed about the costs and administrative consequences of a mandatory override, it would introduce a permissive override: 2.15 The government believes that the introduction of a statutory override mandating that schemes provide flexible payments would be disproportionate. However, several respondents highlighted that some schemes may like to offer increased flexibility to their members, but would prefer not to amend their scheme rules because of the potential legal and administrative costs. In these situations, the government would prefer that schemes were in a position to provide flexibility without having to amend their rules. 2.16 Consequently, the government plans to introduce a permissive statutory override. This will allow schemes to ignore their scheme rules and follow the tax rules instead, in order to pay out payments flexibly or to provide a drawdown facility. In the government’s view, this achieves the most proportionate outcome for both individuals and schemes.238

This is provided for in paragraph 79 which would provide that trustees or managers of a scheme may make certain prescribed payments outlined in the Schedule “despite any provision of the rules of the scheme (however framed) prohibiting the making of the payment.” The list of prescribed payments includes a drawdown pension and an uncrystallised funds lump sum.239 4.9

Provision of information

Part 6 would provide for the passing on of information, both to administrators and scheme members when individuals have flexibly accessed their pension savings. The reporting requirements are intended to ensure that, where an individual has flexibly accessed their pension savings: 235

HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, Box 3B Ibid para 3.34 237 Freedom and choice in pensions: a response by the National Association of Pension Funds, June 2014, appendix 1 238 HM Treasury, Freedom and choice in pensions: the government’s response to consultation, Cm 8901, July 2014 239 Bill 97-EN 236

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  

Schemes of which they are a member are aware of this; The individual gets the right information to declare on their self-assessment tax return and calculate the annual allowance charge due; and HMRC is provided with sufficient information to ensure the right amount of tax is paid.240

An explanation is in HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill (21 October 2014), chapter 8. 4.10

Overseas pensions

Current legislation broadly puts members of overseas pension schemes who receive UK relief in the same position as members of UK registered pension schemes. There are similar limitations on the amount of tax relief available and the benefits that can be provided.241 Part 7 of the Bill would make various changes in the existing limitations on access to pension savings in overseas schemes to maintain compatibility with the UK registered pension scheme tax regime.242 4.11

Restriction and reduction of tax charges on certain lump sums

In certain circumstances, a lump sum death benefit may be provided on the death of the member.243 For example: 

An uncrystallised funds lump sum can be paid from a money purchase arrangement or cash balance arrangement. It is paid from funds that have not yet been put into payment;244 and



If a member receiving with a drawdown pension fund dies, the remainder of their fund may be paid out as a lump sum (‘a drawdown pension fund lump sum death benefit’).245

The legislation does not specify who these lump sums should be paid to. The other lump sum death benefits that may be paid are: a defined benefits lump sum death benefit, a pension protection lump sum death benefit, a charity lump sum death benefit, a trivial commutation lump sum death benefit and a winding up lump sum death benefit.246 Section 206 FA 2004 provides for a ‘special lump sum death benefits charge’ to apply to specified lump sum death benefits: 1) A charge to income tax, to be known as the special lump sum death benefits charge, arises where – a. A pension protection lump sum death benefit, b. An annuity protection lump sum death benefit, or c. A drawdown pension fund lump sum death benefit

Bill 97-EN, para 50 and 178-87; HMRC, Pension Flexibility 2014 – Tax Information and Impact Note, 14 October 2014 241 HMRC, Pension Flexibility 2014 – Tax Information and Impact Note, 14 October 2014 242 Bill 97-EN para 51 243 FA 2004, s 168 244 FA 2004, Sch 29 (15); RPSM10106030 245 FA 2004, Sch 29 (17); RPSM10106060 246 FA 2004, s 168 (1) 240

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Research Paper 14/57 is paid by a registered pension scheme. (1A) The special lump sum death benefits charge also arises where – a. A defined benefits lump sum death benefit, or b. An uncrystallised funds lump sum death benefit Is paid by a registered pension scheme in respect of a member who had reached the age of 75 at the date of the member’s death. […] (4) The rate of the charge is 55% in respect of the lump sum death benefit. […] (7) None of the following is to be treated as income for the purposes of the Tax Actsa. any lump sum death benefit mentioned in subsection (1); b. a defined benefits lump sum death benefit or uncrystallised funds lump sum death benefit paid in respect of a member who had reached the age of 75 at the age of the member’s death.

If the member was under 75 when they died an uncrystallised lump sum death benefit is tax free unless the lifetime allowance charge is payable.247 The rate of the lump sum death benefit charge was set at 55% in the Finance Act 2011, the same legislation which removed the requirement to buy an annuity at the age of 75 (see section 1.2 above). It was intended to reflect the value of the tax relief that had been given. Some respondents to the consultation argued that it was unfairly high, particularly for basic rate taxpayers and existing unsecured pension holders. The Government rejected calls for a lower charge (such as 35%) on the grounds that this “would not fully recover the relief provided for many people, and would create an incentive for some people to save into a pension in order to avoid [inheritance tax].” Death benefits for those who died before age 75 without having accessed their pension savings, would remain tax-free.248 In connection with the reforms announced in Budget 2014, the Government said it would look again at the level of the charge: In particular, the government believes that a flat 55% rate will be too high in many cases given that everyone with defined contribution pension savings will now have the freedom to enter into drawdown rather than an annuity. 249

In his speech to the Conservative Party Conference on 29 September 2014, Chancellor of the Exchequer George Osborne said he would abolish the 55% charge: There are still rules that say you can’t pass on to the next generation any of your pension pot when you die, without paying a punitive 55% of it in tax. I could choose to cut this tax rate.Instead, I choose to abolish it altogether. 250

HM Treasury explained in more detail how this would work:

247 248

249 250

RPSM10106030 HM Treasury, Removing the requirement to annuitise by age 75. A summary of the consultation responses and the Government’s response, December 2010, para 3.15-25; See also, HM Treasury, Removing the requirement to annuitise by age 75, July 2010, para 2.22-23; Library Note SN 712 Pensions: income drawdown (May 2014). HM Treasury, Freedom and choice in pensions, CM 8835 March 2014, para 3.17 George Osborne: Speech to Conservative Party Conference 2014

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From next year, individuals with a drawdown arrangement or with uncrystallised pension funds will be able to nominate a beneficiary to pass their pension to if they die. If the individual dies before they reach the age of 75, they will be able to give their remaining defined contribution pension to anyone as a lump sum completely tax free, if it is in a drawdown account or uncrystallised. The person receiving the pension will pay no tax on the money they withdraw from that pension, whether it is taken as a single lump sum, or accessed through drawdown. Anyone who dies with a drawdown arrangement or with uncrystallised pension funds at or over the age of 75 will also be able to nominate a beneficiary to pass their pension to. The nominated beneficiary will be able to access the pension funds flexibly, at any age, and pay tax at their marginal rate of income tax. There are no restrictions on how much of the pension fund the beneficiary can withdraw at any one time. There will also be an option to receive the pension as a lump sum payment, subject to a tax charge of 45%. […]251

The policy was expected to cost around £150 million per annum. Further detail would be in the Autumn Statement.252 The Government said it intended to make lump-sum payments subject to tax at the marginal rate rather than a flat-rate charge of 45%. It would “engage with pension industry in order to put this regime in place for 2016-17.”253 The Bill Clause 2 (2) of the Bill would amend section 206 (1) FA 2004 to provide that where a lump sum death benefit is subject to the special lump sum death benefit charge, this would only apply where the member had reached 75 at their death. Section 206 (1) as amended would read: 2) A charge to income tax, to be known as the special lump sum death benefits charge, arises where – d. A pension protection lump sum death benefit, e. An annuity protection lump sum death benefit, or f. A drawdown pension fund lump sum death benefit is paid by a registered pension scheme in respect of a member who had reached the age of 75 at the date of the member’s death.254

Clause 2 (3) would reduce the rate of the charge from 55% to 45%. The effect is that of these provisions is that: From 6 April 2015;

251 252 253 254

Gov.UK, Chancellor abolishes 55% tax on pension fund at death, 29 September 2014 Ibid Ibid The words in italics are those added by the Bill

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Research Paper 14/57 

The special lump sum death benefit charge under section 206 of FA 2004 will be 45%. This charge will apply only where the member at the time of their death was age 75 or older, and to lump sum death benefits paid on or after 6 April 2015.



Any lump sum death benefit listed below that is paid where the member at the time of their death was under age 75 will be tax-free. This will apply to lump sum death benefits paid on or after 6 April 2015.

This applies to the following lump sum death benefits. 

A pension protection lump sum death benefit



An annuity protection lump sum death benefit



A drawdown pension fund lump sum death benefit



A flexi-drawdown fund lump sum death benefit



A defined benefit lump sum death benefit



An uncrystallised funds lump sum death benefit.255

Clause 2 (4) would also reduce the level of the ‘serious ill health lump sum charge from 55% to 45%. The Explanatory Notes say: This charge applies where a serious ill-health lump sum is paid to a member after they have reached age 75. All an individual’s uncrystallised rights can be paid as a serious ill-health lump sum where the scheme administrator has received medical evidence that the member has less than 12 months to live. 256

The effect is that: From 6 April 2015; 

The serious ill-health lump sum charge under section 205A of FA2004 will be 45%. This charge will apply only where the member at the time the lump sum is paid was age 75 or older, and to lump sums paid on or after 6 April 2015.



Any serious ill-health lump sum that is paid to a member at the time was under age 75 will continue to be tax-free.257

Comment An article in the Financial Times said the Government and wealth advisers disagreed on who would benefit most: In announcing the measure, which takes effect from April, the Treasury predicted savers with smaller pension pots worth £20,000 to £50,000 would be among the many to benefit from the tax cut. But advisers said the wealthy had most to gain from the reform. “Sadly, the changes to the tax charges on death for pensions will not help those who are still struggling to build up sufficient funds to pay for their retirement,” said Andy James, head of

255 256 257

HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p37 Bill 97-EN HMRC, Pension Flexibility: Draft guidance on clauses for the Taxation of Pensions Bill, 21 October 2014, p37

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RESEARCH PAPER 14/57 retirement planning with Towry, the wealth managers. He added: “The new regime will bring pensions into overall inheritance planning for wealthy people. You can pay the maximum into a pension, currently £1.25 m, and it would pass down the generations completely tax free. Some people will even have bigger pensions built up under the old rules to pass down.”[…]258

The announcement was welcome by organisations including the ABI and CBI. It was also welcomed by the CBI. 259 The National Association of Pension Funds said it was likely to affect people with larger pension pots: While it may encourage some people to save more into their pension, assured they will be able to pass on the lion’s share without tax, the reality is that this is likely to affect only people with larger pension pots. 260

It urged the Government to ensure the Guidance Service, which would affect millions of people, was in place by April 2015 and to “accelerate the review of the annuity market to ensure it is working well and can provide savers with products that offer good value.”261

258

259

260

261

Josephine Cumbo, Alistair Gray and George Parker, Rich forecast to benefit most from axing tax on drawdown pension pots, Financial Times, 30 September 2014 ABI welcomes move to abolish 55% tax on pension income drawdown funds 29 September 2014; CBI comments on Chancellor’s Conference speech, 29 September 2014 NAPF comments on Chancellor’s proposal to abolish 55% tax charge on inherited pension pots, 29 September 2014 Ibid

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Research Paper 14/57

Glossary Annuity – a lifetime annuity is a contract with an insurer to provide a series of payments over the lifetime of the individual (or, in the case of a joint-life annuity over the remaining lifetime of the longest survivor). Annual allowance (AA) – a statutory limit on the amount of tax-relieved pension savings an individual can build up in a year. Benefit crystallisation event - a defined event or occurrence set out in section 216 FA 2004 that triggers a test of the benefits 'crystallising' at that point against the individual's available lifetime allowance. Cash balance scheme – a scheme in which a guaranteed cash sum is built up on the basis of a known formula which is related to the employee’s pensionable earnings in each year of membership. The resulting “cash balance” can be used to buy an annuity or to make other arrangements. Defined benefit pension scheme – a scheme in which the member builds entitlement to pension benefits based on fixed factors such as salary and length of service (section 152 FA 2004). Defined contribution pension scheme – a scheme in which an individual builds up a fund based on contributions and investment returns. This is not defined in pension tax legislation, which instead refers to money purchase arrangements (section 152 FA 2004 - see section 1.2 of this paper). Dependant – defined in Schedule 28(15) FA 2004 as a person married to or a civil partner of the member; a child of the member who has not reached the age of 23 or was dependant on the member at the time of death because of physical or mental impairment; an unmarried partner who was financially (inter)dependent on the member. Income drawdown arrangement – an arrangement from which an individual can withdraw funds while leaving the rest invested. Under current rules there is a cap on the amount that can be drawn down each year except where the individual can show they have other pension income over a certain amount (s165 and Sch. 28 FA 2004). Ill health condition – the legislation provides for a member to be able to take benefits at any age where the scheme administrator accepts qualified medical advice that the member satisfies the ‘ill-health condition’ and so is and will continue to be, medically incapable (either physically or mentally) as a result of injury, sickness, disease or disability of continuing his or her current occupation and as a result of the ill-health ceases to carry on the occupation (Schedule 28(1) FA 2004). Lifetime allowance (LTA) – a statutory limit on the amount of tax-relieved pension savings an individual can build up over their lifetime. From 2014/15 onwards the standard LTA is £1.25 million. Uncrystallised funds - funds held in respect of the member under a money purchase arrangement that have not as yet been used to provide that member with a benefit under the scheme (so have not crystallised), as defined in paragraph 8(3) of Schedule 28 FA 2004.

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