UK: Budget 2014: Legislation Published

Last Updated: 8 September 2014
Article by Ian Greenstreet

Hot on the heels of the Government's response to consultation in July, we now have a draft Taxation of Pensions Bill. This gives more detail on how the new pension flexibilities will work in practice (from 6 April 2015) and the new annual allowance provisions intended to prevent abuse of the tax system. The new provisions will apply to "money purchase arrangements" as defined in the Finance Act 2004. This is much wider than the new definition of "money purchase benefit" in the pensions legislation and includes cash balance arrangements as well as "pure" money purchase or defined contribution. 

Essentially there will be two options for individuals with money purchase arrangements. Take a tax-free lump sum and designate an associated amount for drawdown or, take a lump sum (25 per cent which will be tax-free and the remainder taxed as income). This gives members significantly greater flexibility as to when and how they access money purchase funds.

The provisions are enabling. Schemes will not be required to offer the new flexibilities. Many DC occupational schemes may not want to offer them because of the additional administration costs involved. Many schemes are likely to want to offer members the right to transfer out up to the point of retirement so that they can access new products in the market or take a one-off lump sum. 

New flexi-access drawdown

An amount equal to one-third of the value of the funds designated for flexi-access drawdown can be taken tax-free at the point of designation. So, if £30,000 is designated for drawdown, an additional £10,000 can be taken as a tax-free lump sum (the net effect being a 25 per cent lump sum). The drawdown fund can then be accessed either by income withdrawal or by the purchase of short-term annuities. Any level of income can be drawn and it will be subject to the member's marginal income tax rate. Once any of the drawdown fund is accessed, the new £10,000 annual allowance will apply (see below).

On 6 April 2015, current flexible drawdown funds will convert automatically to flexi-access drawdown funds and the new annual allowance rules will apply. This is an improvement for individuals, as currently those in flexible drawdown have a nil annual allowance.

Existing capped drawdown funds can be converted to flexi-access drawdown funds either automatically where the member draws more than the permitted maximum, or where the member notifies the scheme administrator that he wants to convert. Future designations can be made to the capped fund, or to a new flexi-access drawdown fund.

Uncrystallised funds pension lump sum

This is the new headline feature from 6 April 2015, whereby members can access freely their DC pension savings as a lump sum, part of which will be tax-free. The payment must be made from uncrystallised rights (i.e. not from a drawdown fund). It can only be paid where some (age 75 or over) or all (under age 75) of the amount is within the lifetime allowance.   

Generally, one quarter of the amount taken will be tax-free and the remainder taxed as income. Where a member over 75 takes a lump sum which is in excess of the remainder of his lifetime allowance, the tax-free part will be 25 per cent of the remaining lifetime allowance with the remainder subject to income tax.

Members taking an uncrystallised funds lump sum will be subject to the new annual allowance rules (see below).

New money purchase annual allowance rules

These new rules are intended to prevent individuals taking advantage of the new flexibility by diverting their salary into a pension scheme with tax relief and then immediately withdrawing 25 per cent tax-free.

The new rules will be triggered where the member:

  • takes income from a flexi-access drawdown fund (including payments from a short-term annuity);
  • receives an uncrystallised funds pension lump sum;
  • takes more than the permitted maximum for capped drawdown;
  • receives a "stand-alone lump sum" and is not entitled to enhanced protection;
  • received a pre-April 2015 payment from a flexible drawdown fund.

Where the money purchase annual allowance is triggered, the individual will have an annual allowance of £10,000 for "money purchase" savings and £30,000 for other pension savings. Any carry-forward from previous years can only be used for non-money purchase savings. There is no carry forward of unused money purchase annual allowance.

Individuals will be assessed for a "default chargeable amount" and an "alternative chargeable amount", the higher of which will be the "chargeable amount" on which tax is payable. The default amount is the excess of all pension savings over £40,000. The alternative chargeable amount is the total of excess DB pension savings over £30,000 plus the excess of money purchase savings over £10,000.

The individual will become subject to the new annual allowance from the day the trigger event occurred. The exact treatment will depend on the pension input period for each pension arrangement.

The current rules on the recycling of lump sums will be changed on 6 April 2015 so that they will apply where the amount of lump sums taken in any 12-month period exceeds £10,000 (currently one per cent of lifetime allowance).

Power to make payments

Government policy is that all schemes should be able, but not required, to offer members the new flexibilities. The draft Bill includes a provision allowing trustees or managers to "make the payment despite any provision of the rules of the scheme (however framed) prohibiting the making of the payment". We have some concerns over whether this provision will be technically effective to fulfil the Government's policy, although support the concept. This may be something which will be addressed before the Bill is presented to Parliament in the autumn.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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