UK: Changes To Annual And Lifetime Allowances

Last Updated: 14 January 2016
Article by Ian Greenstreet

Summary and implications

Changes to both the lifetime and annual allowances from 6 April 2016 are going to affect many scheme members. Trustees need to understand the new limits, be aware of their obligations and communicate the changes effectively to members. This includes an obligation to provide pension savings statements where an individual has exceeded the annual allowance.

Everything could change on 16 March 2016 when the Chancellor is due to give the Government's response to its consultation, issued in July 2015, which sought views on the future shape of pensions tax relief. One specific reform which is under consideration is a move from the current EET (Exempt-Exempt-Taxed) system to a TEE (Taxed-Exempt-Exempt) system. The full adoption of this would mean no tax relief for employers or employees on pension contributions. There has been speculation that the Government may keep EET but apply a common rate of tax relief on contributions (30 per cent has been suggested).

Lifetime allowance – falling to £1m

The standard lifetime allowance (SLA) for pension savings is being reduced to £1m from 6 April 2016. The SLA started at £1.8m in 2006 and has been progressively reduced. Benefits are tested against an individual's remaining lifetime allowance as they crystallise.

Various protections have been introduced, in April 2006 and at each point where the lifetime allowance has been reduced, to protect existing pensions savings from new tax charges.

Protection What it covers Formalities Future accrual?
Primary Savings >£1.8m at 5 April 2006. Notify HMRC by 5 April 2009. Y
Enhanced Fully protects rights accrued as at 5 April 2006. Notify HMRC by 5 April 2009 and no accrual from 6 April 2006. N
Fixed Fixes LA at £1.8m (or SLA if higher).

Apply to HMRC by 5 April 2012. Not needed for those with primary or enhanced protection.

N
Fixed 2014 (FP14) Fixes LA at £1.5m (or SLA if higher). Apply to HMRC by 5 April 2014. Not needed for those with primary, enhanced or fixed protection. N
Individual 2014 (IP14) Savings >£1.25m at 5 April 2014. Fixes LA as value of pension rights at 5 April 2014 (max £1.5m) or SLA if higher. Apply to HMRC by 5 April 2017. Not available to those with primary protection. Y
Fixed 2016 (FP16) Fixes LA at £1.25m (or SLA if higher). Apply online to HMRC from July 2016. Not available to those with primary, enhanced or fixed protection or FP14. N
Individual 2016 (IP16) Savings >£1m at 5 April 2016. Fixes LA as value of pension rights at 5 April 2016 (max £1.25m) or SLA if higher. Apply online to HMRC from July 2016. Not available to those with primary protection or IP16. Y

HMRC is introducing an interim process for those wanting to take advantage of FP16 or IP16 and to take benefits before the full application service is established. Individuals can make a temporary written application to HMRC. This will be valid until 31 July 2016 by which date a full online application should be made. More details of the interim process will be given by HMRC "in due course".

Under current rules, a lifetime allowance of £1m would allow a DB pension of £50,000 (assuming no lump sum is taken). The effect of the reduction is likely to hit those with DC pension savings harder, where a pot of £1m would buy an annuity considerably less than £50,000. In his budget speech in March 2015, George Osborne stated that "fewer than 4 per cent of pension savers currently approaching retirement will be affected." This has been estimated to be around 460,000 individuals although significantly more are likely to be affected in the future.

Lifetime allowance – death benefits

The lifetime allowance reduction is also likely to affect significantly more individuals on death. To the extent that the value of the lifetime allowance crystallising on the member's death exceeds any remaining available lifetime allowance, there may, depending on the exact circumstances, be a lifetime allowance charge on the recipient of any lump sum. Benefits paid out in the form of a dependant's pension do not generally count for this purpose.

Many employers are now setting up excepted group life trusts to provide the death benefit lump sum for high earners outside a registered pension scheme so benefits paid will not count for lifetime allowance purposes. Benefits provided under an excepted group life trust have to meet certain criteria. Generally it is not possible to provide different levels of cover for different members and there can be potential inheritance tax issues. Excepted group life trusts are also being offered to new hires who have obtained enhanced protection or one of the forms of fixed protection (which are likely to increase in number). These employees will lose their protection if they are admitted to a registered group life arrangement.

Annual allowance reduction for high earners

The annual allowance for pension savings is to be reduced from £40,000 to £10,000 for high earners from 6 April 2016. The reduction will be on a sliding scale – for every £2 of income an individual has over £150,000, their annual allowance will be reduced by £1 until it has tapered down to £10,000 for those earning £210,000 or more.

The £150,000 is an "adjusted income" figure which includes employer pension contributions (to prevent avoidance through salary sacrifice). The new rules will not apply to anyone with a "threshold income" of no more than £110,000 (in tax year 2016–17).

HM Treasury figures suggest that this could affect 300,000 individuals.

High earners

Individuals with "adjusted income" over £150,000:

- net income; plus
- relief given under net pay arrangements for pension contributions; plus
- pension contributions made under net pay arrangements; plus
- relief for overseas pension contributions; plus
- employer pension contributions; less
- any DB lump sum death benefit received as a result of the death of an individual aged over 75.

But not those with "threshold income" of no more than £110,000 (for 2016–17):

- net income; plus
- employment income given up for pension provision as a result of salary sacrifice made on or after 9 July 2015 (anti-avoidance measure); less
- gross amount of any relief-at-source pension contributions; less
- any DB lump sum death benefit received as a result of the death of an individual aged over 75.

Aligning pension input periods (PIPs) with the tax year

The PIP is the period over which pension inputs (DB accrual or DC contributions) are assessed for the purposes of the annual allowance. The PIP is usually a 12-month period (but can in some circumstances be longer or shorter than that). Pension inputs are tested against the annual allowance in the tax year in which a PIP ends.

In order for the new annual allowance taper to work as intended, all PIPs are being aligned with the tax year. In order to achieve this (and to make it fair for anyone who put in £40,000 prior to the 2015 Budget), there are some fairly complicated transitional provisions.

From 6 April 2016 all existing registered pension arrangements will have a 12-month PIP from 6 April 2016 to 5 April 2017. All future PIPs will run 6 April to 5 April and there will be no power to vary.

Transitional PIP and annual allowance arrangements

  • All PIPs ended on 8 July 2015.
  • New PIPs run from 9 July 2015 to 5 April 2016.
  • The next PIP will start on 6 April 2016 and run to 5 April 2017 (and follow the tax year thereafter).

Individuals will have an annual allowance of £80,000 for the tax year 2015–16 (plus any carry forward from the previous three tax years) for all pension savings in relation to all PIPs between 6 April 2015 and 8 July 2015. This is referred to as the pre-alignment tax year.

Post-Budget 2015 savings (i.e. 9 July 2015 to 5 April 2016) will have a nil annual allowance but up to £40,000 of the £80,000 can be carried forward (plus carry forward of any unused annual allowance from the previous three tax years). This period is referred to as the post-alignment tax year.

From 6 April 2016 the standard annual allowance of £40,000 will apply, subject to tapering for high earners and to the usual rules on carry forward.

This diagram illustrates the transitional annual allowance and PIP arrangements.

Money purchase annual allowance

The money purchase annual allowance is triggered when an individual accesses flexible benefits (broadly money purchase or cash balance benefits) in certain ways including taking an uncrystallised funds pension lump sum or receiving income from assets designated for flexible drawdown. Taking a pension commencement lump sum will not, by itself, trigger the money purchase annual allowance.

Once triggered, the individual will have an annual allowance for money purchase pension saving of £10,000 and for defined benefit accrual of £30,000 (referred to as the "alternative annual allowance"). Alternatively the individual could be subject to the "default chargeable amount" – essentially this gives an annual allowance of £40,000 of which up to £10,000 may be money purchase contributions.

There are transitional provisions in the period up to 6 April 2016. In the pre-alignment tax year, the money purchase annual allowance was £20,000 and the alternative annual allowance £60,000 (or alternatively a default chargeable amount of £80,000). The money purchase annual allowance for the post-alignment tax year is nil, with the remainder of the £20,000 carried over (subject to a maximum of £10,000). The alternative annual allowance is also nil but with the remainder of the £60,000 carried over (subject to a maximum of £30,000). Alternatively up to £40,000 of the default chargeable amount can be carried over. In effect, a total of £40,000 could be brought forward (plus ordinary carry forward from the previous three tax years). This diagram illustrates the position in relation to the money purchase annual allowance.

From 6 April 2016, the money purchase annual allowance will remain at £10,000 but the alternative annual allowance will taper down from £30,000 to nil for high earners. Alternatively, the default chargeable amount will start at £40,000, tapering down to £10,000 for high earners. The usual carry forward rules will apply.

Communicating with members

Trustees must be clear in any communication with members about the new allowances that they are not providing financial advice. High earning individuals or those with pension savings approaching £1m should consider taking their own independent financial advice.

Scheme booklets should be checked to ensure that where detail is given on the PIP and lifetime and annual allowance rates it is accurate.

The extent to which trustees are required to communicate with members about the lifetime and annual allowance is relatively limited (as it is essentially a personal taxation issue for each individual rather than a scheme matter).

The scheme administrator (usually the trustee) must provide an annual pension savings statement to an active member whose pension savings in the scheme in the most recent PIP have exceeded the annual allowance, or a deferred member whose benefits have increased by more then the "relevant percentage" (broadly their benefits have been revalued by more than CPI or the scheme's own revaluation rate if higher). A pension savings statement must also be provided where a member has flexibly accessed money purchase benefits and exceeded the money purchase annual allowance.

Any member or former member may also request a pension savings statement.

A pension savings statement must contain:

  • the individual's pension inputs in the scheme for the relevant PIP;
  • the annual allowance for the tax year in which the PIP ends;
  • the member's pension inputs in the preceding three tax years; and
  • the annual allowance for the three preceding tax years.

Where a member has accessed relevant flexible benefits (i.e. where the money purchase annual allowance has been triggered) then the pension savings statement must show:

  • the member's pension inputs under the scheme for the relevant PIP (with money purchase and DB shown separately);
  • the alternative annual allowance (£30,000 for 2015–16) and for the preceding three tax years (or the annual allowance for years before 2015–16); and
  • pension inputs for the preceding three years.

Pension savings statements must be provided by 6 October following the end of the tax year to which they relate.

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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