The Wrong Road

HMRC’s U-turn on Alternatively Secured Pensions is counter-intuitive.

Until 5 April 2006, it was mandatory for individuals to purchase an annuity with their accumulated pension funds when they reached 75. This ruling committed pension policyholders to make decisions about spouses’ pensions, escalations and guarantees that might not be required.

If the policyholder died shortly after purchasing the annuity, the whole of their fund would be absorbed into the annuity pool, which is used to provide benefits for annuitants.

A breath of fresh air
Then, on 6 April 2006, the Alternatively Secured Pension (ASP) was introduced. It was a great idea that enabled individuals to take their tax-free cash at age 75 and leave the balance of their pension fund invested to provide an income up to approximately 70% of a single life level annuity.

On the pensioner’s death, it was mandatory for the fund to be used to provide similar benefits for their dependants. If there were no existing dependants (or upon the death of the dependants) the remaining fund could either be left to a charity in full, or be allocated to other members of the same pension scheme-subject to IHT. Alternatively, the fund would form a windfall profit for the pension provider.

Suspect device
However, there were rumblings that schemes such as the ASP were seen as intricate tax-planning devices. And so it was announced in December 2006 and confirmed in the March 2007 Budget that fund transfers to allocated members of the same pension scheme would suffer punitive income tax charges of 70% of the value of the fund, with the balance subject to IHT at 40%. This leaves just 18% for the allocated members.

Whilst the full value of the fund can still be passed on to charities, which can now also be nominated by the pension providers, the barrier to worthwhile pension investment has again gone up. The remaining pension savings for those who do not need to provide or have elected not to provide for dependants seem doomed to dissolve into the ether.

The elusive incentive
The government has been wrestling with ways to encourage individuals to save for retirement for many years. It’s quite clear that they have never really understood the reasons why many investors have been reticent to commit resources to an investment that could evaporate into nothing.

The enforcement of annuity purchase by age 75 has always been cited as a reason for investors not wanting to put money into a pension plan to look after them in retirement.

People are concerned that a death shortly after the purchase of an annuity would mean that their fund could end up in an annuity pool that doesn’t provide any benefit to the investor or to their family with years of saving gone to waste.

Passing down the benefit
Advisers, investors and pension providers breathed a sigh of relief when it was announced that a modified form of unsecured income (ASP) would, on the death of the pensioner and their spouse, allow any remaining pension fund to be passed on to other members of the same pension scheme-after a charge to IHT.

Whilst it is understood that this change was made primarily to help members of a religious sect who objected to annuity pooling since they cannot benefit from the death of others, its extension to all investors seemed sensible and pragmatic.

Pension investments could now be passed down the generations to allow individuals to accumulate more in their funds. This would, presumably, reduce the future pensions burden on the state. Investors were encouraged by the prospect of their children and grandchildren being able to benefit from their savings. Pensions saving suddenly looked a whole lot fairer.

Spoiling it for everyone else
However, it seems that a few people have spoilt the party for the majority by advertising this excellent annuity vehicle as a terribly good way of avoiding IHT – which is incorrect in both theory and in practice.

Under ASP as it was originally envisaged, there would have been no loss of tax relative to the alternatives. There is no doubt that a very small minority would be able to pass on 60% of an unused pension fund to their children. But surely these individuals can still quite easily make potentially exempt transfers or find other ways to pass on assets, perhaps by funding pension contributions for the family, to achieve the same end as they would have done within their own pension scheme?

In legitimate cases, and over a period of time, ASP would have started to help to plug the pensions gap as more and more people had their schemes kick-started. The lifetime allowance would still be there to police excessive provision, but HMRC does not seem to view it this way.

Harshly applied penalty
The suspicion that investors’ pension funds will dissolve is an unwelcome psychological factor. It could deter people who might otherwise have been prepared to invest through a pension scheme for their own and their family’s future.

The tax charges (82% in total) will still mean that a small amount of a policyholder’s pension savings can reach the next generation – but was it really necessary to take such punitive steps?

What exactly was HMRC worried about? Was it investors taking transfer values from their unfunded civil sector final salary schemes to generate lump sum death benefits that were not otherwise available? If so, had HMRC identified the real cost? Surely this eventuality could have been corrected in isolation without penalising the majority of investors?

Whatever the reason for the U-turn on ASPs, it seems to be counter-intuitive. Hopefully, good sense will eventually prevail, so that everyone will be given the choice to pass on their hard-earned savings – even if they are subject to the normal rules for IHT.

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