Tech talk

Pensions Simplification - Finance Bill 2006 Changes - TT14/06

In our TechTalk TT11/06 we summarised a number of changes which HMRC announced would be included in the Finance Bill 2006. HMRC has now published the content of a Schedule to the Finance Bill which sets out these changes in more detail together with further changes, some of which were announced previously.

Pension Credit Member

The definition of a pension credit member is extended to include an ex-spouse who dies before a pension sharing order can be implemented. This change ensures that the ex-spouse is treated as a member of the scheme and that death benefits can be paid to her beneficiaries without falling liable to an unauthorised payments charge.

Unauthorised Payments etc.

The Schedule closes a number of loopholes to ensure that the rules relating to unauthorised payments, loanbacks and value shifting apply to former members and former sponsoring employers and also to persons connected to such members and employers.

Bridging Pensions

Some occupational schemes provide a temporary pension payable from normal retirement date until state pension age, when that pension will cease. The amount of this temporary pension is normally equivalent to the State Retirement Pension. Whilst the Finance Act 2004 allows for the payment of a bridging pension, the legislation is too restrictive and difficult for schemes to administer as it provides for the reduction in payment to be based on the actual state pension in payment. It is possible for a member to defer payment of the state pension which would result in no reduction or to be entitled to and receive a pension less than the full amount which would result in a lower than normal reduction. Therefore, the proposal will allow for a reduction in payment to be made irrespective of whether the member takes the state pension at state retirement age, or receives a state pension lower than the maximum.

There will be a limit to the maximum amount of reduction. For contracted out schemes this will be the maximum basic state pension and for contracted in schemes this will be twice the basic state pension.

Pension Commencement Lump Sum

The Schedule removes an anomaly whereby the PCLS under a money purchase scheme could be increased by purchasing a scheme pension instead of a lifetime annuity. The amendment ensures that the PCLS is limited to 25% of the fund value irrespective of the vehicle used to pay the pension. An anti-avoidance rule is introduced to prevent a money purchase scheme being switched to defined benefit to avoid the effect of this change.

Refund of Excess Lump Sum

Currently where a member pays a contribution in a tax year of more than the maximum amount that he can receive tax relief on, he can claim a refund of the excess contribution during the period ending on the 6th anniversary of the end of the tax year in which the contribution was paid. For example, if a member pays a contribution greater than the tax relievable amount in the 2006/07 tax year, the member will be able to claim a refund of the non tax relievable contribution up to the 5th April 2013.

The refund is calculated by the formula RPC - MAR - ALS where RPC is the amount of the relievable pension contribution paid by (or on behalf of) the member in the tax year; MAR is the maximum amount of relief available, and ALS is the total value of any refund of excess contribution lump sum(s) previously paid in respect of that tax year to the member.

The way that the legislation is currently worded, it is possible that where contributions are paid under the 'relief at source' basis, a member would receive a refund greater than the excess amount. The 'relief at source' basis is where the member pays the contribution net of basic rate tax. An example may help highlight the problem. If a member earning £100,000 has paid a 'relief at source' contribution of £156,000 (equivalent to £200,000 gross) and claims a refund of excess contribution, the formula would allow a refund of £100,000 (£200,000 - £100,000 - £0), This is greater than the excess contribution paid by the member of £78,000 paid under 'relief at source'.

The proposal will change the refund basis for excess contributions paid by 'relief at source', to remove from the calculation the tax relief given in respect of the excess contribution.

Age 75 Lifetime Allowance Test

A new benefit crystallisation event will be introduced to test a member's unsecured pension funds against the lifetime allowance when he/she attains age 75. The amount to be tested is the current fund value less the amount originally designated as unsecured pension fund.

Migrant Member Relief

Migrant member relief allows UK tax relief for migrant workers who come to the UK as existing members of overseas pension schemes and continue to make contributions to their overseas scheme whilst in the UK. One of the conditions for migrant member relief is that the individual must have been a non-UK resident when they joined the overseas scheme.

The Revenue is aware that the condition mentioned above would cause a problem if an employer was taken over whilst an individual was claiming migrant member relief. If the individual is forced to join the new employer's scheme by 'block transfer' the individual would be ineligible for migrant member relief. Likewise if the employer closes down the existing pension scheme and forces the employee to join a new pension scheme the employee would be ineligible for migrant member relief. The Revenue propose to include a regulation making power within the Finance Bill 2006 to allow individuals in these situations to retain migrant member relief.

Maximum Permitted Pension

The Revenue announced on the 8th August 2005 that a consequential Order would be issued to ensure that lump sum rights are included in the amounts that are transitionally protected from the lifetime allowance charge. This will now be included in the Finance Bill 2006.

The rules for calculating the maximum permitted pension are based on the assumption that the tax free cash lump sum is available by commuting part of the pension. However, not all schemes allow tax free cash by commutation but instead provide tax free cash as a separate benefit. For these schemes that provide tax free cash as a separate benefit this benefit is not included in the maximum permitted pension formula. A change will be introduced in the Finance Bill 2006 to include tax free cash where this is provided as a separate benefit.

Transitional Protection and Lump Sum Death Benefits

The rules governing Primary Protection will be amended to extend protection to lump sum death benefits. Where an individual who registers for Primary Protection dies his lifetime allowance enhancement factor can be increased if

• a lump sum death benefit is paid
  
  
• the lump sum death benefits payable had he/she died on 5 April 2006 exceed the individual's protected pension rights and
  
  
• the person recovering the lump sum notifies HMRC that this provision should apply

This increased enhancement factor will increase the individual's lifetime allowance to the amount of the lump sum death benefits payable. Where any lump sum is exchanged for dependant's pension that amount is excluded.

Where the pension scheme, other than an occupational scheme with at least 20 members, secures the lump sum death benefit under a life assurance policy the following conditions apply

• the policy paying the benefits is the one that was in force on 5 April 2006 and
  
  
• no variations, including exercise of any options under the policy, have been made to the policy

If the pension scheme is an occupational scheme the following additional conditions apply

• the member dies in the service of the employer by whom he/she was employed on 5 April 2006, or a connected employer, and such service is continuous
  
  
• the employer participated in the scheme on 5 April 2006 and
  
  
• the individual has not become entitled to benefits from the scheme prior to his/her death

The schedule also amends the rules relating to Enhanced Protection where life cover is maintained by contributions paid to a money purchase arrangement after 5 April 2006.

Schedule 36 of Finance Act 2004 provides that where a "relevant contribution" is paid to a money purchase arrangement after 5 April 2006 enhanced protection is lost.

The Finance Bill prescribes that contributions paid to a money purchase arrangement will not be relevant contributions if they are

• used to pay premiums under a term assurance policy effected before 6 April 2006
  
  
• the policy cannot be surrendered and is not surrendered between 5 April 2006 and the date of death, and
  
  
• the policy is not varied to increase the benefits or to extend the term. Variation includes exercise of an option under the policy

In addition contributions to a money purchase occupational pension scheme will not be relevant contributions if

• they are paid by a sponsoring employer and
  
  
• they are paid solely to provide lump sum death benefits which are defined benefits or cash balance benefits

A further amendment provides an alternative test where the lump sum death benefit exceeds the "appropriate limit". The new test is based on the greater of

• the value of the lump sum death benefits at 5 April 2006 increased by 5% per annum or RPI if greater and
  
  
• the benefit based on earnings prior to the date of death (using the same definition of earnings as applied on 5 April 2006) subject to the "post commencement limit"

This amendment will apply if the person to whom a benefit is paid notifies HMRC that he/she wishes to rely on this provision.

Minimum Pension Age

Individuals who have a right, at 5 April 2006, to retire before the minimum pension age enjoy transitional protection provided that they do not become re-employed by a sponsoring employer of the same scheme. An amendment will allow re-employment in certain circumstances, primarily

where the individual is not connected with the employer and the taking of benefits does not form part of an arrangement to avoid tax and National Insurance Contributions.

Comments

On the whole these changes are as announced previously. The extension of protection for life cover under Primary Protection was unexpected but no less welcome for that. HMRC appear to have considered the implications of protection for life cover in almost every scenario. The only omission appears to be where an individual has a large lump sum death benefit but inadequate pension provision. Such an individual could now register for enhanced protection to protect his life cover but he would be prohibited from making any pension contributions.

Ian Westwater - March 2006