Pensions Simplification - one year on

01 March 2007

by Ian Westwater

As we are approaching the first anniversary of the introduction of Pensions Simplification this would seem an ideal time to review the first year and assess whether our hopes and fears have been fulfilled.

Even before 6 April 2006 (A-Day) we had learned that our hopes for wider investment choice had been shattered with the introduction of penalties for SIPPs investing in residential property, tangible moveable property and own company shares.

In addition, the 2006 Budget had also announced that alternatively secured pension (ASP) funds would be subject to Inheritance Tax (IHT). However if HM Revenue & Customs hoped that this would bring to an end the marketing of ASP and "Family SIPPs" as a means to pass on funds to family members, they were sadly mistaken. Some providers actually took to promoting scheme pensions as an IHT free alternative to ASP, while others continued to promote ASP, assuming that members would be satisfied that, at least, part of their pension fund could be passed down a generation.

The Treasury took a dim view of this, arguing that ASP was introduced solely as an alternative for those who had a religious objection to annuities and that tax relief for pension funding was given to provide a retirement income, not to enable individuals to pass their pension funds to their children. In the December 2006 Pre Budget Report (PBR), the Treasury announced changes to ASP, the most significant being that the transfer lump sum death benefit would be withdrawn from the list of authorised payments. Re-allocation of a deceased member's pension fund to other scheme members will therefore be an unauthorised payment resulting in the relevant tax charges.

It was also announced, in the PBR, that legislation would be included in the Finance Bill 2007 to counteract schemes that were used "to pass on wealth that would otherwise be subject to mainstream IHT rules" or "to pass on pension benefits and funds to connected persons other than as acceptable forms of dependants' benefits". The PBR made specific reference to scheme pension.

Whilst these changes should bring about the demise of "Family SIPPs", ASP should continue but will be seen as a straight alternative for those individuals who have a genuine aversion to annuity either because of their religious beliefs or for investment reasons.

Another popular sales idea resurrected by Pensions Simplification was stand alone pension term assurance (PTA), which was marketed as a means to gain tax relief on term assurance premiums. Again the Treasury deemed this to be contrary to the general principle that tax relief is only granted to provide a retirement income. At time of writing we await the results of a review to be carried out by the Treasury and the pensions industry and hope that PTA will continue to attract tax relief albeit possibly with restrictions and possibly only in conjunction with pension contributions.

So much for our hopes - what of our fears?

Pensions Simplification was hailed as one simple pensions tax regime to replace the eight existing regimes. The basic principles, a lifetime allowance to limit tax efficient pension provision and an annual allowance to limit tax relievable pension contributions, seemed simple enough. But what concerned us were the rules to protect large funds, which had accrued prior to A-Day, and tax-free cash sums greater than 25% of the A-Day pension fund. As feared, the rules are very complicated with those relating to Scheme Specific Protection of lump sum rights of more than 25% being particularly complex. This form of protection applies when a member of an Occupational Pension Scheme (OPS) has a tax-free cash entitlement greater than 25% of his/her A-Day pension fund. As long as the member takes his/her benefits directly from the scheme the application of this form of protection is fairly straightforward. However, if the member decides to transfer his/her pension fund to another scheme he/she could lose the protection. To retain the protection the legislation requires that the transfer must be a "block transfer", i.e. part of a single transaction involving two or more members transferring to the same scheme, (commonly referred to as a "buddy transfer").

This form of protection also applies to S32 contracts but obviously the policyholder cannot make a buddy transfer. One-man Executive Pension Plans (EPPs) are similarly restricted.

Realising that the block transfer provisions did not extend to schemes winding up involving transfers to buy-out contracts, HM Revenue & Customs issued amended regulations. These regulations apply to occupational pension schemes that were in force on 5 April 2006, and subsequently wind-up, and include one-man EPPs and S32 contracts. Unfortunately the new buy-out contract cannot provide immediate benefits, meaning that an individual, who transfers in order to exercise an unsecured pension option, must wait for such deferred period as the insurer deems necessary before taking his/her benefits. Because the regulations only apply to schemes or contracts that were in force on 5 April 2006, a subsequent transfer from the buy-out contract would result in tax-free cash being reduced to 25%.

This all seems unnecessarily complicated and restrictive and, in the interests of simplification, should be replaced by a simple tax free cash certification requirement, with the certificate being passed on each time the individual transfers to a new scheme or contract. It should not be necessary for someone to go through hoops to retain his/her tax-free cash entitlement on transfer.

A subject that is causing serious problems for advisers is on the question of tax relief on employer contributions, when paid in respect of a controlling director or an employee connected to a controlling director. On this occasion the legislation is relatively clear, i.e. there is no limit on employer contributions and "if they are allowed to be deducted in computing the amount of the profits of the employer, they are deductible in computing the amount of the profits for the period of account in which they are paid" (FA 2004 S196). The crucial phrase here is "if they are allowed to be deducted". Tax relief on an employer's contributions is not automatic. The local inspector of taxes has to determine that a contribution is "made wholly and exclusively for the purposes of the employer's trade" (BIM46005).

HM Revenue & Customs has provided guidance for local inspectors of taxes and this has been published on HM Revenue & Customs' website. Unfortunately, this guidance is not of any great assistance for IFAs when they are trying to advise a director how much can be contributed by his company. The only positive guidance given is that an inspector should accept a contribution as being paid wholly and exclusively if it is comparable with that paid to unconnected employees. Unfortunately not all employers want to contribute to a pension scheme for unconnected employees never mind at the same level as for a director.

HM Revenue & Customs' registered pension scheme manual (RPSM05102010) states "The HM Revenue & Customs officer dealing with the Income Tax/Corporation Tax return of the employer will consider questions as to whether the contribution is an allowable expense". Unfortunately this does not mean that an employer can obtain prior advice as to whether or not a contribution will be tax deductible. HM Revenue & Customs is not obliged to comment on a proposed contribution and will usually only consider questions after the contribution has been made and the tax return submitted. By then, however, it may be too late as any contribution that the inspector decides does not meet the wholly and exclusively rule cannot be returned to the employer.

Pre A-Day, while contributions to approved occupational schemes were automatically tax deductible, personal pension contributions were subject to the wholly and exclusively rule. However, because contributions were subject to statutory limits, there was rarely any problem in obtaining tax relief and IFAs could advise employers with confidence. Today IFAs are reluctant to encourage employer contributions and some are even recommending that the director takes higher earnings and makes a personal contribution in order to guarantee tax relief - unfortunately not wholly tax efficient as both the employer and the director will suffer higher NI contributions.

This situation cannot be allowed to continue. We urgently need clear guidance from HM Revenue & Customs on the level of tax-deductible contributions an employer can make.

Over this past year, or so, HM Revenue & Customs/Treasury appear to have lost sight of the simplification aim and have become bogged down by principles. In trying to preserve these principles they subject the pensions industry to badly drafted legislation, which only serves to further complicate an already complex regime. We can only hope that, in a few years time, when we are through the transitional stages we shall truly enjoy a simple pensions tax regime.

Published in Pensions Management, March 2007