In this April edition of the Pensions E-Bulletin, we look at some of the pension changes included in the Finance Bill (published on 31 March) that come into effect for the 2011/12 tax year – the new "scheme pays" regime; the removal of the requirement to buy an annuity; the increased flexibility in relation to lump sums; and the changes to the disguised remuneration rules.

"Scheme pays" – managing high annual allowance charges

As highlighted in the December edition of the Pensions E-Bulletin, the Government was consulting on a "scheme pays" option for the annual allowance charge in order to assist the increased number of individuals who could become subject to the tax charge as a result of the reduction in the annual allowance to £50,000. The Government has now confirmed that there will be a "scheme pays" facility, allowing members to meet the annual allowance charge from their pension benefits rather than from current income, and draft legislation is included in the Finance Bill 2011. The key features are:

  • where individuals are liable to pay an annual allowance charge of more than £2,000 they may elect that all or part of the charge be paid by the pension scheme;
  • both defined benefit and money purchase schemes must offer the facility (without charge) and regulations may provide power for them to override scheme rules in order to do so;
  • the tax is payable at the point the charge arises;
  • schemes must offset annual allowance charges by reducing benefits on a basis that is "just and reasonable" having regard to normal actuarial practice;
  • schemes may apply to HMRC not to pay the charge on the basis that it would be to the "substantial detriment" of the interests of members or that in the circumstances it would not be "just and reasonable".

The "scheme pays" facility will apply in relation to charges incurred from the 2011/12 tax year. Individuals will have until the 31 January self-assessment deadline to decide whether to manage their tax affairs in this way – with an irrevocable election having to be made to the scheme administrator by 31 July (extended to 31 December 2013 in the first year of the regime). Schemes must then report the tax charge to be paid in the December Accounting for Tax Return (extended to the March Accounting for Tax Return in the first year of the regime).

Removal of requirement to buy an annuity – money purchase schemes

With effect from 6 April 2011, there is no longer a requirement for members of money purchase schemes to buy an annuity by the age of 75 and the alternatively secured pensions rules are repealed and replaced with a new income drawdown regime. Schemes may now (although are not required to) offer individuals who do not wish to purchase an annuity two drawdown options:

  • "capped drawdown" – individuals will be able to withdraw income from their pension fund up to a maximum limit (the amount of the equivalent annuity that could have been bought with the fund value, based on tables prepared by the Government Actuary's Department); and
  • "flexible drawdown" – provided an individual can satisfy the minimum income requirement (a pension entitlement of at least £20,000 a year), there are no limits on the amount which they can draw from their pension fund and, if a member wants, they may take all of their funds in one payment.

All withdrawals are subject to tax as pension income.

Increased flexibility in relation to lump sums

The restriction on lump sums and lump sum death benefits being payable to, or in respect of, members on or after the age of 75 has also been removed with effect from 6 April 2011. Both defined benefit and money purchase schemes are now able to pay the majority of lump sum benefits, including pension commencement lump sums, trivial commutation lump sums, winding-up lump sums and defined benefits lump sum death benefits, regardless of the age of the member. The tax rate for all lump sum death benefits is set at 55%, except in relation to death benefits for those members who die before age 75 and without having taken a pension, which will remain tax free.

Disguised remuneration and employer financed retirement benefit schemes

The rules relating to disguised remuneration are being overhauled so that with effect from 6 April 2011 an automatic income tax and NIC charge will arise in relation to "disguised remuneration" arrangements. These include:

  • paying money or transferring an asset for an employee's benefit;
  • making an asset available for an employee's benefit; and
  • "earmarking" (however informally) funds for an employee – there is no definition of earmarking but it would include any informal allocation of money or assets for an employee.

From a pensions perspective, the primary target is employer financed retirement benefit schemes (EFRBS) which the Government does not believe are "in keeping with the principle of creating a more affordable pensions tax regime" – without action, EFRBS could have provided pension benefits that would have been more tax advantaged than registered pension schemes for pension savings beyond the new reduced annual and lifetime allowances.

The legislation has been drafted widely and will capture any form of EFRBS which is funded or security backed. It is therefore no longer tax efficient to use an EFRBS arrangement unless it is "wholly unfunded". HMRC has stated that where an unfunded, unapproved retirement benefit scheme promise is recorded as a balance sheet liability of the employer or it is secured by a letter of credit provided by a bank (which is itself secured by a floating charge over the employer's assets) then it is "probable" that this will not trigger the tax charge. However, HMRC unhelpfully states that "this will depend on the facts of the case".

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