The Government announced on 14 October 2010 that the Lifetime Allowance from 6 April 2012 would reduce from £1.8 million to £1.5 million.

Individuals who registered at A-Day for Primary and/or Enhanced Protection are not affected by the change. For Primary Protection a Lifetime Allowance of £1.8 million will still be applied to their personal Lifetime Allowance factor.

However the Government recognised that there would be individuals who had continued to build pension rights in the expectation of a Lifetime Allowance of at least £1.8 million who could be significantly affected by the reduction in the Lifetime Allowance.

They have now announced that individuals who are not registered for Primary or Enhanced Protection will be able to apply for what is known as fixed protection. Although the relevant form is not yet available from HM Revenue & Customs they have confirmed that application for this protection must be received by them no later than 5 April 2012.

What is protected?

The value of an individual’s benefits up to £1.8 million. Any excess value above £1.8 million will still be subject to a Lifetime Allowance tax charge of currently 55%.

What are the rules that will apply for this form of protection?

The rules broadly follow those which applied for the original Enhanced Protection. They are:

• No money purchase contributions paid on or after 6 April 2012.
• Defined Benefit annual accrual of no more than CPI increase unless stipulated in the scheme rules on 9 December 2010.
• Contracted-out rebates received on or after 6 April 2012 will not invalidate fixed protection.
• Contributions used to continue to fund existing life cover arrangements will not invalidate fixed protection.
• Where transfers are concerned the new arrangement can only accept a permitted transfer.
• Permitted transfers are those between money purchase schemes and into a money purchase scheme from defined benefit or cash balance schemes. Transfers between defined benefit schemes and cash balance schemes will fail this test.

Under the proposed auto-enrolment rules due to come into effect from October 2012 individuals wishing to register for this form of protection will have a one month opt-out window, otherwise a contribution will be applied that will invalidate the fixed protection.

Although the Lifetime Allowance will reduce to £1.5 million in the 2012/13 tax year, individuals with protected pre A-Day pension commencement lump sums will have that A-Day protection re-valued by the increase in the Lifetime Allowance using the current Lifetime Allowance of £1.8 million. This will ensure that individuals retain the 20% increase in value of their expected pension commencement lump sum since A-Day whether they crystallise the related fund before or after 6 April 2012.

As a result of the reduction in the Lifetime Allowance these will be restricted to 25% of the Lifetime Allowance, even where the individual has Enhanced or Primary Protection. Individuals will need to crystallise benefits before 6 April 2012 if their pension fund exceeds £1.5 million at that time or lose part of their pension commencement lump sum.

The documents issued today confirm the earlier announcement that the Annual Allowance test, unlike in the current tax year, will still apply in the year of crystallising benefits. The exceptions to this will be on death and serious or severe ill health. HMRC has confirmed the definition of severe ill health as being ill health that makes them unlikely to be able to undertake gainful work (in any capacity) and at any time in the future (otherwise than to an insignificant extent).

Note: There are no exemptions for early retirement or redundancy.

Relief on personal contributions will be available at the individual’s marginal rate for contributions up to the available Annual Allowance, including carry forward of unused Annual Allowance from previous years, or UK relevant earnings if lower. The one exception is where an individual uses the new flexible income withdrawal arrangements described later in this article. Where flexible income applies any further contributions paid to any registered pension scheme will subject the client to an Annual Allowance tax charge on the full contribution value. No tax relief will be granted on contributions paid to registered pension schemes after age 75.

This remains at £18,000, breaking the link with 1% of the Lifetime Allowance. It is now available beyond a client’s 75 birthday.

Existing income drawdown rules are to be replaced with effect from 6 April 2011 by new rules governing capped income and flexible income, with the possibility of deferring lump sum payments beyond age 75.

Capped Drawdown

This replaces both the existing rules for Unsecured and Alternatively Secured Pensions (USP and ASP). The maximum amount of income that can be drawn will be 100% of a comparable annuity based on revised GAD tables that will be extended beyond age 75. The comparable annuity must be reviewed every three years up to the anniversary of entering drawdown after the 75th birthday and annually thereafter.

Existing USP rules relating to the re-basis of maximum income (eg additional designations and annual member reviews) will be carried forward into Capped Drawdown rules up to age 75 except that additional designations cannot reduce current income.

Transition to Capped Drawdown

The Capped Drawdown rules will apply for those who have Unsecured Pension as at 5 April 2011 from the earlier of:

• The end of the current five-year review period.
• The first scheme income year anniversary following the 75th birthday, or if already aged 75 from the first anniversary after 5 April 2011.
• The first scheme income year anniversary following transfer to a new drawdown provider.

The rules also apply for those who entered ASP before 22 July 2010 from the start of the annual drawdown period in which 6 April 2011 falls. This means those currently in ASP can stop taking income if the next anniversary of entering ASP falls on or after 6 April 2011.

Flexible Drawdown

From 6 April 2011 individuals over the age of 55 that meet the Minimum Income Requirement (MIR) of at least £20,000 per annum will be able to drawdown an unlimited amount out of their crystallised pension funds. The amount drawn will be treated as income for tax purposes.
 
To enter Flexible Drawdown individuals will self certify that they meet the MIR. Having entered Flexible Drawdown there will be no restrictions on the income the individual can draw. Capped Drawdown rules will cease to apply.

The income included for satisfying the MIR must be guaranteed and payable for life. The income that will count towards the MIR includes the basic state pension, additional state pension, level annuity income and scheme pensions. Purchased life annuities, other state benefits and drawdown income do not count towards the MIR.

To be eligible for flexible income the individual must have ceased to be an active member of any defined benefit scheme before an election can be made.

Any contributions to a money purchase scheme made in the same tax year as the election for Flexible Drawdown will be subject to an Annual Allowance Charge and therefore taxed at the individual’s highest marginal rate.

The current MIR is set at £20,000 and is reviewable every five years by Treasury Order. Individuals who become temporarily resident abroad will be taxed on all withdrawals of Flexible Drawdown pension if they return to the UK within a five-year period.

The Government has confirmed that there will be no tax charge on uncrystallised lump sum death benefit payments within the Lifetime Allowance, or within higher limits where clients have registered for primary, enhanced or fixed protection. However, a 55% tax charge applies to uncrystallised lump sum death benefits where the individual died aged 75 or over.

Where an individual has crystallised benefits either into income withdrawal, or capital protected annuity arrangements the payment of any lump sum death benefit will be subject to a withholding tax charge of 55% regardless of when the member’s death arises. This changes both the tax treatment of pre-75 arrangements where the tax charge is currently 35% and to the ASP arrangements where a combined tax charge of up to 82% could apply.

The 55% rate of tax will be applied by the scheme administrator where a serious ill-health lump sum is paid to an individual aged 75 or over. Such payments are tax free if paid before a member reaches age 75.

Lump sum benefits paid to charity will not be subject to a tax charge.

It is confirmed that in normal circumstances there will be no inheritance tax liability on such payments regardless of when death occurs, provided they are paid at the scheme administrator's discretion. Also removed are the anti-avoidance provisions currently in existence where a client fails to exercise the right to purchase an annuity and the resultant lump sum is paid to parties other than the surviving spouse or financial dependants.

Inheritance tax may apply where benefits are paid from a non-registered pension scheme or Non-Qualifying Overseas Pension Scheme.

The Government has ended the effective obligation to purchase an annuity at age 75. Individuals with money purchase pension funds who have yet to take benefits will now be able to defer the decision indefinitely. This means that any uncrystallised rights at age 75 will remain so until the individual decides to crystallise them. However, at age 75 there continues to be a Lifetime Allowance test on any uncrystallised funds or funds held in an unsecured pension. Lifetime Allowance charges also continue to apply to funds in excess of the Lifetime Allowance.

Currently no lump sums may be paid once the member has reached age 75. These rules will be removed so that for example, pension commencement lump sums, death benefit lump sums, trivial lump sums, value protected lump sums and serious ill health lump sums will be permitted. These lump sums will be calculated in accordance with the existing rules.

Individuals will now be able to take a pension commencement lump sum after their 75th birthday.

With the reductions in the Annual Allowance and Lifetime Allowance the Government is concerned that other means will be used to avoid or defer income tax and National Insurance contributions (NIC) liabilities. It has therefore announced measures that will make schemes and arrangements aiming to achieve such aims unattractive.

Sums and assets that are earmarked for employees by trusts or other intermediaries will be treated as though the value is a payment of PAYE income provided by the employer to the employee. Similarly the value of loans to employees from trusts and other intermediaries will also be treated as PAYE income.

Legislation will be introduced in Finance Bill 2011 and NI regulations to achieve the above. There will also be anti-forestalling measures to ensure that payments of the above description made on or after 9 December 2010 will be caught by the new legislation.

In practice this means that contributions to Employer Financed Retirement Benefit Schemes and Employee Benefit Trusts and loans made by them will now be subject to income tax and NIC when the payments are made.

Update as at November 2011

HMRC has published technical guidance on the Finance Act 2011 rules on employment income provided through third parties as part of the Employment Income Manual. This includes guidance on non-registered pension arrangements such as employer financed retirement benefit schemes (EFRBS).

http://www.hmrc.gov.uk/manuals/eimanual/eim45000.htm