Implementing Flexible Access To Pension Savings

by Allen & Overy LLP

With a flurry of reading material and a hailstorm of new acronyms, the draft Taxation of Pensions Bill has been published for consultation. There’s a very short deadline for comments, so it’s important to get to grips with the Government’s proposals and contribute to the shaping of the new rules. This briefing provides an overview of the proposals and links to the key documents.

Getting to grips with the changes

The easiest way to get an overall feel for the proposals is to read HMRC’s draft guidance on the draft clauses, which explains the changes and includes a number of worked examples.

Responding to the consultation will be vital, particularly where the current proposals will cause administrative or practical difficulties for your scheme. As the proposals (including the statutory override) apply to money purchase arrangements generally, they will also be relevant to DB schemes with an AVC facility.

It’s important to keep members up to date with the developing framework – especially those who may be looking to access their benefits from April 2015. The detail of the current draft rules is subject to change and likely to be overwhelming for most members, but you may want to provide a general overview of what is proposed, with signposts to further information – members will obviously need to take their own advice, but some may need as much time as possible to plan, for reasons set out below. Please contact us if you would like support in this area.

What’s in the draft Bill?

The key points covered in the draft Taxation of Pensions Bill are:

Flexi-access drawdown funds

All new drawdown funds created on or after 6 April 2015 will be new-style flexi-access drawdown funds (FADF). Existing flexible drawdown funds will convert automatically to FADF on 6 April 2015; members with capped drawdown funds will be able to choose whether to convert them in order to be able to make unrestricted withdrawals (and then be subject to the FADF annual allowance regime – see below) or stay within the current regime. If a member’s withdrawal from a capped arrangement exceeds the 150% cap, it will automatically convert to FADF.

Other withdrawals

Not all flexible access will involve an FADF. Members can access their DC savings without designating funds for drawdown. Any such payment will be an uncrystallised funds pension lump sum (UFPLS). The first 25% of any UFPLS is payable tax-free; the remainder is subject to marginal rate tax. The tax-free element is, therefore, spread across all UFPLS. A member with a single arrangement who wants to access all their tax-free rights in one go would have to opt for FADF and take a pension commencement lump sum, or take a UFPLS amounting to the whole of their pension rights. Small lump sum commutation is also available.

Changes to the annual allowance

The annual allowance is being reshaped so that a reduced AA applies to DC savings after a member has had their first UFPLS or FADF payment (or, for members currently in flexible drawdown, from 6 April 2014). In very broad terms, the member will be taxed on either their default chargeable amount (the excess of the pension input amount over their current AA – e.g. GBP40,000) or, if higher, their alternative chargeable amount. The alternative chargeable amount is calculated on the basis of two segments of AA:

•the individual’s ‘normal’ AA including any carry-forward, less GBP10,000 – this is used to test their defined benefit pension inputs; and

•their money purchase AA of £10,000.

There are some complex rules around valuing pension inputs for hybrid arrangements (i.e. those where benefits could be cash balance, DB or DC depending on the circumstances) and around splitting input periods before and after the first payment under the flexible access rules. Examples are contained in HMRC’s draft guidance and in the explanatory notes accompanying the Bill.

The alternative rules are not triggered by an individual taking a small lump sum of up to GBP10,000; and it appears that existing flexible drawdown members who currently have a nil AA may benefit from a GBP10,000 AA under the new rules.

Changes to trivial commutation and small lump sums

Eligibility for these payments at the new increased levels will be linked to the individual reaching normal minimum pension age (NMPA). Although NMPA is normally 55, members with a protected pension age may be able to access their pension savings before reaching age 55.

Lifting annuity restrictions

Annuity restrictions – for example, the maximum ten-year guarantee period, and the prohibition on annuities decreasing in amount, are removed where the member becomes entitled to a lifetime annuity on or after 6 April 2015.

Override power

The new ‘permissive statutory override’ provides that trustees or managers of a registered pension scheme may pay drawdown pensions, purchase short-term annuities or pay a UFPLS to or in respect of a person who is or has been a member of the scheme ‘despite any provision of the rules of the scheme (however framed) prohibiting the making of the payment’. HMRC’s draft guidance states that:

‘…scheme trustees or managers will not have to make these payments if they choose not to do so. In such a case, [members] may wish to consider whether to transfer to another money purchase arrangement that offers the flexibility [they] want to opt for.’

It’s worth noting that this applies to payments from any money purchase arrangement within a registered pension scheme – so it would include AVCs within a mainly DB scheme.

Initial comments

Administrative systems will need to be updated to cater for the new calculations, which are in some respects potentially very complicated. One key question for scheme administrators will be how they can know whether a member has accessed pension savings flexibly under a separate arrangement, which would trigger different AA treatment in their current scheme.

Individual members will want to study and understand the rules very carefully to ensure that, where they are an active member of money purchase arrangements only, they do not inadvertently lose the benefit of any unused carry-forward by accessing any savings flexibly under the new rules. Once the first UFPLS or FADF payment is received, the alternative chargeable amount rules are triggered and no carry-forward is permitted in relation to DC savings. In addition, members with primary or enhanced protection will need to be aware that they cannot realise their higher lump sum rights via a UFPLS – they would have to designate funds as FADF and take a pension commencement lump sum to get the benefit of their full tax-free lump sum.

Despite HMRC’s comment, quoted above, there is concern that the existence of the permissive override could put trustees at risk of complaints where a member is disgruntled about a refusal by trustees to make a payment or implement drawdown directly from the scheme (for example, if significant additional costs are incurred as a result of a transfer to an external provider).

What’s not in the Bill?

Other elements of the proposals, including provisions on the guidance guarantee and the advice requirement which will apply to DB/DC transfers, will be covered separately in the Pension Schemes Bill.

What’s next?

The consultation closes on 3 September 2014 – a very tight deadline, especially over the summer period, but one that’s arguably necessary in order to achieve certainty in reasonable time for schemes to implement any required changes. We will be responding to the consultation – if you have points you would like us to include in that response, please do let us know (or respond independently).


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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