December 2010 Autumn tax updates

Pensions

Removing the effective requirement to annuitise by age 75

June’s Emergency Budget saw the new Government announce the end of so-called compulsory annuitisation at age 75.  A period of consultation followed; this has now closed and the decisions listed below set out the framework of the new regime.

The new rules will take effect from 6 April 2011.

One fundamental change we’ll all have to get used to is the removal from legislation of the terms ‘Unsecured Pension or USP’ and ‘Alternatively Secured Pension or ASP’.  USP is replaced by the term ‘Drawdown Pension (DP)’.  ASP is abolished completely.

Decisions and summary of draft legislation:

• Removal of ‘age 75 rule’ – from age 55 people can buy an annuity or access a DP at any time.  Or they can choose not to take an income and defer a decision indefinitely.
• DPs will be available in two forms: ‘capped drawdown’ and ‘flexible drawdown’.
• Capped drawdown will be similar to USP – income withdrawals subject to Government Actuary’s Department (GAD) limits.  However, the maximum withdrawal (currently ‘120% of GAD’) will change to ‘100% of GAD’.
• The maximum withdrawal under capped drawdown must be reviewed at least every three years, until the end of the drawdown pension year in which the individual reaches age 75, and every year thereafter.  (Currently it is every five years pre 77 and every year thereafter).
• GAD will issue updated tables of rates including ages beyond age 75 for use with capped drawdown.
• Existing ASPs will switch to either of the two new types of DP arrangements above from 6 April 2011.  The default route will be capped drawdown.
• Transitional rules will apply to existing USPs/ASPs from 6 April 2011.  The new GAD limits will apply from the earliest of: 
  • The 5^th anniversary of the last review.
  • The first anniversary of the most recent review, if the individual passes, or is already over, their 75^th birthday (but with one exception – see below).
  • From the start of the drawdown pension year in which 6 April 2011 falls if the individual reached age 75 before 22 June 2010.
  • The start of the next drawdown pension year, when the individual makes a drawdown to drawdown transfer to another pension arrangement.
• Under interim measures, pension scheme members and dependants, who reached age 75 on or after 22 June 2010 without having secured a pension, have been able to defer a decision on what to do with their pension savings until the earlier of reaching age 77 or until the new rules are finalised.  They will now switch to the new regime from the start of their first drawdown pension year beginning on or after 6 April 2011.
• There will be no minimum withdrawal at any age.
• Flexible drawdown will allow accelerated, unlimited withdrawals of the pension fund as long as the individual can meet a minimum income requirement (MIR).  Withdrawals will be subject to income tax at the individual’s marginal rate.
• If an overseas individual effects flexible drawdown, the tax liability will be deferred to the year in which they become UK resident again (but only if they are non-UK resident for less than five complete tax years).
• Flexible drawdown will only be possible if the individual can declare that, as well as meeting the MIR, there won’t be any contributions to a money purchase scheme in the tax year then current, and active membership has ceased under any defined benefit scheme.
• Any subsequent pension contributions/accrual will be subject to the annual allowance tax charge – effectively no tax relief will be given even if contributions are less than the annual allowance of £50,000.
• The level of MIR is to be £20,000 per individual regardless of their age or marital status etc.  It aims to ensure that the individual does not fall back on state benefits as a result of having exhausted their pension prematurely.
• The level of MIR will be reviewed by Treasury order at least every five years.
• The MIR will be based on a secure income stream already in payment.  The MIR only includes pension income, comprising one or more of state pensions, annuities and occupational pensions that are guaranteed for life.  Purchased life annuities (PLAs) and drawdown pensions cannot count towards the MIR.
• The onus for checking that MIR conditions are met (and hence that flexible drawdown is an option) rests on the individual and the scheme administrator. 
• Pension Commencement Lump Sums remain tax-free, but will now be available post 75.
• Trivial commutation, winding up and value protection lump sums (under annuities) will also be available post 75.
• A serious ill health lump sum may be paid post 75, although it will be subject to tax at 55%.
• Lump Sum Death Benefits from 6 April 2011:
  • Pre-75 uncrystallised funds remain tax-free.
  • All other funds on death incur 55% tax.  This is an increase over the current 35% for under 75s in USP, but a reduction from the 82% for the over 75s under ASP rules.
  • Pre or post 75 lump sum benefits may be payable to a member nominated charity tax-free, but only in the absence of any living dependants
• Lifetime allowance: all benefits to be tested against lifetime allowance (LTA) by age 75 (as now).
• Inheritance tax (IHT) – no explicit IHT charge pre or post 75.  Clauses in Section 3 (3) of the IHT Act 1984 (the so-called ‘Omission to Act’ rules) will no longer apply to pension scheme lump sum death benefits.
• The Government recognises that extending the scope of DPs will mean that it is more important than ever that individuals receive suitable advice. 
• Annuities: The Government recognises that annuity purchase remains the best option for many people but has reiterated that it wants to improve consumer access to advice and take-up of the Open Market Option.  Legislation to make this happen has not been ruled out.
• There are a number of other consequential amendments to pension rules including:
  • Uncrystallised funds no longer default into USP/DP the day before age 75.
  • Additional fund designation cannot trigger a reduction in the maximum withdrawal until the start of the next DP year.  (Currently it applies immediately and in extreme circumstances can trigger unforeseen unauthorised payment charges)

Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change.  However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given.  This information is based on announcements made in the December 2010 Autumn tax updates which may change before becoming law.