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ANNUITIES: Annuities Tax, Annuities Taxation


Pensions and Annuities Tax Research:

APSS/Joint Working Group - 

Annuities questions and answers

From the technical meeting of 16th May 2006 Contents Classification of Money Purchase Pensions Non-Standard Relevant Valuation Factors Trivial commutation lump sums Trivial commutation lump sum death benefit Meaning of "extinguishes the member's entitlement to benefits" Assignment of Term Insurance Policies (S226A and Personal Pension) Surrender of excess rights before registering for enhanced protection Existing Income Withdrawals which will become Designated for Unsecured Pension Unsecured Pensions – existing income withdrawal cases Transitional protection of lump sums exceeding 25% Retirement cash: 25% + "scheme specific protection" Occupational schemes with a 'section A' Calculation of the Initial Member Pension Limit for Dependants' Pensions Calculation of increases for Dependants' Pensions Lump sum death benefits: protected and non-protected rights Benefit guarantee cases under the pensions review BCE 3 Permitted Margin Calculation of Pension Input Amount following a transfer from a DB scheme Classification of Money Purchase Pensions JWG: Where a money purchase member declines to select an insurance company (and so the scheme administrator selects one instead), it is unclear from Sch 28 (paras 2 and 3) whether the resulting pension is a "scheme pension" or "lifetime annuity". This needs to be clarified as important consequences arise from the distinction. Scheme pensions and lifetime annuities are treated very differently in terms of (1) their value for lifetime allowance ("LTA") purposes and (2) the amount that can be taken as a pension commencement lump sum ("PCLS"). The ambiguity arises because the pension is arguably a lifetime annuity (because the member has at least had the opportunity to select the insurer) but also arguably a scheme pension (because it is the scheme administrator has actually chosen the insurer). HMRC : This is not really a legislative issue per se and it should be made clear from the terms of the arrangement whether what is provided is a "scheme pension" or "lifetime annuity". First, it is fair to say that where money purchase arrangements are concerned, the provision of a scheme pension as opposed to a lifetime annuity, will tend to be a minority option. That said, we can appreciate that confusion can arise over what is being purchased by the money purchase arrangement because the distinction between a scheme pension and a lifetime annuity in these circumstances can be a pretty fine one. One distinguisher which the published guidance makes clear, is whether the member is involved in the selection process. With a lifetime annuity the member has the right to choose the insurance company from which to purchase the annuity whereas with a scheme pension the right lies with the scheme administrator. But this does not lead to the conclusion that where the member is given the opportunity to select the insurance company, but fails to do so, then what is then given by the scheme axiomatically becomes a scheme pension. In circumstances where the member is given the opportunity to select the insurance company from which to purchase the annuity but fails to respond to that offer, it would still be open to the scheme to provide that member with a lifetime annuity offered by the scheme administrator by default (in other words the scheme would offer an open market option but if that wasn't taken up, could instead offer an "internal" open market option). The way we see it working is that where a member takes their open market option and selects a insurance company, all the member's funds in their arrangement are passed to that insurance company and the member gets whatever annuity those funds are sufficient to purchase based on the profile of annuity selected. The conditions for this are set out in paragraph 3 of Schedule 28, Finance Act 2004. At this point there should be no question that the pension granted is indeed a lifetime annuity. If a scheme pension is to be given, then the scheme must extend that as an alternative. The conditions for payment of a scheme pension are set out in paragraph 2 of Schedule 28, Finance Act 2004, but section 165(pension rule 4/6) is perhaps key here. This requires that "a scheme pension may only be paid if the member had an opportunity to select a lifetime annuity instead." So if the scheme wants to be clear that a scheme pension has been provided, then they should ensure that the discussion and options are so structured that it becomes clear whether the member has rejected the open market option to take a lifetime annuity in the first place. Should the member decide not to take up their option to purchase a lifetime annuity on the open market then the scheme could provide for either a lifetime annuity or scheme pension to be paid to the member. In all cases, it will boil down to a question of fact as to what the arrangement is actually providing the member with. There is an example in the guidance at RPSM09101460 which illustrates the position where a scheme pension is provided under a money purchase arrangement. It was added that Finance Act 2004 is silent with regard to whose name an annuity policy (securing either a lifetime annuity or scheme pension) should be written under and therefore from HMRC's perspective it could either be secured in the name of the trustees or the member Non-Standard Relevant Valuation Factors JWG: RPSM11104230 is still under development and RPSM11104370 implies that a non-standard factor would be granted on a scheme basis applicable to all arrangements under the scheme although S276 FA 2004 allows this to be granted on an arrangement basis. Many schemes will have different rates of pension increase applicable to different members or even different tranches of benefit and therefore a different factor may be appropriate for these. An update on the HMRC position is needed to clarify this situation. HMRC : The HMRC position has now been set out in Pensions Newsletter No 13 issued on the website on 28 April 2006. The issue of having different factors within a single registered pension schemes was discussed. The more varied the use of factors, the greater the likelihood that the advantage of the broad-brush approach to factors generally would be undermined. It was agreed that the legislation is flexible and allows for more than one factor in a scheme. JWG reps suggested that there were schemes with different categories of membership where a non-standard factor would be appropriate for those particular categories. It was agreed that JWG reps would provide information about this issue, following which HMRC would consider further. Trivial commutation lump sums JWG: Para 7 Sch 29 (trivial commutation lump sum) and para 20 Sch 29 (trivial commutation lump sum death benefit) should be clarified as to whether the individual's consent is required HMRC : The tax rules don't require the individual's consent to make one of these payments – this is a matter for scheme rules. But, of course, because the trivial commutation rules require that a member's aggregate benefits must be below the trivial commutation limit and that all commutations must be within a 12 month window, we expect the pension scheme will need assurances/details from the members on such points in order to avoid making unauthorised payments. JWG: Para 7 Sch 29 (1)(d) states that the trivial commutation lump sum should extinguish the member's entitlement to benefits under the scheme. However, the Act is silent on the payment of further contributions or accrual of further rights after the nominated date. RPSM 09105070 states that any further contributions or benefit accrual after the nominated date cannot be included in the trivial commutation lump sum, but this is not clear from the Act. The RPSM does not clarify whether this would then prevent the trivial commutation payment of rights held at the nominated date under the scheme as at the date of payment all rights would not be extinguished. We would appreciate clarification and the Finance Act and RPSM should be amended to be clear and consistent. HMRC : RPSM09105070 is based on what the Act says. It is clear from this that the trivial commutation limit applies not only at the nominated date but also for the whole of the commutation period. This means that only rights which are tested at the nominated date can be commuted. Further contributions/accrual of benefits after the nominated date create new rights that won't have been tested at the nominated date, so cannot be commuted. Since the "extinguishing all rights under the scheme" rule won't be satisfied, this will preclude the trivial commutation of rights held at the nominated date under the scheme. Trivial commutation lump sum death benefit JWG: We would appreciate clarification of how this is intended to be measured and payments taxed. Para 20(1)(d) Sch 29 requires the payment to extinguish the dependant's entitlement under the pension scheme to all pension death benefit and lump sum death benefit in respect of the member. HMRC : If the aggregate of the dependants' pension death benefit and lump sum death benefit does not exceed 1% of the SLA (so £15,000 in 2006/07) then the lot may be paid as a trivial commutation lump sum death benefit and will be liable to tax under section 636C ITEPA 2003, which treats the individual as having taxable pension income for the tax year in which the payment is made equal to the amount of the lump sum. It is the amount of the lump sum paid that is tested against the 1% SLA and not the value of the benefits in respect of which it is being paid (so it is unlike at trivial commutation lump sum in that respect). JWG: However, Para 20(2) states that if a lump sum payment that falls within paragraph 20(1) exceeds 1% of the lifetime allowance then the excess over 1% is not a trivial commutation lump sum death benefit. The question then arises, if that part of the payment is not a trivial commutation lump sum death benefit, what is it? HMRC : If the deceased member had remaining available lifetime allowance, then the "excess" could be paid as a defined benefits lump sum death benefit or an uncrystallised funds lump sum death benefit. The provision works so as to ensure that one cannot "trivially" commute benefits above a certain amount but it does not constrain the scheme in terms of what they provide in lump sum form on death. The effect of this is that it is possible to have a tax-free lump sum death benefit up to the deceased member's remaining available lifetime allowance plus a trivial commutation lump sum of £15,000 taxed under PAYE. JWG: RPSM10105260 describes the taxation of such a payment. This page states that the excess will be treated as either another form of authorised member payment or an unauthorised payment. Firstly, it is not clear from Para 20 that such a payment should be treated as an authorised member payment. HMRC : Paragraph 22(2) makes it quite clear that it could be another form of authorised payment. JWG: If so, what is the purpose of aggregating the death benefits payable to a dependant to determine triviality. Why not just require the commutation payment in respect of the dependant's pension entitlement to be less than 1% of the standard lifetime allowance? Secondly, it is possible to interpret Para 20(1) as meaning that the trivial commutation lump sum death benefit could be comprised of part trivial commutation payment and part other lump sum death benefit paid to the member. HMRC Agreed that trivial commutation lump sum death benefit could cover both elements (although note condition in para 20(1)(b) also needs to be met). JWG: How is the payment then taxed? HMRC : If it is all being paid as a trivial commutation lump sum death benefit, then it will be taxed accordingly. However, all the lump sum death benefits below 1% of the lifetime allowance are not required to be paid as trivial commutation lump sum death benefits. JWG: Please see the following examples: Example 1: A dependant has an entitlement to a dependant's scheme pension which has a commuted value of £3,000 and is also the chosen recipient for a pension protection lump sum death benefit of £10,000. Together the payments amount to £13,000 which is less than 1% of the lifetime allowance when paid. The whole payment will be treated as a trivial commutation lump sum death benefit payment. HMRC : In this case the whole payment will be taxable as pensions' income so will be chargeable at recipient's marginal rate of taxation. JWG: How is the payment of £13,000 taxed? Is the whole payment of £13,000 taxed under PAYE as a trivial commutation lump sum death benefit or is £3,000 taxed under PAYE and the value protection payment of £10,000 taxed at 35%? HMRC : Depends on the facts – the taxation treatment will follow whatever treatment they decide on. JWG: Example 2: A dependant has an entitlement to a dependant's scheme pension which has a commuted value of £3,000 and is also the chosen recipient of a defined benefit lump sum death benefit of £40,000. If the lifetime allowance at the time of payment is £1,500,000 these payments when considered together will exceed 1%. Does this mean that the first £15,000 of the payment will be treated as a trivial commutation lump sum death benefit? If so, will £12,000 of the defined benefit lump sum death benefit be taxed under PAYE (together with the £3000 commutation payment) with only the remainder of the lump sum death benefit being treated as a defined benefit lump sum death benefit and tested against the lifetime allowance? HMRC : No, the taxation treatment will follow what they do. So if they pay out DBLSDB then this will be tax-free. And there is nothing in the tax rules (though there might be some in schemes &/or DWP rules) to prevent them also commuting pension into a DBLSDB – so they could pay the full amount out as a DBLSDB, rather than a trivial commutation lump sum death benefit. Meaning of "extinguishes the member's entitlement to benefits" JWG: This requirement appears in para 4(1)(d) Sch 29 (serious ill-health lump sum), para 5(1)(d) Sch 29 (short service refund lump sum) and para 7(1)(d) Sch 29 (trivial commutation lump sum). It should be amended so as to clarify whether benefits payable on the future death of the member are also required to be extinguished, as the current wording is open to interpretation on this point. The answer may lie in the fact that para 4 refers to benefits under "the arrangement" whereas para 5 and 7 refer to benefits under "the pension scheme", but it is difficult to rely on this with confidence. HMRC : For both short service refund lump sums and trivial commutation lump sums, the requirement is that the payment of the lump sum must "extinguish the member's entitlement to benefits" under the scheme. So all benefits to or in respect of the member must be "cleared out" including any contingent dependants' benefits. For serious ill-health lump sums the requirement to extinguish all member benefits operates at arrangement level and so provided all benefits are extinguished under the arrangement by the payment of the lump sum, the condition will be satisfied. Where because of contracting-out requirements, dependants' benefits have to be retained under the scheme, then either before or at the time a serious ill-health lump sum is paid, the dependants' benefits have to be moved to a separate arrangement. This requires no more than documenting the creation of a new arrangement in a manner which is considered acceptable under the scheme. Assignment of Term Insurance Policies (S226A and Personal Pension) JWG: HMRC have helpfully clarified the position over section 172(1) to remove any immediate concern over the assignment of term assurance policies into trust. Legal advisers have reiterated, however, that, while the wording of sub-section (b) is retained, section 172 remains capable of being interpreted as penalizing assignment of policies into trust. Sub-section (b), which reads, "any right in respect of any sums or assets held for the purposes of any arrangement under the pension scheme" was inserted into section 172(1) by paragraph 37 of Schedule 10, F.A. 2005. Similar wording was inserted into sub-section 3 by the same amendment. It would be helpful if the wording could be suitably amended to remove the uncertainty it clearly creates. HMRC : confirmed that they don't regard the creation of a trust, external to the pension scheme, to apply the distribution of death benefits to the member's dependants etc. at the discretion of the trustees, as constituting an assignment for the purpose of section 172 Finance Act 2004. That section is aimed at cases where rights or benefits are assigned away from the original member. HMRC will put this in guidance. Surrender of excess rights before registering for enhanced protection JWG: If the value of a member's uncrystallised benefits under an occupational arrangement on 5 April 2006 exceeds the maximum that could be paid under the existing regime without HMRC withdrawing approval, the excess ("the relevant excess") must be surrendered before the member may register for enhanced protection. Draft regulations (The Pension Schemes (Surrender of Relevant Excess) Regulations 2006) have been published explaining what constitutes, and how to determine the value of, relevant excess. The draft regulations also confirm that, provided that the relevant excess has been determined and valued in accordance with the regulations, payment of an amount representing the value of the excess would not constitute an unauthorised payment. Where a member's rights include benefits attributable to AVCs, it is not clear what is being surrendered. It would seem fair to assume that AVC benefits are refunded in preference to other benefits, but the Surplus AVC regulations fall away on 6 April 2006 and scheme rules are unlikely to have anticipated such scenarios. HMRC : A refund of a member's voluntary contributions is a surrender of uncrystallised rights for the purposes of these regulations [SI 2006/211]. Such refunds will be unauthorised payments. Whether they are also scheme chargeable payments will be determined in accordance with SI 2006/365. A refund of a member's voluntary contributions under the provisions of Article 38 of SI 2006/572, a "pipeline lump sum", is not a surrender of uncrystallised rights as the member was entitled to the lump sum before 6 April 2006. The surplus AVC regulations [SI 1993/3016] do fall away on 6 April 2006. Scheme rules may give trustees the power to refund AVCs in order to meet the requirements of the 1993 regulations. Trustees may need to check their rules to see whether they have the power to make refunds of AVCs after 5 April 2006. Existing Income Withdrawals which will become Designated for Unsecured Pension JWG: Article 29 of SI 2006/572 helpfully excludes existing pre 6 April 2006 income withdrawals from creating a BCE2, 4 or 8. However, if the member gets to age 75, there does not seem a similar exemption from BCE 5A and this is a crucial point which needs to be clarified. Where the new BCE 5A occurs at age 75, (assuming this is the first BCE for the member since 5 April 2006) as the unsecured pension fund is a "relevant existing pension" under para 20 of Sch 36 a notional BCE is deemed to occur immediately before the BCE at age 75. Although the notional BCE won't give rise to a Lifetime Allowance Charge, it will use up some or all of the member's LTA before the real BCE occurs at age 75. HMRC : confirmed that it is intended to further provide that arrangements in drawdown or annuity deferral at 5 April 2006 which become unsecured pensions on 6 April 2006 won't be subject to the new BCE 5A. This will apply to the arrangements which are separate from other arrangements and are not mixed with other rights where the normal lifetime allowance provisions apply. Pre A day drawdown or annuity deferral will continue to subject to normal rules as a pre-commencement pension. As such it will be valued at the first BCE from another source of pension on or after 6 April 2006 for the purpose of deciding how much lifetime allowance has been used. Unsecured Pensions – existing income withdrawal cases The requirements for unsecured pension in Sch 28 are modified for existing income withdrawal cases by draft Transitional Orders published on 16 June 2005 and 21 July 2005. However, from these it is not clear exactly how the rules apply and we would appreciate clarification in particular on these issues: As a new unsecured pension year is deemed to commence on 6 April 2006, it is likely that the immediately preceding period will be less than 12 months. Presumably the existing maximum amount can be drawn in this period? HMRC : confirmed that this is the case. JWG: Also is the requirement for a minimum withdrawal of 35% of the maximum removed? HMRC : confirmed that minimum withdrawal is removed. JWG: The first reference period commences on 6 April 2006 and can be a period up to 6 April 2008. The first unsecured pension year commences on 6 April 2006 and ends at the earliest of 5 April 2007 or the date set out in the rules for the maximum to be assessed. If the first reference period extends beyond 5 April 2007 but ends before 6 April 2008, the second unsecured pension year may less than 12 months, although this is not clear from the draft Order. Can the maximum amount be taken in this shortened unsecured pension year? HMRC : confirmed that is the case. Transitional protection of lump sums exceeding 25% JWG: Schedule 36 of the Finance Act 2004 gives transitional protection for lump sums exceeding 25% of pre-A Day uncrystallised rights. The amount of uncrystallised lump sum rights under an arrangement is to be determined in accordance with paragraph 25, which refers in sub-paragraph (6) to "the amount of any lump sum to which the individual would have been entitled under the arrangement on 5th April 2006 on the assumption that the individual became entitled to the present payment of a lump sum under the arrangement on that date". This paragraph does not, as it could have done, refer simply to the "maximum permitted lump sum" (i.e., the maximum permitted under the current tax regime - see paragraph 26(3)). It must therefore be that the uncrystallised lump sum rights could be different from the maximum permitted lump sum. It is therefore necessary to identify what rights the member would have had under the arrangement on A-Day (making the assumptions required by paragraph 25(7)). Many DB schemes (type A) have rules which give members an option to commute pension for lump sum but the option can be exercised only with the consent of the trustees/employer/principal employer, and the amount of the lump sum cannot be more than the maximum permitted lump sum. Others (type B) have rules which give members an option to commute pension for a lump sum up to a specified maximum (eg, 3N/80ths of final pensionable salary) without having to obtain consent, but they also make provision for a larger amount if consent is obtained (but not more than the maximum permitted lump sum). Therefore, members of a type A scheme may have no entitlement to a lump sum and therefore cannot benefit from the transitional protection. There is nothing in the legislation to say that, when determining the uncrystallised lump sum rights, it must be assumed that consent would be given. For members of type B schemes, the legislation clearly confers transitional protection for the specified maximum in the scheme rules at A-Day, but it is difficult to see that members could claim protection in relation to the full maximum permitted lump sum (if greater). Page RPSM03105060 of HMRC's Manual states that "the value of the member's uncrystallised lump sum rights include rights to take a lump sum benefit with the consent of the trustees/employer/any other party". HMRC : Our view is that lump sum rights payable with the consent of the scheme trustees and/or employer should be included in the value of a member's lump sum rights for the purposes of transitional protection. This view is set out clearly in our guidance. The transitional protection provisions increase the maximum amount of tax free cash that can be paid as an authorised payment i.e. as a pension commencement lump sum. The transitional protection provisions don't alter the member's rights under the scheme. The transitional protection provisions don't force scheme administrators to pay members the maximum permissible pension commencement lump sum. Retirement cash: 25% + "scheme specific protection" JWG: RPSM 03105515, which appears in a very recent HMRC release, identifies an operation of the Act out of line with what we all were led to expect in relation to scheme specific protection. We urgently need to clarify a practical way forward. We had all expected "protection" to be an option, available if the Trustees wished, and usable if leading to a better limit than Schedule 29 unprotected limits. As highlighted by the RPSM page, the Act actually says that "protected limit" is a matter of fact not [Trustee] choice and that where it leads to lower limits than the unprotected limits, the lower limit applies. [We note that the "matter of fact" will depend on a separate issue we have raised in our list elsewhere.] The RPSM then goes on to say that it is possible to overcome this problem by paying a token DC contribution, to which "there is no objection". Algebraically we see that this artificially creates relevant benefit accrual so this works by triggering the formula in Schedule 36 para 34 which we understand is always at least as good as the formula in Schedule 29 paras 2 and 3, unmodified by Schedule 36). Schemes across the country have been led to believe that members can take 25% of their benefits as retirement cash. Many trustees have put in place a generic practice of 25% of the value of the package for all members. The above means that this may exceed an individual's limit and be an unauthorised payment for some people in some circumstances, unless using an artificial action. This is likely to be a problem for many schemes, and we feel strongly that our clients should not have to go through artificial token payments (which involve admin, may require adding the ability to make employer DC payments to scheme rules, may have unforeseen effects (for example for a scheme that has closed to contributions or accrual it might change the "ceased pensionable service date"), would lose Enhanced Protection for some members etc). HMRC : The purpose of the transitional protection provisions is to protect lump sum rights in excess of 25% where those rights accrued before 6 April 2006. The provisions in paragraphs 31 to 34 of Schedule 36 FA2004 will only apply where the result is to provide a lump sum in excess of the normal maximum permitted under paragraphs 1 to 3 of Schedule 29 FA2004 (the provisions for pension commencement lump sums). Paragraphs 31 to 34 of Schedule 36 don't apply where the effect would be to restrict the normal maximum payable under paragraphs 1 to 3 of Schedule 29. The guidance will be amended at the next opportunity. Occupational schemes with a 'section A' JWG: Regarding an occupational pension scheme with a section ("A"), for works staff, which provides only a 3n/80ths of final pay lump sum benefit, on a non-contributory basis, but where these employees have the option to join different contributory sections, which provide a pension accrual. Clearly accrual under section A must cease before 6 April 2006 if the scheme is to remain "approved". If these members switched to another section of the scheme on 6 April 2006, the permitted maximum cash on retirement in relation to service up to date will be 3n/80ths times CSLA/FSLA (with ALSA for future service), i.e. if they retain a final pay link for the pre-A day cash benefit and their pay increases are greater than the increase in the LTA then they may exceed the permitted maximum cash (or the ALSA amount would have to be restricted). If these members decided not to join another section of the scheme but opted out on 5 April 2006 and say joined the same sponsoring employer's stakeholder scheme, the accrued benefit would be revalued in deferment in line with the preservation requirements, i.e. with inflation up to 5% pa. However, since relevant benefit accrual would not occur in the scheme, from FA2004, schedule 36 section 34(2) the permitted maximum is then 3n/80ths times CSLA/FSLA, which means that unless the increase in the LTA exceeds or is equal to the increase necessary to satisfy statutory revaluation, then the lump sum required by preservation will exceed the permitted maximum. We understood that the outcome of the discussion last year was that HMRC were to discuss the issue with DWP and seek to address the conflict between preservation requirements and the post April 2006 tax regime in this situation. However, no such clarification has been forthcoming. There is the same need for clarification over the different possible interpretations of the effect of Articles 25 and 26 of SI 2006/572. Our understanding is that although this permits payment of a lump sum without the need for a related pension to come into payment, it does not change the calculation of the maximum amount which is an authorised payment. This is not clearly set out in RPSM03105640. Also if there is an excess which constitutes an unauthorised payment, is it the intention that this will be exempt from being a scheme chargeable payment under SI 2006/365? HMRC : Members in section A of the scheme for whom no "relevant benefit accrual" occurred after 5 April 2006 could take their lump sum rights as a "stand-alone" lump sum under the provisions of Article 25 of The Taxation of Pension Schemes (Transitional Provisions) Order 2006 [SI 2006/572]. Increases to the amount of the deferred lump sum by virtue of revaluation of the preserved benefit would not constitute "relevant benefit accrual" and could be paid in addition to the amount of the lump sum as it stood on 5 April 2006. A stand-alone lump sum is not subject to the calculation in paragraph 34 of Schedule 36 FA2004 as this is the calculation of the maximum amount payable as a pension commencement lump sum under the modified provisions of paragraphs 2 and 3 of Schedule 29 FA2004. A stand-alone lump sum is not a pension commencement lump sum. The payment of a lump sum (other than a refund of AVCs) that is an unauthorised payment won't be a scheme chargeable payment to the extent that: it is referable to "subsisting rights" that accrued before 6 April 2006 under a defined benefits arrangement, or it is referable to contributions paid to a money purchase arrangement before 6 April 2006. Article 2 of SI 2006/365 defines "subsisting rights". Calculation of the Initial Member Pension Limit for Dependants' Pensions JWG: The rules of most occupational pension schemes provide for dependants' pensions up to a limit of 100% of the member's pre-commutation pension, as indexed. Unless paragraph 16B(3)(c) of Schedule 28 is amended, unauthorised dependants' pensions will be paid, which is not the Government's intent. It will result in considerable extra administration in checking compliance, reporting and payment of unauthorised payment charges and scheme sanction charges, not just once but for every year that the dependants' pensions are in payment. The commuted part of the member's pension is brought into account by use of a factor of 5% of the lump sums paid. This assumes that the scheme commutation factor is 20:1 ) and contains no provision for indexation. It should allow for the actual commutation factor used and should be indexed in line with the member's pension. Alternatively the actual pension commuted should be used notionally increased in line with the member's pension. HMRC : see our response below. Calculation of increases for Dependants' Pensions JWG: As above, paragraphs 16B and 16C of Schedule 28 cause major problems: Under paragraph 16B(1) there is no allowance for any increase in the dependants' pensions in the first 12 month period following the member's death. Legislation requires increases to be paid to at least the LPI level and scheme rules will frequently provide for greater increases. For any dependants' pensions at the 100% limit, that part of any pension paid as an increase in the first year will be unauthorised. Under paragraph 16C, which covers increases in subsequent years, increases granted in the first post-death year, which continue, would be likely to be unauthorised if unauthorised in the first post-death year. The 'permitted margin' calculation in sub-paragraphs (6) to (12) permits increases in the third and subsequent post-death years, with the first increase being based on 5% or RPI increases over the course of the second post-death year. There is no provision for increases during the second post-death year. Increases so paid, as required by legislation and/or scheme rules, would be unauthorised if the dependants' pensions were at the 100% limit. The 'excepted circumstances amount' would hardly ever apply as it is based on the assumption that increases occur at the anniversary of the member's death – this is never the case. Sub-paragraph (14) should cover percentage increases as well as amount increases. In sub-paragraph (5), 'section' should read 'paragraph'. HMRC : Under the old regime, benefits could not generally exceed two thirds of the members' pension (and built into the 20:1 valuation is an assumption of dependants scheme pensions of two thirds the value of the members). Therefore, we consider that there is already scope within the dependants' scheme pension limit to allow pensions of at least the amount that was permitted before A-Day. We have, of course, already recognised some of the difficulties with obtaining information about pre A-Day pensions (such as the amount of the lump sum paid) and, therefore, a regulation has been made to disapply the dependants scheme pension limit in respect of all members who die with scheme pension to which they became entitled before A-Day. Given the regulation to exclude pre A-Day scheme pensions, we don't envisage that the dependants' scheme pension limit is likely to have immediate effect in many cases as it applies only to members who die after reaching age 75, but saying this, if this is causing practical difficulties for schemes then we'd be happy to discuss and consider their concerns. If JWG want to provide examples, send these to Angela Walker in the HMRC policy unit. Lump sum death benefits: protected and non-protected rights JWG: A further related example would be trivial commutation lump sum death benefits where there are both protected rights and non protected rights, where, for example, the non-PR fund were £25,000 and due to be paid to the deceased's estate and the PR fund £14,000 to be applied for the spouse or civil partner. Para 20 of Sch 29 mentions a trivial commutation lump sum death benefit extinguishing the dependant's rights to pension death benefit and lump sum death benefit under the pension scheme. In the above example, as the no-PR fund is due to the estate, can the PR be trivially commuted? HMRC : Yes as the PR fund is within the paragraph 20(2) Schedule 29 limit and payment of the trivial commutation lump sum death benefit would extinguish the dependant's rights to benefits under the scheme (but if the lump sum death benefit due to go to member's dependant, they'd need to ensure that this was paid out at the same time or before the trivial commutation lump sum death benefit). Benefit guarantee cases under the pensions review JWG: These are where providers agree to match benefits a member would have received in their DB scheme had they not transferred/opted out of it instead of paying a monetary amount of compensation up front. How are such benefits valued for LTA purposes - as hybrid schemes? HMRC : For transitional purposes rights under such arrangements should be valued on a hybrid basis as at 5 April 2006 i.e. as the higher of the values of the money purchase rights and of the guaranteed defined benefit rights. JWG: Members generally currently belong to a personal pension - what is the situation regarding the tax-free cash where it would have represented more than 25% of the member's DB scheme benefit? Can it be protected despite the member not being a member of an occupational scheme? HMRC : No. Transitional protection is not possible where the rights were held in a personal pension arrangement on 5 April 2006. Lump sum rights can be protected where the rights were held in a section 32 policy on 5 April 2006. BCE 3 Permitted Margin JWG: For the purposes of calculating the Relevant Annual Percentage, RPSM11104390 states that the starting month and month of increase as should be counted as full months. Therefore, if a pension commences on 1 June and the first increase takes effect on the following 1 June it would appear acceptable (although not wholly logical) to allow for increases for a 13 month period. This would appear an appropriate interpretation in the way paragraph 11(3) of Schedule 32 FA 2004 is worded. Are HMRC happy with such an interpretation? HMRC : confirmed that the legislation works in this way. Similarly, this will apply to calculating increases in RPI. But in practice, for the latter, schemes may want for example to make pension increases by reference to a known change in the RPI, using a preceding month's RPI figure. But the provisions of the legislation should be borne in mind. Calculation of Pension Input Amount following a transfer from a DB scheme JWG: The calculation required under section 236(5) won't be possible in many cases. In others it will result in penal taxation or the effective loss of transfer options. Under block transfers following sales and mergers, the block transfer amount is not normally broken down into individual amounts. Individuals will therefore be unable to complete their self-assessment tax returns. There should be an exemption for block transfers. An individual transferring from one occupational pension scheme to another or to a personal pension to take advantage, for instance, of more generous tax free cash terms is potentially increasing his pension input amount inadvertently. Take a member with accrued pension of £50,000 pa with a transfer value of £1m. The act of transferring will create a pension input amount of (£1m less 10x£50,000) or £500,000, resulting in a tax bill of 40% of (£500,000 - £215,000) = £114,000. This cannot be Government policy, as it will, at best, result in no transfers for older members with larger than average pensions. In some cases, such as a scheme winding up, what would normally be a valuable transfer option won't be available. A related issue, and of more limited application, is that the same phrase is used for testing whether there has been relevant benefit accrual with regard to loss of EP when taking an individual permissible transfer payment from a DB arrangement. So where the solution to the AA problem lies in a change of wording (eg to define a notional valuation of the DB benefit a nano second before transfer payment, using the valuation approach similar to pre A-day benefit valuation as at 5.4.2006), it would be helpful if it had the secondary effect of sorting out EP DB transfers too. The Act reference is Schedule 36 15(2). HMRC : confirmed that the annual allowance test is by reference to a deemed pension entitlement at the start and end of a pension input period. The test is not on the transfer value. The transfer is an adjustment to the closing value, which enables the deemed pension entitlement to be re-instated. The HMRC view would be set out in the next Pensions Newsletter, and then in the published RPSM guidance. Also confirmed that the EP test (in paragraph 15(2) of Schedule 36 FA2004) was a test of the actual value of the sums and assets transferred out of the defined benefits/cash balance arrangement. ?©Crown Copyright Keywords: Pension, Annuities, Annuity, Pensions, Annuities Tax, Taxation Please note that the annuities and income drawdown information contained within the articles and general text on Annuities Central may not be intended for annuity consumer use, may no longer be current and should not be used by consumers to make financial decisions. It is very important that you don't use this annuity information in isolation to decide which annuity or annuity alternative to buy. Annuity comparisons and pensions information or opinions expressed are made as at the date of this publication and are subject to change without notice. Always seek the help of an annuity broker before you buy an annuity.

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