HM Treasury: options to meet high annual allowance charges from pension benefits

Comments from ACCA to HM Treasury, January 2011.

Executive summary

ACCA is concerned that the 'scheme pays' option for settling liabilities of scheme members could present significant administrative and legal difficulties for schemes, which are designed to make payments out from funds only after benefits crystallise and not before.

With this in mind, ACCA favours the deferred payment model for settlement of liabilities. ACCA further recommends that the election for deferred settlement of the liability should not be irrevocable. If the member is later in a position to settle the liability from their own income, this option should be available. Deferred payment by the member of the rolled up liability (including interest incurred to date) would relieve HMRC and the scheme of further administrative requirements in relation to the relevant liability, and also of course deliver a cashflow advantage to HMT relative to freezing payment until the date benefits crystallise.

General comments 

ACCA recognises the need for HMRC and HM Treasury to play their part in seeking to reduce the current national deficit, and acknowledges that some measures which might otherwise be considered too damaging in their indirect effects may have to be accepted in the short term. However, ACCA remains committed to the principle that pensions are a long term investment, and that the legislation affecting them should be changed as little as possible and designed to encourage saving for retirement by all sectors of society. With this in mind, we remain concerned that overall the latest raft of changes fall well short of the ideal on both counts, and that there may be better ways for the government to achieve its economic aims.

Specifically when considering the proposed introduction of the 'scheme pays' mechanism to counteract the unfairness inherent in a tax liability being imposed on income which has yet to be received, we are concerned that the effect of the system, which HMRC and HMT acknowledge in the consultation document will operate in parallel with the 'time to pay' scheme, will be to put into statute a complex administrative mechanism which serves only to duplicate the effect of the existing procedures. Imposing administration costs on the pension schemes themselves, in addition to the tax burden on individuals, serves only to compound the unfairness – or to put it more simplistically, two wrongs don't make a right.

Nonetheless, the opportunity to comment on the proposals is welcome, as has been the response of HMRC and HM Treasury to the previous rounds of consultation on the policy to restrict tax relief on pensions saving. The current draft legislation as a whole is a considerable improvement on its predecessors. ACCA recognises the value in the consultation process, and remains committed to engaging with policy makers and implementers at all levels in the mutually beneficial quest to improve the UK tax system for all its stakeholders.

Specific comments 

1. The Government's current thinking is that it would be appropriate for individuals to pay the first £2,000 to £6,000 of any AA tax charge from their current income; and welcomes evidence to indicate an appropriate threshold figure. (Paragraph 2.9)

The effect of the flat factor on the taxable value of defined benefit schemes is to exaggerate the value of a single year's pay rise for the recipient. For long serving members of schemes with high accrual rates, the taxable value of any pay rise can easily exceed 10 times the actual income received in the year. As a result, if the AA is breached at all, there is a good chance that it will be breached by a level at which the tax due as a result of the pay rise will exceed the post tax income derived from that pay rise.

If 'scheme pays' is implemented, the setting of a limit above which individuals can opt for it should be informed by the issue of affordability for the individual taxpayers. Although a lower threshold will increase the administrative burden on schemes, much of their cost will arise from the fixed element of setting up the new procedures. The relative marginal change in overall administrative burdens arising will be less significant than the threefold difference to individuals between the lowest and highest suggested thresholds. Whether the limit is set at £2,000 or £6,000 of tax, the difference in the number of individuals who can apply will be relatively small.

In the short term, the limit should be set at the lower end of the suggested range. One of the side effects of taxing only the excess over an initial threshold is that if a charge arises as a result of a pay rise, it is likely that the tax due will exceed the post tax value of that pay rise. The wider the window of fund increases that could trigger a charge, the greater the chance that individuals will be faced with a tax bill that they cannot reasonably meet from disposable income.

Once the scheme has bedded in and employers and employees are used to managing pension affairs in such a way as to avoid charges arising, the numbers of individuals affected will fall and so the possibility of serious difficulty arising will fall. The limit could at this point be revisited.

However, as indicated above, ACCA considers that use of the existing time to pay provisions might impose a lower burden on the economy overall. We acknowledge that this would potentially impose an unwelcome extra administrative burden on HMRC at a time of financial constraint. However, the marginal cost to HMRC of considering a small number of extra time to pay cases would be less than the cost to the schemes of implementing and operating an entire new procedure. There would also be the advantage to HM Treasury that tax due from individuals who could afford the charge themselves would be payable earlier than under 'scheme pays', while avoiding the risk of hardship to individuals who would fall just the wrong side of the artificial threshold of 'scheme pays'.

2. The Government welcomes views and evidence on whether individuals in DC schemes would have need of and/or would make use of a facility to meet AA charges from pension benefits. Views are also sought on whether restricting access to members of DB schemes only creates significant material administrative or communication issues for schemes. (Paragraph 2.11);

While there should be no apparent need for DC scheme members to need access to a 'scheme pays' facility, administration of it for a DC scheme would in many ways be simpler than for a DB scheme. The assets attributable to each member would be more readily ascertainable, and reducing the member's entitlement to assets at the appropriate time a relatively simple matter. The main difficulties that might arise would be around the prohibition on administrative charges for scheme administrators. As a result, the costs of complying with the member's request would have to be shared between all members of the scheme.

With the exception of hybrid schemes, there should be little in the way of significant administrative issues for schemes to deal with if the mechanism is restricted to DB schemes. The tax liability for DC schemes will simply remain the sole liability of the individual. In terms of communication to members, although surveys tend to indicate that awareness of pensions is relatively low among younger people, those employees who have a DB pension and are in an income bracket where the AA may potentially be breached will tend to be more financially aware, and in many cases already nearing retirement and considering their retirement provision.

3. The Government welcomes views on whether there are other exceptional circumstances in which it is appropriate to exempt certain schemes from facilitating payment of AA tax charges, including whether this would differ under the broad options. (Paragraph 2.13);

Any measures which impose an extra burden, financial or regulatory, on schemes must be weighed carefully and their potential to further harm the declining health of DB schemes considered and minimised.

Where a pension scheme is in severe financial difficulty, forcing it to divest cash on a short term basis would be harmful to its chances of continued survival, particularly if it is heavily invested into illiquid assets. However, as it would be a challenging task to evaluate the precise parameters which should exempt a scheme from making unexpected (in actuarial terms) payments prior to actual failure of the scheme and entry into the PPF, this could be seen principally as an argument in favour of a move to the deferred payment option. Under the deferred payment regime the scheme's cashflow would not vary from current models.

4. The Government welcomes views on its proposed approach to multiple pension-holders. That is, that individuals are allowed to elect for a single scheme – in which they are an active member – to meet the AA charges each year; and that where the AA has been exceeded outright in a single scheme in a given year, that is the only scheme that can be elected to meet the liability from their pension benefits. (Paragraphs 2.14 and 2.15);

Although imposing the burden of operating 'scheme pays' on just one scheme out of potentially many is unfair on the fellow members of the one chosen scheme, it is the only practical way to operate the charges. Viewed on a wider scale, it could even be argued to be fairer, as only one scheme per individual will have to incur the administrative costs of payment, rather than all schemes contributing to the breach of the AA. In this way the 'collateral unfairness' to fellow scheme members of the individual would be reduced.

5. The Government welcomes views on whether it would adversely affect schemes, administratively or otherwise, to meet a charge that did not arise exclusively in that scheme. (Paragraph 2.16);

The administrative cost of meeting the charge is unlikely to vary significantly with the sum payable, so it makes more sense to have only one scheme administering payments per member than many.

The level of unfairness to a particular scheme of bearing tax charges for which it is not wholly 'responsible' will depend upon the chosen mechanism for settling the liability. Where payment of the tax is deferred, there should be no unfairness, as it is most likely that the tax will be settled out of the individuals cash pot on benefit's crystallisation. The scheme pays out the same amount of money as it would always have done, but simply to two payees (HMRC and pensioner) rather than just one. However, where the scheme has to divest funds in the short term to settle the liability, the result will be a reduction in the funds available for investment by the scheme for the benefit both of the member triggering the charge and all other members.

6. To inform the overall approach, the Government would be interested to see evidence on the numbers and characteristics of employees or scheme members respondents have identified as potentially eligible to meet AA liabilities from pension benefits. (Paragraph 2.17);

Many public sector schemes would be affected by the revised AA and the Government should turn to those for a greater understanding of those who will be affected.

7. The Government welcomes views on whether respondents agree that it would be insufficient to report the value of the charge to be offset without explaining the corresponding effect on pension benefits to members; and whether the level of detail and precision required varies across the options. (Paragraph 3.13);

ACCA agrees that members should be informed of the effect on their benefits of opting for 'scheme pays'. The level of detail which is desirable would vary not only with the options, but also with the profile of the scheme members. The concepts involved are complex and require a level of financial knowledge to fully understand and appreciate. Scheme administrators are best placed to understand the needs of their members, and should be free to communicate as they see fit, taking into account their duties and responsibilities to those members.

9. The Government welcomes views on whether there are other circumstances in which the application of either option may need to be given specific consideration? (Paragraph 3.23);

ACCA suggests that under the deferred payment option, the election to by the taxpayer to have the tax settled by the scheme at date of benefit crystallisation is not irrevocable. The tax payer should have the option, if circumstances permit, to repay the excess AA charge (as augmented by interest) in full at any point themselves. As discussed above, in many of the cases where the tax cannot be met immediately, it may nevertheless be an amount which the individual can pay from savings accumulated over a period of several years. For many people, the ability to remove the potential liability on their schemes would be welcome. It would also provide cash to HM Treasury earlier than would otherwise have been the case, and relieve the administrative burden on the schemes.

A complementary refinement to the scheme would be to allow the deferral or repayment of AVCs where a DB scheme member's AA excess arises from payment of AVCs. An option would be to carry forward excess AVCs after exhaustion of the AA carry forward, and in the following year require repayment of the AVC if the allowance would otherwise be breached again, so as to maintain the cumulative level of tax advantaged saving allowed.

10. The Government welcomes information that explains how and why these might work differently in practice, and where that leads to different impacts for scheme members, or scheme administration. (Paragraph 3.24);

From a financial perspective there is a clear advantage to government in opting for the immediate payment alternative. From the taxpayer's point of view there is perhaps less difference, as the taxpayer will not see any benefit from their pension until retirement, and the aim of the legislation would be for the value of tax paid at that point to be the same as it would have been had the immediate option been enacted.

From the schemes' perspective, while the administrative cost of the deferred option might be slightly higher than for the immediate payment option, the cash flow impacts might offset that extra element of record keeping.

There is one further significant difference, which relates to the situation where a scheme fails. In this case, under deferral, although no tax would be paid, this is arguably the correct position as the "benefit" to which the tax was purported to relate has in fact never come into existence. Conversely, if the tax had already been paid, not only would this appear unjust to the victims of the fund failure but it might even open the government to accusations of contributing to the scheme's demise.

13. The Government welcomes views on whether there are particular advantages to this approach of rolling-up AA excesses, rather than AA charges. (Paragraph 3.28).

Taxing rolled up excesses at a later date would move away from the concept of taxing the deemed cost of funding the promises made to pensioners at the time those promises are made. It would be administratively simple, and the tax arising would be no more or less accurately related to the actual cost of providing the benefits (based as it is on the flat factor model for valuing the investment pot).

However, moving to the 55% rate for LTA excesses would reduce the overall coherence of the regime. The administrative benefits of replacing immediate calculation of marginal tax with deferred calculation of flat rate tax would not make up for the difficulties caused by introducing a different tax regime for one specific class of pensions. Reintroducing this sort of complexity would be a step back towards the pre-A Day regime, and should be avoided.