22 March 2016 - Post by:Helen Powell
6 April 2016 marks the 10-year anniversary of ‘A-Day’, the start date of the new regime of pensions tax simplification. How is that working out for you?
The policy objective underlying simplification was to rationalise the layers of legislation and tax regimes which had silted up over decades under successive governments, and which were seen as a barrier to retirement planning. The December 2002 consultation document ‘Simplifying the taxation of pensions: increasing choice and flexibility for all’ reads:
‘These proposals for radical simplification will enable people to make clear and confident decisions about pension saving. They will mean far greater individual choice and flexibility about when and how much to save in a pension. And they will reduce administrative burdens on employers and pension providers alike… For the vast majority of people, the tax system will simply cease to be a consideration when planning for retirement. Instead they will be free to concentrate on the real issues – deciding when and how much to save.’
And so simplification arrived in April 2006, with a lifetime allowance (LA) of £1.5 million and an annual allowance (AA) of £215,000. For a few years those allowances were increased, reaching a peak of £1.8 million and £255,000 respectively in 2010/11.
The first Chancellor to show an inclination to fiddle with the regime was Alistair Darling, who announced in Budget 2009 that, from 6 April 2011, tax relief on member pension contributions would be reduced for individuals earning £150,000 or more (later reduced to £130,000), tapering from 40% down to 20% for those earning £180,000 or more. As an anti-forestalling measure, a ‘special annual allowance’ would apply for the next two years, to be followed by the complex, unloved and unlovely high income excess relief charge (HIERC).
However, political events, in the shape of the new coalition government of 2010, intervened – the Emergency Budget of 2010 announced that the special annual allowance and HIERC were too burdensome and would be swept away, but would have to be replaced by measures producing the same revenue. Later that year, simplification was confirmed in the form of cuts to the AA from April 2011 and to the LA from April 2012. These were accompanied by the introduction of the carry-forward mechanism for unused AA (designed to protect individuals with low to moderate incomes from ‘spikes’ in income), plus plans for ‘scheme pays’ to ease payment of tax charges. The factor for valuing final salary benefits was increased from 10 (which in hindsight seems extraordinarily low) to 16.
Budget 2011 included the abolition of compulsory annuitisation at age 75 and the introduction of new drawdown and flexible drawdown arrangements, as well as confirmation of the intention to establish a single-tier state pension.
The reduction in the LA to £1.5 million from April 2012 brought with it the first of the post-A-Day fixed protection regimes. By the time Budget 2012 came around, the industry had settled into an annual expectation of further cuts to the AA and LA, but these didn’t come until the Autumn Statement that year, which announced a reduction in the LA to £1.25m from 2014/15, with a parallel fixed protection regime and a new-style individual protection regime which permitted ongoing contributions/accrual, plus a reduction in the AA to £40,000.
Budget 2013 contained no major changes (simplifying or otherwise) – but then came Budget 2014, with a completely unexpected announcement of radical reform at the other end of the process – ‘choice’ and ‘flexibility’ were the buzzwords yet again, leaving the industry with just a year to prepare for the changed landscape of 6 April 2015. There were immediate changes, too, with increases to the trivial commutation and small lump sum limits, the minimum income requirement for flexible drawdown, and the limits for capped drawdown. Budget documents estimated that the move would increase tax income by £1.2bn a year by 2019, and would raise £320m in the first year of operation – in fact it is now estimated that tax receipts from flexible access in 2015/16 will be around £900m.
6 April 2014 also saw the implementation of reductions to the LA and AA, to £1.25 million and £40,000 respectively – with further associated protection regimes alongside.
The Chancellor came back for more simplification in Budget 2015, with the announcement of a further cut to the LA from April 2016, down to £1m – but with the LA then to be indexed from 2018/19. The other big announcement was the plan to introduce a secondary annuity market, initially planned for April 2016 but later pushed back to April 2017 – it is understood that the Government has planned for tax revenues in the region of £500 million a year in each of the first two years of operation.
The post-election Summer Budget allowed a second bite of the tax simplification cherry, with the announcement of the tapered AA, reducing the AA by 50p in every £1 of income between £150,000 and £210,000 – plus the announcement that the Chancellor was ‘open to further radical change’, including changing the basis of entire system from exempt/exempt/taxed (EET) to taxed/exempt/exempt (TEE) – for more on this see our July 2015 blog post.
In the event, as the Chancellor made clear in his Budget speech on 16 March, the consultation revealed no consensus on making compulsory changes to the pensions tax system (this could be seen as something of an understatement) – so he announced the introduction of even more freedom and choice instead. Announcing plans for the new Lifetime ISA, he told under-40s that they “don’t have to choose between saving for your first home, or saving for your retirement”.
So, after a decade of pensions simplification, what do we have?
- A lifetime allowance which, after initial increases, has been reduced three times, resulting in five additional protection regimes (on top of the original two).
- An annual allowance cut to less than a sixth of its original amount, and subject to further reductions for high earners and individuals who take flexible access, resulting in complexity such that some members won’t be able to tell until after the end of the tax year what their annual allowance for that tax year actually was.
- A radical reshaping of access and tax rules at retirement age, removing the requirement to use pension savings to fund income in retirement at all; and another giant leap to come in the form of the ability for individuals with annuities to sell these back for a capital sum.
- A system which continues to be EET, but with a new kid on the block from April 2017 which introduces TEE into the savings/pensions system for the first time, accelerating the move from pension saving to all-purpose lifetime saving.
- A single-tier state pension which is designed to lift people out of eligibility for means-tested benefits and set them free to make their own choices from among this multiplicity of options.
What price now the confident prediction of 2002: ‘For the vast majority of people, the tax system will simply cease to be a consideration when planning for retirement. Instead they will be free to concentrate on the real issues – deciding when and how much to save.’
Helen Powell is a PSL Counsel at Allen & Overy LLP