11 October 2011 - Post by:Helen Powell
It sounded like a simple enough idea in principle: the new, lower, annual allowance for pension saving could lead to hefty tax charges for some members – substantially in excess of their actual income for the year – relating to increases in pension benefits which won’t translate into cash in hand for years or possibly decades to come. Some members might not be able to pay that tax bill, so the neat solution devised by the Treasury was to allow members to require their pension scheme to meet the annual allowance tax charge instead of paying it personally, with a corresponding deduction from pension – the facility known as ‘scheme pays’.
Except, like everything in pensions, it’s not quite that simple. There are live issues currently being debated with HMRC about how exactly a scheme should make the deduction where DB benefits are involved, since the official guidance seems to suggest that the most obvious route – deduction from AVC funds – is not necessarily favoured by HMRC. There’s also the question of whether or not any allowance can be made for costs (the initial proposal was that the scheme pays facility should be free of charge for members, but the legislation only says that the adjustment must be made ‘on a basis that is just and reasonable having regard to normal actuarial practice’, which seems to allow some wiggle room on expenses).
More urgently, there’s an issue for retiring members. The deadlines for making a scheme pays election fall significantly after the end of each tax year – but a retiring member who wants his or her scheme to pay any annual allowance charge must make that election much earlier, before the benefits come into payment. In practice, this could mean that a member gets a retirement benefit quotation, decides the future looks rosy, lets the employer know that he or she intends to retire, and only then (if at all) makes any scheme pays election. If that happens today, the election will only be for a charge arising for 2011/12, but in future years a member might suddenly notify the scheme administrator of up to three years’ worth of scheme pays elections. Of course, those elections are all going to feed into an adjustment to the member’s final pension, and could make a significant difference to the member’s income – and indeed to whether or not the member wants to retire after all. It may not be possible to unwind all the decisions that have been made, so things are going to get complicated.
What to do? My suggestions for scheme administrators are, first, to flag up to members that any relevant scheme pays elections must be made before they retire, and that as they approach retirement, doing this sooner rather than later will give them a more accurate idea about their retirement income. Secondly, consider adding some standard wording to your retirement benefit quotations as a reminder that any elections must be made before taking benefits, and that the value of benefits will be affected by any elections which are made. The risk of not doing this is that, even though you issue an entirely correct benefit quotation, the member ends up disappointed at the end of the day, and you get drawn into a complaints process which takes up time and effort even if it’s completely unfounded. With everything else that’s going on in the world of pensions, you can do without unnecessary disputes: so avoidance action now seems like the simplest option.
Helen Powell is a senior professional support lawyer at Allen & Overy LLP.