Tax simplification legislation makes progress: DC limit unchanged, despite rumours

A House of Commons Standing Committee has finished debating amendments to Part 4 of the Finance Bill and related Schedules, which deal with simplification of the pension tax regime. At the same time, the Inland Revenue has started publishing draft Regulations* in respect of the pension tax changes on its website.

Most of the government amendments to the Finance Bill are intended as "tidying-up" or clarifying measures, and there are few substantive changes to the provisions of the Bill as originally published (see Finance Bill gets second reading). However, opposition parties tabled a large number of amendments that were either intended to change certain substantive provisions of the Bill or to force clarification of matters that they felt were not covered adequately by the Bill.

Opposition amendments

The provisions of the Bill with which the Conservative members of the committee were particularly dissatisfied concerned the requirement to take an annuity by the age of 75, and the factor of 20:1 used to value defined benefits (DB) for the purpose of testing them against the lifetime limit.

On the former point, the opposition members tabled amendments proposing to raise the age to 80 on the grounds that as people are living longer, it is a more appropriate maximum age for taking annuities. The standard valuation factor was considered to be unfair for many members because it would be too generous in some cases and not generous enough in others. Unsurprisingly, these amendments were not accepted.

DC lifetime limit unchanged

The opposition members were also unhappy that the Bill only sets out the initial lifetime allowance of £1.5 million. Although details of the table containing increases up to 2010 announced in the Budget are repeated in the explanatory notes, the Conservative members pointed out that there seems to be no requirement in the Bill for the amount to be revised. They proposed that the table of increases and the method of reviewing the lifetime limit be written into the Bill. However, the government believes that it is not necessary to do so and the amendments were rejected by the Committee.

Rumours also started to circulate during the committee hearings that the lifetime limit for members of defined-contribution (DC) schemes was being increased by a further £1 million to £2.5 million. This misconception resulted from existing provisions of the Bill that were not amended by the committee but which were discussed.

Several committee members pointed out that if a valuation factor of 20:1 was used (as is proposed), it means that a defined-benefit (DB) scheme member could receive a pension of £75,000 a year (ie the lifetime limit of £1.5 million ÷ 20). However, if a member of a DC scheme tries to convert a fund of £1.5 million into pension, the resulting amount would be about £55,000 a year because of the operation of annuity rates. Therefore, the Bill permits members of DC plans, whose schemes permit it, to build up a fund worth more than £1.5 million and then to buy an annuity that will pay up to £75,000 a year. DC scheme members can, therefore, have a bigger fund, in excess of the lifetime limit, but cannot draw a more generous pension.

Changes to primary protection rules

As originally drafted, the Bill stated that the value of benefits that have built up before the effective date of the tax changes, that is 6 April 2006 (A-day) for primary protection purposes, would be 20 times the pension available on early retirement at A-day, rather than 20 times the unreduced deferred pension. However, this provision has been amended.

Eleanor Dowling, research solicitor at Mercer Human Resource Consulting, points out that early retirement at the youngest permissible age was to have been assumed for those who were too young to retire. As pensions paid very early are generally reduced by an early retirement factor, this provision would have reduced the value of the pension that would receive primary protection.

The Bill has been amended to provide that, for the purposes of primary protection, a member's benefits will be valued as if the member were the age at which a pension would first be payable from the scheme without an early retirement penalty being applied. Eleanor Dowling gives the example of a member who is aged 45 at A-day and who has the right to take an unreduced pension at 58. Under the amended provision, that member's pension will be valued as if the member were 58 on A-day.

Simplified calculations

The government also introduced amendments in the final days of the Committee stage to protect lump sums in excess of £375,000 in a simpler way than that originally proposed in the Bill. Pension scheme members will be able to take their protected amount from any of their schemes from which they think fit. As originally drafted, the Bill contained an additional requirement that the lump sum must be taken as an equal percentage from each arrangement.

In addition, the same basis for the valuation of the protected lump sum has been adopted as for the protected pension rights. The protected value will be the lower of: the accrued lump sum without the imposition of any early retirement factors; and the maximum lump sum allowed under the Inland Revenue's discretionary approval regime in force on 5 April 2006.

Procedural Regulations

While the Committee stage was progressing, the Inland Revenue started publishing draft Regulations in respect of administrative and procedural matters. These include disclosure requirements, provisions regarding which occupations may take pension before the minimum pension age of 55, extensive rules regarding the registration of entitlement to enhanced pension rights and details of who can be an auditor.

Draft Regulations also set out the interest rates that employers must pay on approved loans from their pension schemes. This is set at 1% above the average of the base rate charged by a number of banks.

Although the Bill has the aim of simplifying the taxation of pensions, as several members of the committee commented, the statute and Regulations made under it will be far from simple. Yet again, consultants will come into their own (see Surveys reveal mixed intentions in response to new tax regime).

* The draft Regulations can be found on the Inland Revenue website (at www.inlandrevenue.gov.uk/finance_bill2004/index.htm).