Pensions legislation: Change of fortune

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Small self-administered schemes - February 2013

Just over 10 years ago, Gordon Brown, then chancellor of the exchequer, said he was “setting out proposals for a radical simplification of the tax rules for pensions… replacing them with a single lifetime limit on the amount of pension saving that can benefit from tax relief”. Writing in the foreword to a green paper, he added that his proposals would enable people to make “clear and confident decisions about pension saving”, allowing “greater individual choice and flexibility” about when and how much to save in a pension and reducing administrative burdens on employers and providers.

Historically, pensions saving has benefited from significant tax advantages. These tax breaks are primarily an incentive to ensure as many people as possible save for their retirement, reducing those who would be dependent on state benefits in their old age. But in tough economic times, there is no question of increasing the tax benefits for pension arrangements; in fact, successive governments have looked at ways to reduce the tax incentives available to pensions savers while trying not to destroy the concept of independent provision.

In practice this has led to multiple changes – each reducing the sum that can be saved and the amount of pension that can be granted in a tax-beneficial manner – and never really established the stable environment envisioned by Mr Brown. What has happened to the main pillars of the 2006 simplification regime?

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Lifetime allowance

Successive changes over the years have affected all forms of pensions, and the small self-administered scheme (SSAS) is no exception. For higher earners who have sizeable pensions, alterations in the lifetime allowance are more likely to make an impact.

The initial lifetime allowance set in 2006 was £1.5m, with a proposed stepped increase to £1.8m during a five-year period. This was broadly equivalent to a maximum pension under prevailing occupational pension rules for a man of 60 drawing an indexed pension and providing a surviving spouse’s pension. Allowing for the then-appropriate salary cap, this was effectively a pension of £70,000 pa.

After increases were made in accordance with the proposed formula, subsequent chancellors first froze the lifetime allowance and then reduced it to £1.5m from April 2012. The latest proposal, effective from April 2014, reduces it again to £1.25m. Using today’s interest rates, a fund of this size could purchase an annuity increasing at 3 per cent pa and with a two-thirds spouse’s pension of approximately £35,000 pa. In addition, the maximum pension commencement lump sum has reduced from 25 per cent of £1.8m in 2011 (£450,000) to a proposed 25 per cent of £1.25m (£312,500) after April 2014. It is clear why the chancellor thinks this is a good idea given today’s mood of austerity.

To complicate matters, it has been possible for individuals who already have reasonably substantial pension pots to apply for ‘protection’. With primary and enhanced protection in 2006, fixed protection in 2012, new proposals from the recent Autumn Statement for ‘fixed protection 2014’ and ‘personal’ protection, there will soon be five different protection regimes in place, plus lump-sum protection. Is this really the simple approach the government anticipated when the new pension regulations were introduced in 2006?

Annual allowance

When simplification became effective, the annual allowance was originally set at £215,000, to increase over five years to £255,000 pa. In reality, it was always believed that these were extremely high levels of potential contributions and a new, much lower annual allowance of £50,000 was introduced, effective from April 2011, albeit with a new three-year carry-forward provision. From April 2014, this will be followed by a further reduction to £40,000.