Clampdown on pension income recycling

With the new pension flexibilities, the government is limiting the extent to which individuals can recycle their pensions income. Accessing these savings – part of which is tax-free – and then simultaneously making a large contribution seems like an obvious abuse of the flexibilities, which is why the government is amending the rules around the Annual Allowance.

From April 2015, when funds from new pension arrangements are drawn in excess of the tax-free cash entitlement, the new reduced money purchase annual allowance (MPAA) of £10,000 will apply. This is one of several events that can trigger an MPAA.

As with any changes to pension legislation a degree of complexity surrounds the new rules.

For example, assuming the MPAA rules are triggered, a £10,000 annual allowance applies but only to the client’s money purchase arrangements.

Assuming the full £10,000 is used up by the mooney purchase arrangement, a reduced £30,000 AA will apply to any defined benefit savings the client may hold. When the reduced AA applies, any unused relief from the previous three years can be carried forward for the DB arrangement. But any unused MPAA cannot be carried forward.

Let us look at a few examples, based upon those used by Revenue & Customs in its draft guidance dated October 2014.

Example 1

Andrew is a member of a money purchase arrangement and after 6 April 2015 takes an uncrystallised fund pension lump sum (UFPLS). He is therefore subject to the £10,000 MPAA and cannot carry forward any unused MPAA. He has no other pension arrangements.

Andrew makes a contribution of £8,000. As this is below the MPAA there is no charge. If Andrew had exceeded the MPAA he would have been subject to the annual allowance charge on the excess amount.

Example 2

Jill is a member of both an MP and DB arrangement. Like Andrew, Jill takes a UFPLS and becomes subject to the £10,000 MPAA.

Jill contributes £9,000 in her money purchase arrangement. As this is below the MPAA her total savings are tested against an AA of £40,000, but her MP pension is still subject to the £10,000 limit. Accruals to Jill’s DB scheme are £20,000, which means that her total contributions are £29,000. This is less than £40,000 so no annual allowance charge is due. Jill also has £11,000 unused AA to carry forward – but on her DB arrangement only.

Example 3

Paul is also a member of both a MP and DB arrangement. Paul has decided to take drawdown from his flexi-access drawdown fund (FADF) and as a result becomes subject to the £10,000 MPAA.

Paul’s contributions to the MP arrangement are £11,000 and as this is more than £10,000, a reduced AA of £30,000 will apply to his DB arrangement. Accruals to Paul’s defined DB total £28,000, which is within the new limit so no charge will apply to that. But Paul is subject to an annual allowance charge on the excess MP savings of £1,000.

When a trigger event occurs in a tax year then the MPAA is applicable from the next day. This means that any MP contributions already made will not be subject to the MPAA. However, as contributions are counted in the pension input period (PIP) this makes things a whole lot more complicated.

As we know, while tax relief on contributions is given in the tax year of payment, the AA is assessed upon contributions made within a PIP ending in a tax year; but the PIP need not match the tax year.

Again, a few examples should clarify this:

Example 4

Emma has two MP arrangements with two different PIPs – the first is 1 October 2014 to 30 September 2015 and the second from 1 January 2015 to 31 December 2015. Emma contributes £400 a month to the first arrangement and £200 a month to the second, on the 15th of each month. Both PIPs end in tax year 2015/16 and this is the tax year that they will be assessed against the AA.

Emma triggers the MPAA on 1 November 2015 by taking a UFPLS. As the PIP for the first arrangement ends before the trigger event, the 12 contributions of £400 that are tested against the 2015/16 AA are not tested against the MPAA. They will be tested against the 2016/17 MPAA.

As the PIP for the second arrangement ends after the trigger event, the two contributions of £600 paid in November and December are tested against the 2015/16 MPAA with the remaining 10 contributions tested against the 2016/17 MPAA.

This means, assuming no other pension contributions, that only £1,200 is tested against the £10,000 MPAA. As this is less than £10,000, all her contributions (totalling £12,000) are also tested against the £40,000 AA.

Example 5

Charlie has two arrangements; the first, a cash balance arrangement (this is treated as an MP arrangement) with a PIP from 16 February 2015 to 15 February 2016, and the second, an MP arrangement with a PIP from 1 April 2015 to 31 March 2016. Charlie triggers the MPAA on 15 September 2015.

Charlie’s savings to his cash balance arrangement is £12,000 and he makes two payments to his MP arrangement: £15,000 on 1 July 2015 and £8,000 on 1 February 2016.

The £12,000 input to the cash balance arrangement needs to be apportioned before and after 16 September 2015. For his 2015/16 MPAA his pensions input amount is £12,000 x 153 (the number of days from 16 September 2015 to 15 February 2016) divided by 365 = £5,030.

For Charlie’s MPA it is only the payment of £8,000 made on or after 16 September 2015 that counts.

Charlie therefore has made total savings of £13,030 for 2015/16 and as this exceeds the MPAA there is an amount of £3,030 subject to an AA charge.

The pre-6 April 2015 rules for an individual taking flexible drawdown say that they get a nil AA for all types of pension saving, that is both MP and DB.

From 6 April 2015 a flexible drawdown arrangement will automatically become an FADF and so the individual would be automatically subject to the £10,000 MPAA from that date with an overall £40,000 AA if they also have a DB arrangement. No unused AA can be carried forward on the MP arrangement.

The current rules remain, which are no less complicated, but the upper limit will be dropping to £7,500 from £10,000 at present.

The basics of the new £10,000 MPAA seem quite straightforward, but in practice they become more complex because, as usual, they have to interact with other rules.

Advisers must take care to ensure they know clients’ PIPs before they start planning.

Nigel Orange is technical support manager (pensions) of Canada Life

Key points

With the new pension flexibilities, the government is limiting the extent to which individuals can recycle their pensions income.

When funds from new pension arrangements are drawn in excess of the tax-free cash entitlement, the new reduced money purchase annual allowance of £10,000 will apply.

In practice, the rules become more complex because as usual they have to interact with other rules.