TaxApr 27 2018

Government urged to fix pension freedoms side effects

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Government urged to fix pension freedoms side effects

The government is being urged to fix some of the 'unintended consequences' arising from pension freedoms, which are starting to affect advisers.

Jessica List, pensions technical manager at self-invested personal pension (Sipp) provider Curtis Banks, said advisers have been enquiring about issues around the tapered annual allowance and beneficiary drawdown.

She said there were a number of outdated rules, which had not been adjusted when pension freedoms came in, which were causing problems and could easily be changed.

One example is around 'scheme pays' rules.

'Scheme pays' allows an individual who has breached their annual allowance to pay a charge for doing this from their pension scheme - the scheme pays the annual allowance charge direct to HMRC on their behalf, and the tax charge is taken out of their pension fund.

Currently the rules dictate an investor has to exceed the normal annual allowance they can put into their pensions of £40,000 before the provider has to offer the scheme pays process.

But since 6 April 2016, people with a taxable income over £150,000 will have their annual allowance for that tax year restricted. This means that for every £2 of income they have over £150,000, their annual allowance is reduced by £1. 

The maximum reduction will be £30,000. So anyone with an income of £210,000 or more will have an annual allowance of £10,000. People with high income caught by the restriction might have to reduce the contributions paid by them and/or their employer or an annual allowance charge will apply.

So this means a high earner, who is subject to a reduced annual allowance of anything as little as £10,000 under the taper rules, may find themselves denied scheme pays if their provider does not allow it on a voluntary basis.

Another unintended consequence affects beneficiaries of a pension who want to go into drawdown but the pension is sat with a provider which does not offer drawdown.

Current rules don’t allow a beneficiary to set up a new drawdown account with a different provider as they don’t allow the pension to change hands during a transfer.

“The provider settling the death claim can change the pension to a beneficiary drawdown account but you can’t transfer to a new drawdown provider and do that. It’s a rule that predates pension freedom,” Ms List said.

“Even if those weren’t an issue drawdown transfer rules say you’ve got to do it on a like for like basis so you couldn’t transfer your member’s drawdown account to a dependant's’ drawdown account.”

This forces beneficiaries in this situation to take the cash as a lump sum, which is less tax efficient.

Ms List said: “These are rules that just haven’t been updated. It doesn’t seem sensible.

“Changing a few lines of legislation seems to be an easy fix.”

She pointed to similar issues occurring in the aftermath of pensions freedoms which the government decided to fix, such as death benefits rules affecting young dependants who initially lost this status when turning 23.

But an HMRC spokesperson said: “The consequences of the scheme pays rules are not unintended. 

“'Scheme pays' was introduced to help lower paid individuals who might incur annual allowance charges, particularly as a result of one-off spikes in their pension inputs. 

“The conditions did not change as a result of the introduction of the annual allowance taper.”

On beneficiaries drawdown HMRC stated: “Pension scheme rules determine what type of death benefits can be paid. Payment of death benefits is not a transfer. 

“If an individual already has a drawdown account and wishes to transfer to another provider they can do so, but the tax rules stipulate that the benefits provided must be on a like for like basis.  This is to prevent manipulation of the rules.”

carmen.reichman@ft.com