Summer Budget 2015 Changes to Pension Taxation Webinar

16 July 2015

1

Introductions

Paul Darlow is the Head of Proposition Development at Xafinity

Steve Hobbs is an actuary, and one of our leading experts on the Annual and Lifetime Allowances

2

Agenda for Today

1. The Lifetime Allowance (“LTA”)

a) Recap

b) Latest changes

c) Implications and considerations

2. The Annual Allowance (“AA”)

a) Recap

b) Latest changes

c) Implications and considerations

3. Suggested actions

3

Agenda Item 1a

The Lifetime Allowance - Recap

4

The Lifetime Allowance (LTA) A limit on the pension benefits that can be built up by an individual across

his or her lifetime without being liable for a Lifetime Allowance tax charge.

LTA is currently £1.25 million.

Individuals can earn benefits in excess of the LTA, but they will be subject to a tax charge on any benefits in excess of the LTA.

Total value of benefits Lifetime

Allowance

A tax charge will fall due on these “excess

benefits” Excess

5

How the LTA tax charge is calculated Subject to scheme Rules, excess benefits can be paid as a cash lump sum

rather than pension.

Where excess benefits are paid as a cash sum they will be subject to a 55% tax charge.

If excess benefits are paid as pension they will be subject to a 25% tax charge upfront. They will also be subject to income tax when paid:

– For a member who is a 40% tax payer in retirement the total effective tax rate on excess benefits taken as pension is 1 – (1-25%) * (1-40%) = 55%

Upfront 25% tax charge

Income tax on receipt

6

How benefits are valued against the LTA

Cash lump sum of £300,000 from DB

Scheme

Residual DB pension of

£50,000 p.a.

DC fund of £200,000

Benefit received by member Value on Lifetime Allowance Test

£300,000

£200,000

£1,000,000 £1,500,000

Face Value

Face Value

X 20

+

+

+

+

Defined benefit Defined contribution Each £1 of pension is valued at £20 Funds are taken at market value

Each £1 of cash is valued at face value

7

Agenda Item 1b

The Lifetime Allowance - Most recent changes

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Changes to the Lifetime Allowance

CPI increases from April 2018

“Protection” options are to be introduced for members who were planning on utilising an LTA of £1.25 million. Details are awaited.

-

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

2,000,000

Life

time

Allo

wan

ce (£

)

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Bringing it all together – LTA Example

If excess benefits are taken as cash a tax charge of 55% is due. The Administrator would pay a tax charge of around £275,0001 (55% * £500,000) to

HMRC and £225,5001 (45% * £500,000) to the member.

1The actual mechanics are complex and depend on decisions taken by the Scheme’s Trustees. This is a simplified description and illustration.

Cash lump sum of £300,000 from DB

Scheme

Residual DB pension of

£50,000 p.a.

DC fund of £200,000

Benefit received by member Value on Lifetime Allowance Test

£300,000

£200,000

£1,000,000

Value of £1,500,000 This is £500,000 above the new LTA Unless Protection is held a penal tax charge will fall due on £500,000 of excess benefits

Face Value

X 20

+

+

+

+ Face Value

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Agenda Item 1c

The Lifetime Allowance - Implications

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Who will be impacted by the new LTA? LTA £1 million

DB pension £50,000 p.a. DC pot £1,000,000

A 25 year old with £30,000 salary and 10% contributions (on average) each year until

65*

A pot of £600,000 at age 55 could become:

£1.1 million at age 65 £1.4 million at age 70

with no further contributions*

* Assuming 6% p.a. investment growth

65 year old with salary £100,000 and 30 years

service in a 1/60th scheme

65 year old with salary £150,000 and 20 years

service in a 1/60th scheme

50 year old with deferred pension currently £32,000.

Likely to be worth £1,000,000 by age 65

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Implications Members

Pensions not an efficient way of remunerating

senior employees

Suffer a reduction in benefit expectations

(if impacted)

Need to understand whether impacted or not

(and when)

May take action to reduce the impact:

Take benefits early Maximise tax-free cash Cease accrual Stop paying AVCs Take Protection

(where available)

Trustees Sponsors

The need to make members aware and

answer questions

Operating additional Protection regimes

Updating booklets etc

Money being paid to HMRC as tax could otherwise be used to increase member benefits, increase benefit

security, or reduce company costs

PIE at retirement less attractive to members

(higher initial pension = higher LTA value)

DB to DC transfers unappealing from an LTA

perspective Factors and procedures for paying the tax

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Agenda Item 2a

The Annual Allowance - Recap

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The Annual Allowance (AA) A limit on the pension benefits that can be built up by an individual in any one

year (“Pension Input Period” or “PIP”) without incurring an Annual Allowance tax charge.

AA is currently £40,000. (Although a reduced “Money Purchase Annual Allowance” of £10,000 applies if members “flexibly access” benefits.)

Individuals can earn benefits in excess of the AA, but they will be subject to a tax charge on any benefits in excess of the AA.

Value of benefits

earned in the year “Pension

Input Amount”

Annual Allowance

A tax charge will fall due on this “excess accrual” unless they have sufficient “carry-forward” of unused

Annual Allowance

Excess

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Carry Forward

Carry Forward Unused AA from last 3 tax years can be carried forward

2013/14 AA = £50k PIA = £46k

Unused = £4k

2012/13 AA = £50k PIA = £40k

Unused = £10k

2011/12 AA = £50k PIA = £36k

Unused = £14k

Total carry forward amount into 2014 / 2015 = £28k

Many high earners will already have exhausted their carry forward, but lower paid members who breach the AA due to a promotion could well benefit

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How the AA tax charge is calculated Excess accrual treated as income, and subject to income tax.

Tax charge can either be paid:

by the member (BUT this would be paid out of post-tax income), or

by the pension scheme (in which case the scheme would reduce the member’s benefits by an amount equal in value to the tax due – “Scheme Pays”).

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How benefits are valued against the AA Defined benefit Defined contribution

Step 1 – Calculate the value of benefits at the start of the year/PIP, and allow for inflationary increases over the year (A) = Pension at start of year x 16 x inflationary

increase over the year

Step 2 – Calculate the value of benefits at the end of the year, allowing for additional accrual and salary increases over the year (B) = Pension at end of year x 16 Step 3 – Pension Input Amount = (B) – (A)

Contributions paid (both employee and employer

contributions)

An example of how this works in a DB scheme is shown on the next slide

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Example Member A – (significant promotion) Step 1 - Calculate the value of benefits at the start of the year, and allow for inflationary

increases over the year

Step 2 – Calculate the value of benefits at the end of the year

Step 3 – Pension Input Amount = £470,400 - £395,520 = £74,880

20/50th

(service / accrual) £60,000

(salary)

1.03 (inflation)

Defined Benefit pension of £24,720

21/50th £70,000 Defined Benefit pension of £29,400

Defined Benefit pension of £24,720

16 (valuation factor) Pension value of £395,520

Defined Benefit pension of £29,400 16 Pension value of £470,400

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Example Member B – (high earner, long service) Step 1 - Calculate the value of benefits at the start of the year, and allow for inflationary

increases over the year

Step 2 – Calculate the value of benefits at the end of the year

Step 3 – Pension Input Amount = £1,309,440 - £1,236,000 = £73,440

30/50th £125,000 1.03 Defined Benefit pension of £77,250

31/50th £132,000 Defined Benefit pension of £81,840

Defined Benefit pension of £77,250 16 Pension value of £1,236,000

Defined Benefit pension of £81,840 16 Pension value of £1,309,440

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Agenda Item 2b

The Annual Allowance - Most recent changes

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Changes to the AA (1 of 2) Income

(excluding pension contributions)

Impacted by the

changes? Details of the changes

<£110,000 No No change Annual Allowance remains at £40,000

Between £110,000 and £150,000 Possibly

Need to calculate income including pension contributions (employer and employee)

“Adjusted Income”

If Adjusted Income > £150,000 then £1 of AA is lost for each £2 of Adjusted Income in excess of

£150,000 (AA has a floor of £10,000)

> £150,000 Yes £1 of AA is lost for each £2 of Adjusted Income

in excess of £150,000 (AA has a floor of £10,000)

To calculate Adjusted Income, DB members need to include the Pension Input Amount (as “employer and employee contributions”)

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Changes to the AA (2 of 2)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1300

0013

3000

1360

0013

9000

1420

0014

5000

1480

0015

1000

1540

0015

7000

1600

0016

3000

1660

0016

9000

1720

0017

5000

1780

0018

1000

1840

0018

7000

1900

0019

3000

1960

0019

9000

2020

0020

5000

2080

0021

1000

2140

0021

7000

2200

0022

3000

2260

0022

9000

Annu

al A

llow

ance

(£)

Adjusted Income = Income plus pension contributions (£)

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Example – Revisiting Member B (1 of 2) Step 1 - Calculate the value of benefits at the start of the year, and allow for inflationary

increases over the year

Step 2 – Calculate the value of benefits at the end of the year

Step 3 – Pension Input Amount = £1,309,440 - £1,236,000 = £73,440

30/50th £125,000 1.03 Defined Benefit pension of £77,250

31/50th £132,000 Defined Benefit pension of £81,840

Defined Benefit pension of £77,250 16 Pension value of £1,236,000

Defined Benefit pension of £81,840 16 Pension value of £1,309,440

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Example – Revisiting Member B (2 of 2)

Income £132,000 Pension Input Amount £73,440

Adjusted Income £205,440

Adjusted Income £205,440

Income Threshold £150,000

Adjusted Income over Threshold £55,440

Annual Allowance £40,000

Adjusted Income over Threshold £55,440 / 2

Tapered Annual Allowance £12,280

Pension Input Amount £73,440

Tapered Annual Allowance £12,280 Excess Accrual £61,160

If no carry-forward is available, a tax charge is due on Excess Accrual of £61,160

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Changes to Pension Input Periods

This provides individuals with the opportunity to make additional pension contributions before the reduced allowances come into force

They may be able to pay up to £80,000 plus any available carry-forward in tax year

2015/16

8th July 2015 Start of previous

PIP

5th April 2016

New “mini-PIP” for remainder of 2015/16 tax year

Annual Allowance of up to £40,000 Annual Allowance of up to £40,000

From 5th April 2016, all Pension Input Periods will run in line with the tax year. Transitional provisions have been introduced

PIP open on 8th July 2015

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Agenda Item 2c

The Annual Allowance - Implications

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Implications Members

Pensions not an efficient way of remunerating

senior employees

Suffer a reduction in benefit expectations

(if impacted)

Need to understand whether impacted or not

(and when) – complicated!

May take action to reduce the impact:

Utilise carry-forward Stop paying AVCs Cease accrual

Trustees Sponsors

The need to make members aware and

answer questions

Additional administrative complexity of operating

Scheme Pays

Updating booklets etc

Money being paid to HMRC as tax could otherwise be used to increase member benefits, increase benefit

security, or reduce company costs

Pay rises and promotions can cause unexpected

tax charges (that can be very large)

Additional reporting requirements

Short-term opportunity to pay additional contributions?

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Agenda Item 3

The Annual and Lifetime Allowances - Suggested actions

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Suggested actions Trustees Sponsors

Understand high-level impact: Number of people impacted now, and in the future, in different scenarios Expected amount of tax payable Scope out practical implications and options for this group

Communicate with members

Consider pension strategy for high earners

July / August 2015

Thereafter

Update member booklets and other Scheme documentation as

appropriate

Revisit (or put in place) scheme policy regarding factors to reduce members’ benefits (when paying

tax to HMRC)

Be mindful of the specific tax implications of liability management

exercises for high earners

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Questions ?

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Paul Darlow paul.darlow@xafinityconsulting.com Telephone: 0118 918 5525

Steve Hobbs steven.hobbs@xafinityconsulting.com Telephone: 0118 918 5423

A recording of this webinar (together with a copy of these slides and Q&A document) will be made available on www.xafinity.com shortly – we will email you when available

Your usual Xafinity consultant would be delighted to answer any supplementary questions

Or please feel free to contact one of us

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