Complex draft pension tax rules highlights the importance of free, impartial guidance, says expert

HM Revenue and Customs (HMRC) is running a technical consultation on the draft Taxation of Pensions Bill and accompanying guidance until 3 September 2014. Once approved, the new legislation would introduce the necessary changes to allow those aged 55 or over access to their defined contribution (DC) pension savings in whatever form that they wish without having to purchase an annuity, subject to their marginal rate of income tax.

Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that the draft legislation was complex by necessity, as the government needed to reduce the risk of tax avoidance resulting from misuse of the new flexibilities.  The draft legislation introduces a 'money purchase annual allowance' of £10,000 that will apply once an individual takes advantage of the new flexibilities.  It will limit the amount of tax relief the individual will be able to claim in respect of any further contributions to a DC pension scheme.  The overall annual allowance of £40,000 will continue to apply to combined DC and defined benefit (DB) pension savings.

"One loophole that some commentators have been anxious about is opened up by the new flexibility that will be available for annuities," he said. "At the moment, a tax penalty applies if an annuity bought using DC savings is reduced; but from April 2015, annuities can be reduced without penalty."

"As annuities do not trigger the new £10,000 money purchase annual allowance, individuals could potentially avoid that low annual allowance by buying an annuity that pays a large sum up front, followed by a series of only nominal payments for the lifetime of the individual. However, any such front-loaded annuities are likely to be caught by the General Anti-Abuse Rule and Disclosure of Tax Avoidance Schemes rules," he said.

As announced by the chancellor of the exchequer as part of this year's Budget, the new pensions regime is due to come into force in April 2015. It will give members of DC pension schemes more flexibility to access their savings as they choose, and will be backed by a right to free independent guidance at the point of retirement.

Once in force, the new regime will continue to allow savers to take up to a quarter of the value of their pension pot tax-free on retirement.  Any additional lump sum or pension will be taxed at their normal marginal tax rate. Instead of buying an annuity, savers would be able to keep their pension invested and access the balance over time.

According to a policy impact document published by HMRC, an estimated 130,000 DC savers each year will take advantage of the new arrangements once they come into force. The rest are expected to take out a traditional annuity or another form of retirement product, or to leave their savings in their pension pot to be reinvested.

The draft legislation reveals that DC schemes will be able to pay an 'uncrystallised funds pension lump sum' under the new regime, which will be a simplified, one-off lump sum form of drawdown.  The new money purchase annual allowance of £10,000 will apply if such a sum is paid, as well as if the member enters the new flexible form of drawdown ('flexi-access drawdown').

"Commentators have widely welcomed the new flexibilities that will be available to pension savers from next year, but now that some more of the detail is out things are looking more complicated," said pensions expert Simon Tyler. "Accessing the new flexibilities will come at a cost: an annual allowance for DC pension savings of £10,000 instead of £40,000. And one of the current forms of drawdown, capped drawdown - which will keep individuals outside the new £10,000 annual allowance - will continue to run alongside the new 'flexi-access' drawdown. This complexity will make it more difficult for individuals to reach appropriate decisions about their pension savings."

"Many DC pension schemes will be reluctant to introduce full flexi-access drawdown because of the administrative complexity, but payment of the new 'uncrystallised funds pension lump sum' will be relatively straightforward and we expect most DC schemes to allow it. The downside is that this development may encourage more members to cash out their pension savings, rather than draw them down gradually over time. Members may prefer the simplicity of this one-off payment to a transfer to another scheme offering flexi-access drawdown," he said.

Tyler said that the complexity of the new arrangements highlighted the importance of access to the free impartial guidance that will be made available alongside the new regime, and also to good-quality financial advice paid for by the pension scheme member.