TECHTALK JANUARY 2017 – ISSUE 1 – VOLUME 16
EDITOR Sandra Hogg Sandra is the senior tax manager within Scottish Widows with 17 years of hands on experience dealing with HMRC and advising owner managed businesses as an accountant and tax adviser. She also has over 18 years insurance industry experience as a financial planning expert within the group. She represents Scottish Widows at industry forums and at the ABI’s Life Insurance Product Tax Panel and is Scottish Widows’ expert spokesperson on Tax and Financial Planning.
CONTRIBUTORS
CONTENTS
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Jeremy Branton Jeremy has over 25 years experience working for financial services providers in a number of technical and advisory roles in life, pensions and protection. Having joined the group in 2006 he now specialises in corporate pensions, with particular focus on pensions reform.
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Chris Jones Chris joined the group in 1996. He’s worked in a number of technical roles in marketing, product development and technical support. After many years specialising in life and investment products his recent focus has been on the new pension reforms.
Bernadette Lewis Bernadette joined the group in 2006. She has over 35 years experience in Financial Services with both intermediaries and providers. She has broad and deep technical experience across pensions, protection, tax and trusts.
Johnny Timpson Johnny Timpson is Scottish Widows’ protection specialist. Johnny is a member of the Income Protection Task Force, a member of the IPTF Welfare Working Group and is also a member of the Seven Families initiative project team. He is also a member of the ABI Protection committee, the CII Insuring Women's Futures Programme and chair of TISA's Consumer Protection Policy Council.
Mat Zimmerman Mat joined the Group in 2012 and has worked in a variety of marketing and operational roles. He currently works in corporate pensions, with a focus on our industry research and engaging employees with long-term saving.
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Chris Jones The recent increases in cash equivalent transfer values, coupled with further reductions in the lifetime allowance, mean the lifetime allowance charge adds a further complication to many defined benefit transfer decisions. Can pension freedoms help?
BARE BONES: THE MONEY PURCHASE ANNUAL ALLOWANCE Thomas Coughlan A detailed look at the money purchase annual allowance following announcement of the forthcoming reduction in April 2017.
WORKPLACE PENSIONS REPORT 2016: ONE IN TEN OPT-OUTS POINT TO EMPLOYER INFLUENCE Mat Zimmerman Our Workplace Pensions Report shows that some employers need to be more aware of their automatic enrolment responsibilities concerning opt outs.
Thomas Coughlan Tom has spent over 15 years in technical roles. He has wide experience including the provision of technical support to financial advisers covering life, pensions and investment compliance. He currently specialises in pension planning.
DEFINED BENEFIT TRANSFERS AND THE LIFETIME ALLOWANCE
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A GAME CHANGER? THE WORK, HEALTH AND DISABILITY GREEN PAPER Johnny Timpson A look at the Government’s green paper with a focus on its group/worksite income protection proposals.
PENSIONS – NOT FOR RECYCLING Chris Jones The planned reduction in the money purchase annual allowance confirmed the Government are not happy to allow significant recycling of pension income but what about tax free cash?
ARE MILLENNIALS UNDERVALUING PENSIONS IN FAVOUR OF CASH SAVINGS? Mat Zimmerman A majority of younger people expect to rely on cash savings for retirement – but how realistic is this?
LESS OF A BENEFIT: SALARY SACRIFICE CHANGES Bernadette Lewis Autumn Statement proposals will end tax and NI savings on many benefits in kind provided via salary sacrifice. We explain the consequences for some key benefits.
NATIONAL INSURANCE REFORM – SUMMARY OF THE CHANGES Jeremy Branton A round up of the NI changes announced in the Autumn Statement, including those linked to the self-employed and redundancy payments.
WELCOME TO THE JANUARY 2017 EDITION OF TECHTALK Welcome to the January 2017 edition of Techtalk. In this bumper edition we’ve included our in depth analysis of the impacts of the recent Autumn Statement as well as a broad range of topical subjects and specialist planning considerations. Tom takes a detailed look at the money purchase annual allowance following the Autumn Statement announcement of its proposed reduction in April 2017. And Chris considers more widely the Government’s view of pension recycling including using tax free cash. Bernadette explains the consequences of the Autumn Statement proposals to end tax and national insurance savings on many benefits in kind provided via salary sacrifice, from April 2017, focussing on the potential impacts for some key benefits. And Jeremy rounds up the national insurance changes announced in the Autumn Statement, including those linked to the selfemployed and redundancy payments.
2016 has certainly been a momentous year full of change on the political front, and of course a lot of uncertainty remains as we move forward into a new era outside of the EU. In our Techtalk editions throughout the last year we have tried to help you by covering off all of the legislative changes that could impact your clients. Looking forward, may I wish you a happy and successful New Year! With the Greens topping the table at Christmas, for the second year in a row, my wish for 2017 is that we forge on and achieve a long awaited promotion out of League Two! I hope you’ll find this is a useful addition to your technical library. We will of course endeavour to remain a constant source of support through whatever changes 2017 may bring. Enjoy the read.
Sandra Hogg
Chris also highlights an issue with the lifetime allowance charge that has gained increased significance with recent increases in cash equivalent transfer values and he looks at how the pension freedoms may help. I’m pleased to welcome back our protection specialist, Johnny Timpson, as a guest author for this edition. Johnny reviews the group income protection proposals in the Government’s recent green paper on Work, health and disability. And we welcome a new guest author from our Corporate Propositions team, Mat Zimmerman. Mat explores some important findings from the 2016 Scottish Widows Workplace Pensions Report, looking at what it revealed in two key areas of retirement planning: the savings expectations of 18-29 year olds; and the concerning number of workers who have said they opted out of their workplace pension scheme because their employer encouraged them to do so.
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DEFINED BENEFIT TRANSFERS AND THE LIFETIME ALLOWANCE Chris Jones
The recent increases in cash equivalent transfer values, coupled with further reductions in the lifetime allowance, mean the lifetime allowance charge adds a further complication to many defined benefit transfer decisions. Can pension freedoms help?
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Following the outcome of the referendum on membership of the EU, the cash equivalent transfer values for many defined benefit (DB) scheme members increased significantly. Some had already been tempted to consider a transfer to access the pension freedoms available within defined contribution (DC) schemes since April 2015 and increases in transfer values have sparked further interest. However, the way the different types of schemes are treated for lifetime allowance (LTA) purposes varies significantly and can lead to unexpected tax charges. With DB schemes, benefits are normally valued at a fixed factor of 20 times the first year’s annual pension at the time the benefits are taken, plus any tax free cash. (It’s technically possible for the scheme administrators to agree a higher figure than 20 with HMRC.) There is only one LTA test and usually no further test for any annual increases in payments. Example Alex is about to take benefits from his DB scheme. His annual pension in year one will be £25,000 and he’ll receive a tax free lump sum of £100,000. The value of the benefits for LTA purposes is: £25,000 X 20 + £100,000 = £600,000. This will use up 60% of the current LTA of £1m. For LTA purposes, DC schemes are tested at the monetary value of the fund crystallised. Where benefits are moved into drawdown they also face a second test on annuity purchase or at age 75, whichever is sooner. This tests any growth since the first crystallisation.
CASE STUDY In January 2017 Denise is aged 55 with 30 years’ service in a 60ths DB scheme. Her salary is £80,000. She hopes to retire in five years’ time. She is considering transferring her benefits to a DC scheme and has been offered a transfer value of £1,200,000. Currently within the DB scheme her accrued pension is 30/60 X £80,000 = £40,000. So the value for LTA purposes is £40,000 X 20 = £800,000. This is well within the current LTA. Even if Denise remains in the scheme until her planned retirement date she should still be within the LTA. She may also have scope to reduce this amount if she commutes some of her pension for tax free cash. If she transfers to a DC scheme Denise may have an immediate LTA problem. The transfer value of £1,200,000 exceeds the current LTA by £200,000. If she were to take all her benefits immediately, the excess would be subject to a LTA charge of 55% if taken as a lump sum or 25% if used to provide an income. In addition, further funding will also be subject to a LTA charge. So further personal contributions are unlikely to be beneficial. Employers may be willing to offer an alternative to pension contributions but many will not. Employer contributions may also be conditional on her making personal contributions. All these factors need to be weighed up in the transfer decision.
CAN TRANSITIONAL PROTECTION HELP? Unfortunately in this situation neither Individual Protection or Fixed Protection will be able to help Denise. As she’s currently still an active member of the DB scheme she will have received benefit accrual since April 2016. This means she is not eligible to apply for Fixed Protection 2016. For Individual Protection 2016 purposes her benefits must be valued as at 5th April 2016 and this must be on the DB valuation basis. This means although the value of benefits post transfer is well in excess of £1m, it will be less than £1m as at 5th April 2016 and she won’t be eligible to apply for Individual Protection 2016.
CAN PENSION FREEDOMS HELP? One of the key reasons for considering a DB to DC transfer will be to access the fully flexible retirement options the DC regime offers. The full flexibility of the DC regime provides some scope to limit or delay the amount of LTA charge in addition to other planning opportunities. Denise could, for example, crystallise some of the funds immediately and move into drawdown. This can limit the growth of the fund for LTA purposes as long as enough income is withdrawn to avoid a further charge at age 75 or earlier annuity purchase. As there are no limits on the amount of income that can be withdrawn it is possible to fully control the value at the point of the second LTA test. Of course any income taken will be subject to income tax. However, if she plans to take the funds at some point, income tax on withdrawals will normally be favourable compared to income tax plus the 25% LTA charge or the flat 55% charge. Another possible option is that she could crystallise up to the LTA at age 60. This would avoid an LTA charge until age 75 on the excess. Yet another possible alternative would be to just take what she needs at age 60 each year in the hope that the LTA will increase faster than the funds grow or possibly even be removed altogether. If Denise has no need for the funds in excess of the LTA then she can consider leaving this inside the pension regime. Although she will have to pay the LTA charge of 25% at age 75, the funds will remain outside of her estate. If she dies post age 75 the ultimate beneficiaries will have to pay income tax on the benefits but this may be preferable to her paying income tax on the income and inheritance tax on any funds that remain in her estate. Denise could also make use of the small pots regime to take up to £30,000 without these being tested for LTA purposes. The flexibility of the DC regime offers many options but the markedly different valuations of pension benefits for LTA purposes adds yet another layer of complexity to the transfer decision.
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BARE BONES: THE MONEY PURCHASE ANNUAL ALLOWANCE Thomas Coughlan
To counter possible abuse of the recently introduced pension freedoms, the money purchase annual allowance (MPAA) was established. This was effective from 6th April 2015 and was initially set at £10,000. The Government’s current view is that this does not limit the scope for tax avoidance to a satisfactory level, so it will be reduced to £4,000 from 6th April 2017. Although the precise amount will be subject to consultation. It is clear from the proposed limit that the objective is to set the allowance at the lowest possible level without compromising automatic enrolment policy.
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Since 6th April 2015, it has been possible to access money purchase pension savings in their entirety under the ‘Freedom & Choice’ reforms. Access isn’t entirely unfettered though, as full vesting will result in the fund value apart from the tax-free cash being subject to income tax at a rate that will most likely be higher than the member usually pays. This option to take unlimited amounts of a pension fund with 25% paid tax-free opened up an opportunity to avoid a significant amount of tax on employment income. The opportunity is a simple one: some or all of an employee’s salary is diverted to their personal pension as an employer contribution. If they are over 55 they can withdraw the full amount as tax-free cash and flexi-access drawdown. Or, they could receive an uncrystallised funds pension lump sum (UFPLS). In either case, 25% would avoid income tax, and the full amount would avoid national insurance deductions. The following example demonstrates the potential tax saving. Example An employee (age 60) receives a salary of £90,000. The top £40,000 of this payment sits entirely within the 40% income tax band and 2% national insurance band. The total tax on this £40,000 segment of salary is: £40,000 x 40% = £16,000 £40,000 x 2% = £800 Total = £16,800 If this £40,000 was, instead, paid as an employer pension contribution to a personal pension and withdrawn immediately as a UFPLS, the tax would be: £40,000 x 75% x 40% = £12,000
This is a tax reduction of £4,800, which would otherwise be achievable with few drawbacks for over 55s, save a small amount of paperwork. The employer would also save 13.8% employer national insurance. The MPAA rules effectively allow this approach to use the full annual allowance and carry forward just once. The receipt of flexible income in this example means that subsequent attempts at this kind of tax avoidance are limited because the MPAA restricts what can then be paid in, including employer pension contributions. Subsequent contributions in excess of the MPAA give rise to an annual allowance excess and tax charge at the member’s marginal rate of tax, even if the full standard annual allowance has not been exceeded. So only contributions within the MPAA will reduce tax on employment income in this way. The next example shows the potential tax saving within the limit of the forthcoming MPAA.
Example In a later tax year, the employee in the example above wishes to divert up to the MPAA into his pension via an employer pension contributions. This will be £4,000 of his £90,000 salary, which sits entirely within the 40% income tax band and 2% national insurance band. The tax on this £4,000 segment of salary is: £4,000 x 40% = £1,600 £4,000 x 2% = £80 Total = £1,680 If this £4,000 was, instead, paid as an employer pension contribution to a personal pension and withdrawn immediately as a UFPLS, the tax would be: £4,000 x 75% x 40% = £1,200
This tax reduction for this employee is limited to £480, along with some savings in employer national insurance. An employee with income sitting entirely within the 20% income tax band and 12% national insurance could still save up to £680. Whilst the new limit of £4,000 from 2016/2017 allows some scope to reduce tax, the reality for many individuals will be that they are already close to or above this limit, in which case further savings will not be available. To limit this kind of tax avoidance appears to be the main intention of reducing the MPAA. In doing so, recycling of pension income and tax-free cash, to artificially inflate the fund value, are also restricted. This is discussed in more detail in Chris Jones’ article, ‘Pensions - not for recycling’ in this edition of Techtalk.
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WHAT TRIGGERS THE MONEY PURCHASE ANNUAL ALLOWANCE? As the MPAA was introduced in response to Freedom & Choice, it is any access to pensions under these reforms from 6th April 2015 that triggers it, as well as access to flexible drawdown before then. The events that trigger the MPAA are:
• being a flexible drawdown member prior to 6th April 2015, • receipt of flexi-access drawdown income, • receipt of income from a capped drawdown contract in excess of the maximum income limit after 5th April 2015, • receipt of an uncrystallised funds pension lump sum, • receipt of a stand-alone lump sum by a member under the primary protection rules, • accessing a flexible annuity, • receipt of a payment from a scheme pension with fewer than 12 members that was set up after 5th April 2015, • certain payments from overseas pensions. The MPAA applies from the day after the trigger event, with the exception of pre-6th April 2015 flexible drawdown, which invoked the restricted allowance immediately from 6th April 2015.
WHAT DOES NOT TRIGGER THE MONEY PURCHASE ANNUAL ALLOWANCE? Those wishing to avoid being restricted by the MPAA can usually do so simply by avoiding the trigger events above, but anyone who has previously set up flexible drawdown does not have this choice – they will be subject to the MPAA. The following events do not trigger the MPAA:
• receipt of a pension commencement lump sum, • an individual commences flexi-access drawdown, either by a new designation or through conversion of a capped drawdown contract, and does not receive any income,
• an individual holds a capped drawdown contract that was set up before 6th April 2015, and does not receive income above the maximum income limit for the contract after 5th April 2015,
• receipt of payment from a standard lifetime annuity or scheme pension, • receipt of a small lump sum or trivial commutation lump sum, • receipt of income from a dependant’s drawdown contract.
WHAT HAPPENS WHEN THE MPAA IS TRIGGERED? The restricted allowance applies from the day after the trigger event, and once triggered it applies for the rest of the tax year and each subsequent year. Perhaps most importantly it is not contract-specific: if it applies, it covers all of a client’s money purchase arrangements. If contributions exceed £10,000 in 2016/2017 or £4,000 in tax years from 2017/2018 onwards this will result in an annual allowance excess, with no option to carry forward from earlier years. The remainder of the standard annual allowance – called the ‘alternative annual allowance’ – can be used to accrue defined benefits, to which carry forward can be added. To determine any tax charge arising as a result of the MPAA applying, there are two basic situations to consider: where money purchase contributions exceed the MPAA; and where they do not. We’ll look at the former, first.
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After the trigger, money purchase contributions exceed the MPAA: – Hywel received a UFPLS payment on 1st May 2016 triggering the £10,000 MPAA from 2nd May 2016. – Having paid no money purchase contributions in the tax year before 2nd May 2016 he pays £15,000 to a personal pension on 1st September 2016. – Over the tax year he accrues £41,000 in a defined benefit scheme. – Hywel has carry forward available of £13,000. Where the MPAA is exceeded, the calculation required is as follows: 1. Work out the excess above the MPAA. 2. Work out the excess of DB accrual over the £30,000 alternative annual allowance plus carry forward. 3. Add these two excesses together. 4. Compare this result with the excess against the standard annual allowance. 5. Take the higher of the two excesses calculated
The calculation of the annual allowance excess for Hywel is as follows: 1. Excess over the MPAA: £15,000 - £10,000 = £5,000 2. Excess over alternative allowance: £41,000 – (£30,000 + £13,000) = £nil 3. Total excess: £5,000 + £nil = £5,000 4. Excess over standard allowance: £56,000 – (£40,000 + £13,000) = £3,000 5. Take highest excess: £5,000 Hywel’s annual allowance tax charge will be based on £5,000. This will be added to his income and taxed at a rate which depends on the income tax band it falls in.
After the trigger, money purchase contributions do not exceed the MPAA: – If instead, Hywel had only paid £5,000 in money purchase contributions in the tax year after the trigger event, the calculation would be much simpler. Where the MPAA is not exceeded, the standard annual allowance calculation is used: 1. Work out the total pension input for the tax year. 2. Deduct the total annual allowance plus carry forward. The calculation of the annual allowance excess for Hywel is as follows: 1. The total pension input: £5,000 + £41,000 = £46,000 2. Deduct the total annual allowance: £46,000 – (£40,000 + £13,000) = £nil. In this case, Hywel does not have an annual allowance excess as the amount in excess of the standard annual allowance for the tax year is covered by carried forward allowances.
The trigger event will, in the vast majority of cases, occur part way through a tax year. As it is only money purchase contributions after this that are tested against the MPAA, that year must be apportioned. Contributions that were paid before the trigger are tested against the alternative annual allowance along with defined benefit accrual; all other contributions are tested against the MPAA. For instance, a monthly contribution to a group personal pension of £1,000 gross paid by a member who triggers the MPAA half way through the tax year will have the following annual allowance test: £6,000 tested against the MPAA; £6,000 tested against the alternative annual allowance. Subsequent tax years are much simpler because the MPAA applies for the whole year.
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PLANNING There is very little scope for planning with the MPAA, save avoiding the triggers discussed in this article. Clients who can do that will, assuming they are not caught by the tapered annual allowance, continue to benefit from the full £40,000 annual allowance plus carry forward. Access to pension funds is still available via standard annuities, most scheme pensions, capped drawdown and small lump sums. Where suitable, these options should be exhausted first, to enable continued money purchase contributions. Those that wish to access – or through necessity, must access – their pension flexibly under the pension freedoms will have little choice but to keep subsequent pension input to money purchase arrangements within the limit. A reduction to £4,000 offers very limited to scope to build up significant pension benefits without triggering a tax charge.
THE INTERACTION WITH THE TAPERED ANNUAL ALLOWANCE Where both the MPAA and the tapered annual allowance apply, the MPAA applies in the usual way. The tapering only applies to the alternative annual allowance. In 2016/2017 the MPAA and minimum tapered annual allowance are both £10,000, which means that the alternative annual allowance can be tapered away to nothing, leaving only the MPAA. However, carry forward from earlier years can still be used to cover defined benefit accrual and/ or money purchase contributions before the trigger event. From 2017/2018, when the MPAA is reduced to £4,000 or whatever level is decided after consultation, there will always be some alternative annual allowance available, but the interaction will otherwise work in the same way.
A sensible approach for those who are planning to access their benefits soon, is to pay the maximum allowance using carry forward, allowing a contribution of up to £170,000. The Scottish Widows carry forward calculator on the Adviser Extranet can help you calculate the maximum contribution for a given client.
SCHEME PAYS An annual allowance as low as £4,000 is bound to result in many more scheme members having to pay an excess tax charge. As the rules stand currently, most will have to pay this direct to HM Revenue & Customs after the end of the tax year. The reason for this is that the scheme can only be required to deduct the tax charge from the member’s fund if the total tax is at least £2,000 and the total savings to the scheme in the tax year exceed the standard £40,000 allowance. This misalignment between the MPAA – not to mention the tapered annual allowance – and the scheme pays conditions may motivate the Government to revisit these rules, but there is no sign of any change at the time of writing.
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WORKPLACE PENSIONS REPORT 2016: ONE IN TEN OPT-OUTS POINT TO EMPLOYER INFLUENCE Mat Zimmerman
A concerning number of workers have said they opted out of their workplace pension scheme because their employer encouraged them to do so. Employers need to be made aware of their responsibilities under automatic enrolment and should carefully consider how conversations may be perceived by their employees. Research for this year’s Scottish Widows’ Workplace Pensions Report revealed some really positive insights: only 3% of people said they intend to opt-out when minimum contributions go up, fewer people are failing to save for retirement and there are clear opportunities to better engage younger workers. But there is cause for concern after we examined the reasons people gave for opting out of their workplace pension scheme. Unsurprisingly, affordability is the most commonly cited reason, but strikingly, 9% said their employer encouraged them to opt out. This seems to be more prevalent in smaller workforces (fewer than 50 employees), where the figure rises to 14%. The rules for employers are very clear and noncompliance can lead to fines or criminal prosecution. In fact, the notices that employees submit in the process of opting out must always include a statement explaining that employers cannot ask or force people to opt out. The smallest employers that are yet to stage should take note, as should organisations going through reenrolment. The Pensions Regulator (TPR) has already issued over 7,000 fixed or escalating penalty notices for non-compliance with automatic enrolment rules.
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There’s certainly a strong chance that some of this is unintentional – employers may not be aware that they’re dissuading members from saving for retirement. For that reason, it’s important to consider communications (conversations in particular) carefully. However employers shouldn’t shy away from talking about pensions. In addition to mandatory communications, there is a huge amount of value in providing more information on the scheme and on saving for the long-term generally. Workers will have questions too, and will expect their employer to at the very least be able to point them in the right direction. Advisers and employers can play a big role here, whether it’s giving specific, tailored advice or guidance to individuals, or providing generic content to the whole workforce.
TPR also has guidance for employers, explaining what they can and can’t say about a pension scheme: www.thepensionsregulator.gov.uk/employers/ communicating-with-your-scheme-members The recent Financial Advice Market Review recognised some employers feel it is unclear where the line is drawn between general support for employees and regulated advice, and recommended that the Financial Conduct Authority (FCA) and TPR give greater clarity on what employers can or can’t say without being subject to regulation. While this is being developed, advisers and pension providers are well placed to help and guide employers to support their employees in the most appropriate way.
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A GAME CHANGER? THE WORK, HEALTH AND DISABILITY GREEN PAPER Johnny Timpson
The Government’s ‘Work, health and disability’ green paper is a potential game changer.
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The Government released a joint Department of Work and Pensions and Department of Health green paper in November 2016 which focuses on how more employers, especially SMEs and micro-businesses, can get on board with group/worksite income protection. It is also consulting with the insurance industry on closing the protection gap for individuals. The report, called ‘Work, health and disability: improving lives’, has called on the insurance industry to develop affordable group/worksite income protection products for smaller firms and the Government’s primary focus is said to be keeping people engaged with the workplace and improving physical, mental and financial health and resilience. In my view, this is a game changer. The green paper, which specifically asks about the role of insurance, is set to change the shape of workplace and individual support provision. As a result, protection solutions will also change, particularly health improvement incentives, helping hand support service and rehabilitation intervention. The consultation and engagement with the industry is very welcome. Our own research makes the position very clear, with fewer than one in ten people in the UK having critical illness insurance, and only a third having life cover. As a result, there are an alarming number of families who could face a significant financial struggle in the event of an unexpected loss of income due to serious illness or disability. Mortgage-holders are particularly vulnerable, particularly given the reforms to Support for Mortgage Interest Benefit and the working age household benefit cap that are underway. Many are at risk of hardship or losing their home and/or lifestyle if they were to suffer a life-changing or life-limiting health event.
We now have a debate between the Government, health insurers, health charities and employers which will bring this issue to the fore and provide us with the opportunity to bring about important change. Hopefully it will also create a collaborative financial protection industry relationship with working age welfare, which rewards the appropriate steps that households need to take to improve their financial resilience. I’d like to see the development of simpler life, income protection and critical illness menu plans to make things easier for consumers, along with much better use of language. The term ‘income protection’, for example, is often seen as too ambiguous and is mistaken for the much-maligned ‘payment protection insurance’. We also need to take a hard look at the current design of the advice/guidance process and product solutions to ensure that they meet the needs of our ageing population who are working and borrowing into later life. The growing number of consumers who have a portfolio of jobs and practice agile working are making annual reviews, flexibility, communication and portability increasingly important. There could also be a role for having a quasi-income protection and critical illness mortgage product given the changes to Support for Mortgage Interest Benefit and its replacement by the Housing Element of Universal Credit and accompanying ‘no earnings’ rule. The priority should be putting clients in an informed position so they understand how much support the state and their employer will give them if they are unable to work due to a health issue. At a time when welfare reform is resulting in significant changes to benefits, families need to take appropriate financial advice to protect themselves in the event that the unexpected happens and they are at risk of being underserved by state and/or occupational benefits. The Government is seeking views on the report, with the consultation closing on 17th February 2017.
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PENSIONS – NOT FOR RECYCLING Chris Jones
The planned reduction in the Money Purchase Annual Allowance confirmed the Government are not happy to allow significant recycling of pension income but what about tax free cash? RECYCLING INCOME Until the introduction of the Money Purchase Annual Allowance (MPAA) as part of the Pension Freedoms reforms in April 2015, there were no specific regulations restricting the recycling of pension income. The ability to re-invest pension income was limited simply by the fact that it does not qualify as relevant UK earnings. So contributions would be limited to either the client’s other relevant earnings or £3,600 if higher.
Example
Pension income could be re-invested immediately. The tax relief on the contribution cancels out the tax paid on the withdrawal. The amount re-invested would then benefit from a further 25% tax free cash.
If he immediately reinvests the £8,000 into a personal pension, the provider adds 20% tax relief. This brings it back to £10,000.
Toby is aged 55 and a basic rate tax payer. He earns £20,000 a year and takes £10,000 income from his flexi-access drawdown fund. The drawdown income is subject to 20% tax and so he receives £8,000.
If Toby now withdraws the £10,000, 25% is free of tax and the remaining £7,500 is subject to 20% tax ie £1,500. He now receives a net £8,500 instead of £8,000. The savings will of course be greater for higher rate and additional rate taxpayers.
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When pension freedoms were introduced allowing full flexibility to withdraw income, it was feared that those aged 55 or over could divert most or all of their income in this way. If this was done via salary sacrifice the savings would be far greater as both employers and employees could pay less national insurance. The MPAA was introduced to restrict this. Where a client exceeds the MPAA they are subject to an annual allowance charge which effectively claws back the tax relief received on the contribution. Tom Coughlan’s article, ‘Bare bones: the money purchase annual allowance’ looks at the MPAA and the planned reduction in detail. Those in receipt of other pension income eg defined benefit pensions, continue to be free to recycle that income subject to their level of relevant earnings or £3,600 if higher.
RECYCLING OF TAX FREE CASH (TFC ) Recycling of TFC cash is potentially a far more serious issue. It is one of the specific situations where HMRC may apply an unauthorised payment charge. This can mean that instead of receiving a tax free lump sum the individual can be subject to a charge of 55%. So it’s very important that clients don’t fall foul of this rule. Thankfully the application of the charge is rare. HMRC guidance is reassuring in that it states ‘It should be noted that very few lump sum payments will be affected by this recycling rule. Pension commencement lump sum payments will not be caught if they are paid as part of an individual’s normal retirement planning.’ When could it apply? For the TFC recycling rule to bite, all four conditions listed below must apply: 1. The TFC payment, plus any other TFC payments in the previous 12 months must exceed £7,500. 2. The total of any additional contributions must exceed 30% of the TFC in the 2 tax years before or after receipt of the TFC. 3. The additional contributions must exceed 30%* of the original ‘normal’ pattern of contributions. 4. The use of TFC to pay any additional pension contributions must be pre-planned. Condition 1 is straightforward and will apply in many cases. Crystallising funds of more than £30,000 in any 12 month period and taking 25% TFC will mean that condition one applies. Conditions 2 and 3 rely on the interpretation of the normal contribution levels. It’s possible for normal contributions to vary from year to year as long as the basis doesn’t change. For example, where someone pays a percentage of their selfemployed profits but profits fluctuate considerably from year to year. Also, any increase that is unrelated to the TFC payment eg increases due to automatic enrolment minimums, should not cause any issues.
*HMRC guidance refers to a ‘significant increase’ in contributions. However they accept that as a rule of thumb this doesn’t occur unless the additional contributions are more than 30% of contributions that might otherwise have been expected. Condition 4 is really the key one. Often clients making significant contributions will fall foul of the first three conditions and it then comes down to whether or not the contributions were pre-planned. Pre-planning applies where the client makes a conscious decision to take their TFC and use it to, either directly or indirectly, make increased pension contributions. It doesn’t matter whether the increased contributions are made before or after the TFC is paid. The key is the intention. For example, if a client made the increased contributions from their other savings but with the intention to replace those savings with their TFC payment, this could be seen as pre-planning. On the other hand if someone took their TFC and shortly afterwards received an inheritance and subsequently decided to increase the contributions due to the inheritance, this should not be seen as pre-planned. HMRC guidance again provides clients with some comfort stating ‘The onus is not on that individual to prove the absence of the intention to use the lump sum to pay the significantly greater contributions when the lump sum was taken. Instead, the onus is on HMRC to show that preplanning took place.’ HRMC guidance in the Pension Taxation Manual also sets out further examples to illustrate when the recycling rule does and doesn’t apply. See https://www.gov.uk/hmrc-internal-manuals/pensions-taxmanual/ptm133850 https://www.gov.uk/hmrc-internal-manuals/pensions-taxmanual/ptm133860 What is very clear is the need for advice. The price of clients getting this wrong, if they are not aware of the recycling rules is extremely high, with a 55% tax charge. Key points
• The MPAA is the only specific legislative measure aimed at preventing income recycling.
• Tax free cash recycling can lead to an unauthorised payment charge of 55%.
• However, this only applies if all four of the recycling conditions are met.
• The key condition is that the recycling must be preplanned.
• HMRC expects that very few clients will be subject to the recycling rules and it should not affect normal retirement planning.
• It is very important that clients who have taken or are taking a lump sum and want to increase pension contributions seek financial advice before doing so.
The key to these conditions is that the contribution increase must be because of the tax free lump sum payment rather than any other reason.
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ARE MILLENNIALS UNDERVALUING PENSIONS IN FAVOUR OF CASH SAVINGS? Mat Zimmerman
Scottish Widows’ Workplace Pensions Report revealed that more than half of 18-29 year-olds expect cash savings, including cash ISAs to help them with a reasonable standard of living in retirement. But is that realistic? Many younger people could be missing out if they’re not making the most of workplace pensions. People expect to call on a range of sources in retirement, but there’s a clear generational split in what people expect to rely on. Property (34%) and cash savings (51%) ranked much higher for those aged 18-29 than for older groups. Only a quarter of those aged 30-64 expect to be able to rely on property and just over a third (36%) on cash savings. Instead, older workers are more likely to have higher expectations for the state pension and workplace pensions. That aspect isn’t particularly surprising; older workers will be less impacted by the changes to the state pension age and have had better opportunity to take advantage of generous defined benefit schemes, many of which have since closed. But, in spite of this, for long-term saving, the confidence younger people are putting in cash savings could be misplaced. Whatever your definition of a comfortable retirement, most people will need total assets or savings running into hundreds of thousands of pounds. The average amount people say they save for retirement, outside of pensions or property is just £150 per month across all ages, and less than £100 for those under 30. Importantly, this money isn’t necessarily locked away for later life and may be accessed for short-term needs. With a workplace pension, employer contributions, favourable tax treatment and investment growth all work together to give workers the best chance to save the considerable sum required. Cash savings have alternative merits, including easy access, but that doesn’t lend itself to saving for the long-term, where holding back any spending temptation is advantageous.
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Recent Government changes have made ISAs, including cash ISAs more attractive. Along with the introduction of automatic enrolment and the upcoming introduction of the lifetime ISA (LISA), this has formed a real push towards a savings culture in the UK. But the role for both Government and the industry is to help people understand how different products meet different needs. ISAs are well suited to short or mediumterm goals, where easy access is important and the tax treatment can add some extra value. But when it comes to saving for retirement, there are features of workplace pensions that can’t be replicated in other products.
While the LISA will share some similar benefits with workplace pensions (although significantly, not the employer contributions), the Financial Conduct Authority (FCA) recently flagged a risk that customers may not be invested appropriately – especially if savings which are initially earmarked for a property purchase are then to be used for retirement. Without an employer/ adviser-chosen default investment strategy, customers will need some understanding of which asset classes are most appropriate for long-term saving. All of these challenges point to the need for education and, where appropriate, tailored guidance or advice. Employers will be able to support this by making educational material accessible in the workplace. This will be particularly beneficial when the content goes beyond the workplace pension and explains how various products work together to support short and long-term financial wellbeing. Pension providers and advisers should be expected to support this.
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LESS OF A BENEFIT: SALARY SACRIFICE CHANGES Bernadette Lewis
Legislation proposed in the Autumn Statement will end the current income tax and employer national insurance savings linked to many benefits in kind when provided via salary sacrifice. The good news is that pension funding is excluded. We explain the consequences for some other key benefits.
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BACKGROUND In the recent Autumn Statement, the Chancellor confirmed the Government’s intention to include legislation in Finance Bill 2017 to remove the tax and employer national insurance (NI) advantages of most salary sacrifice, subject to grandfathering provisions and some exemptions. The Government first expressed concern about the rising costs of salary sacrifice to the Exchequer in the July 2015 Budget. It initiated an evidence-gathering exercise at the following Autumn Statement. It used the March 2016 Budget to confirm that it was considering limiting the range of benefits attracting tax and NI advantages when provided via salary sacrifice. The recent Autumn Statement announcement followed HMRC’s August 2016 ‘Consultation on salary sacrifice for the provision of benefits in kind’. The following article is based on HMRC’s August consultation and Autumn Statement 2016 documentation including draft Finance Bill 2017. However, the proposals will add additional layers to already complex legislation. Therefore, some change is possible as the draft legislation is consulted on and undergoes Parliamentary scrutiny before becoming law.
PROPOSALS The proposals affect the income tax and employer NI treatment of benefits in kind provided by:
• salary sacrifice arrangements where employees agree to give up cash remuneration in exchange for some form of non-cash benefit in kind
• flexible benefit arrangements where employees can
The aim of the proposed legislation is to ensure that where benefits in kind are provided through salary sacrifice, they will be chargeable to income tax and employer Class 1A NI even if normally exempt, at the higher of:
• the amount of salary sacrificed • the cash equivalent value of the benefit in kind set out in statute (if any) If the normal taxable value of the benefit in kind is higher than the amount of salary sacrifice, it will be subject to tax and Class 1A NI in the normal way.
EXEMPTIONS There will be no changes to the tax and NI treatment of any of the following benefits provided in connection with salary sacrifice arrangements:
• employer pension contributions • employer-provided pension advice based on the recommendations of the Financial Advice Market Review
• employer-supported
childcare
and
provision
of
workplace nurseries
• cycle to work scheme – cycles and cyclist’s safety equipment
• ultra-low emission cars (CO2 emissions below 75g/km).
TRANSITIONAL PROVISIONS The Autumn Statement took into account some of the concerns raised during HMRC’s consultation and the following grandfathering provisions will apply:
exchange cash remuneration for one or more benefits in kind
• salary sacrifice arrangements in place before April 2017
• flexible benefit arrangements where employees have
• salary sacrifice arrangements in place before April
allowances that can either be used for benefits in kind or taken in cash.
will be protected until April 2018 2017 for cars, accommodation and school fees will be protected until April 2021.
The proposals aren’t intended to cover:
• flexible benefit arrangements giving employees a choice of benefits in kind in addition to cash pay, without including a cash option
• benefits in kind not linked to salary sacrifice. Under current legislation, many benefits in kind are exempt from both income tax and all NI, while some are subject to income tax and employer class 1A NI, but exempt from employee NI. Where benefits in kind are subject to tax and NI, statutory valuations often apply. Giving up salary for a benefit in kind is attractive to employers and employees where it leads to income tax and NI savings for the employee, and NI savings for the employer. However, it’s not possible to sacrifice salary below the national living wage / national minimum wage. And sacrificing salary can affect entitlement to some state benefits.
WHAT MIGHT THIS MEAN IN PRACTICE? It’s good news that there’s no change to the treatment of salary sacrifice for pension contributions. We offer extensive material explaining the benefits on the Scottish Widows adviser extranet. The position is different for a range of other benefits commonly provided via salary sacrifice, including mobile phones and private use cars. An employer can provide a director or employee with a mobile phone – including a smartphone – for private use. The value of this benefit in kind is currently exempt from income tax and all NI whether or not it’s funded by salary sacrifice. Any existing salary sacrifice arrangements linked to the provision of a mobile phone in place as at April 2017 will be protected until April 2018. But any new salary sacrifice arrangements set up from April 2017 will be caught by the new rules.
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Example An employer provides a new mobile phone to an employee, covering the cost of a £670 two-year contract via salary sacrifice. The overall position under current legislation is as follows for basic, higher and additional rate taxpayers. This treatment will continue for existing salary sacrifice arrangements in place as at April 2017 until April 2018. Salary sacrifice in place by April 2017
Basic (£)
Higher (£)
Additional (£)
Gross salary sacrifice
670.00
670.00
670.00
Employee NI saving
80.40
13.40
13.40
Income tax saving on salary
134.00
268.00
301.50
Income tax on benefit in kind
0.00
0.00
0.00
Cost to employee
455.60
388.60
355.10
Employer class 1 NI saving Employer class 1A NI Net employer NI saving
92.46 0.00 92.46
92.46 0.00 92.46
92.46 0.00 92.46
For new salary sacrifice arrangements set up from April 2017, the overall position under the proposed changes is as follows. New salary sacrifice from April 2017
Basic (£)
Higher (£)
Additional (£)
Gross salary sacrifice
670.00
670.00
670.00
Employee NI saving
80.40
13.40
13.40
Income tax saving on salary
134.00
268.00
301.50
Income tax on benefit in kind*
134.00
268.00
301.50
Cost to employee
589.60
656.60
656.60
Employer class 1 NI saving Employer class 1A NI* Net employer NI saving
92.46 92.46 0.00
92.46 92.46 0.00
92.46 92.46 0.00
* Based on higher of benefit in kind valuation and gross salary sacrifice.
Employees can currently benefit from private use cars obtained via a range of options linked to salary sacrifice. Any existing salary sacrifice in place as at April 2017 will be protected until April 2021, but any new salary sacrifice arrangements set up from April 2017 will be caught by the new rules. The NI and income tax treatment currently depends on the precise nature of the arrangements. For example, in schemes where an employer leases a car and makes it available to the employee for private use, the employer incurs a Class 1A NI liability under benefit in kind rules, providing the car benefit is taxable on the employee as general earnings under ITEPA 2003.
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Example A higher rate taxpayer is given private use of a car leased by their employer over three years, funded by salary sacrifice. For benefit in kind purposes, the car has a £14,500 list price and CO2 emissions of 99g/km. The monthly cost is £252.50 (£3,030 over a year). To simplify the calculations, the three-year lease is aligned to tax years in the following examples. Salary sacrifice in place by April 2017
2016/2017 (£)
2017/2018 (£)
2018/2019 (£)
Over 3 years (£)
Gross salary sacrifice
3,030.00
3,030.00
3,030.00
9,090.00
Employee NI saving
60.60
60.60
60.60
1,212.00
1,212.00
1,212.00
14,500 x 16% = 2,320
14,500 x 18% = 2,610
14,500 x 20% = 2,900
928
1,044
1,160
2,685.40
2,801.40
2,917.40
8,404.20
418.14 320.16 97.98
418.14 360.18 57.96
418.14 400.20 17.94
173.88
Income tax saving on salary Taxable value under benefit in kind rules Income tax on benefit in kind Net cost to employee Employer class 1 NI saving Employer class 1A NI cost Net employer NI saving
For new salary sacrifice arrangements set up from April 2017, the annual costs under the proposals are as follows. New salary sacrifice from April 2017
2017/2018 (£)
2018/2019 (£)
2019/2020 (£)
Over 3 years (£)
Gross salary sacrifice
3,030.00
3,030.00
3,030.00
9,090.00
Employee NI saving
60.60
60.60
60.60
1,212.00
1,212.00
1,212.00
14,500 x 18% = 2,610
14,500 x 20% = 2,900
14,500 x 23% = 3,335
Income tax on benefit in kind*
1,212.00
1,212.00
1,334
Net cost to employee
2,969.40
2,969.40
3,091.40
9,030.20
418.14 418.14 0
418.14 418.14 0
418.14 460.23 (42.09)
(42.09)
Income tax saving on salary Taxable value under benefit in kind rules
Employer class 1 NI saving Employer class 1A NI cost* Net employer NI saving/ (cost)
* Based on higher of benefit in kind valuation and gross salary sacrifice.
INSURANCE AND HEALTH RELATED BENEFITS Disappointingly, no exemptions were announced for insurance and health related benefits, and HMRC has confirmed to the ABI that an appearance to the contrary in draft Finance Bill 2017 is an error. It’s become increasingly common for employers to fund a core level of group life cover and possibly group income protection or group critical illness cover, and offer employees the option to top up their cover funded by salary sacrifice. Under current rules, group life and group income protection benefits for employees are exempt from income tax and all NI, both when the employer is fully funding the cost and when employees have selected top-up cover paid for by salary sacrifice. However, group critical illness benefits for employees are subject to income tax and class 1A NI. Under the proposals, there will be differential treatment for these types of cover, depending on whether top-up cover has been funded by salary sacrifice or not. When funded by salary sacrifice, benefits including group life cover and group income protection will be taxable and subject to class 1A NI. This is likely to create confusion and deter employees from topping up existing cover provided through their workplace. Premiums paid by an employer on relevant life policies are also exempt from income tax and all NI. We are not aware of employers offering this type of cover via salary sacrifice. However, it appears that employers offering relevant life cover to employees who wish to opt out of group life cover on a registered pension scheme basis because of lifetime allowance concerns may need to ensure they don’t offer a cash alternative. Finally, it’s important to remember that these changes won’t affect personal protection policies funded by individuals themselves.
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NATIONAL INSURANCE REFORM – SUMMARY OF THE CHANGES Jeremy Branton
Following announcements made in the last Budget, the Chancellor confirmed a number of changes in the Autumn Statement.
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The measures affecting salary sacrifice schemes are covered in a separate article, ‘Less of a benefit: salary sacrifice changes’, while the other key changes to national insurance are outlined below. Our summary is based on the Autumn Statement 2016 documentation and draft legislation published shortly afterwards. Some change is, therefore, possible as this is consulted on and undergoes Parliamentary scrutiny before becoming law.
THE ALIGNMENT OF NATIONAL INSURANCE THRESHOLDS From 6th April 2017 the national insurance primary threshold (employee) and secondary threshold (employer) will be aligned. Both employees and employers will then start paying national insurance contributions (NICs) on weekly earnings over £157. This removes the £1 discrepancy between the thresholds and aims to reduce complexity for employers.
THE ABOLITION OF CLASS 2 NICs From 6th April 2018, Class 2 NICs will be abolished. Class 2 NICs are flat-rate weekly contributions (£2.80 per week in 2016/2017) paid by the self-employed to gain access to contributory benefits. They are liable to be paid for every week or partial week of self-employment in a tax year, if the person’s profits for that tax year equal or exceed the Small Profits Threshold (£5,965 in 2016/2017). Payment of Class 2 is voluntary for those with profits below this level. From 2018/2019, Class 2 liabilities will cease as will the ability to make voluntary payments in that year and later years. However, payments in respect of 2017/2018 and earlier tax years may still be made including voluntary contributions. Class 4 NICs are paid by the self-employed on net profits that are subject to income tax. Class 4 contributions are payable at a rate of 9% on profits between the Lower Profits Limit (£8,060 in 2016/2017) and Upper Profits Limit (UPL) (£43,000 in 2016/2017) and 2% on profits above the UPL. The Autumn Statement confirmed that, following the abolition of Class 2 NICs, the self-employed will be able to use Class 3 (voluntary contributions) and Class 4 NICs to continue to build entitlement to the state pension and other contributory benefits. A Small Profits Limit will be introduced to allow Class 4 NICs to count for benefit entitlement purposes when annual taxable profits are at or above this limit (52 x lower earnings limit). Class 3 NICs which can be paid voluntarily to protect entitlement to the state pension and Bereavement Benefit will be expanded to give entitlement to Maternity Allowance and contributory Employment and Support Allowance for the self-employed.
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OFFICE OF TAX SIMPLIFICATION STUDY INTO THE CLOSER ALIGNMENT OF INCOME TAX AND NATIONAL INSURANCE Both of the above measures were part of a number of proposals made by the Office of Tax Simplification (OTS) following the Government’s request for it to review the closer alignment of income tax and national insurance. The OTS provided a number of recommendations intended to create a simpler, more transparent and fairer system for taxpayers and employers. These include assessing employees for NICs in a similar way to how PAYE operates for income tax. Currently, if an individual has more than one employment source, these are treated separately for NICs with the result that someone with two parttime jobs can pay less NICs than someone earning the same from a single employment. The Government is understood to be reviewing a number of the recommendations.
TERMINATION PAYMENTS As announced at Budget 2016, the Government confirmed that from 6th April 2018, termination payments above £30,000 which are subject to income tax will be subject to employer NICs. Termination payments will remain exempt from employee NICs and free from income tax up to £30,000. Termination payments can comprise minimum statutory amounts together with compensation paid by the employer for loss of employment.
STATUTORY RIGHTS TO REDUNDANCY PAYMENT Employees selected for redundancy must receive at least one week’s notice for each year of service up to a maximum of 12 weeks. An employee who has accrued at least two years’ service is entitled to a minimum level of compensation by means of a statutory redundancy payment – SRP – calculated as follows:
• Half a week’s pay for each year’s service before age 22; plus • One week’s pay for each year’s service between ages 22 and 40; plus • One and a half week’s pay for each year’s service from age 41 While no upper age limit applies, the maximum length of service for these purposes is capped at 20 years and with weekly pay currently capped at £479, the maximum SRP is £14,370 for those made redundant on or after 6th April 2016. Many employees will be entitled to a termination package considerably better than the statutory minimum, and favourable tax treatment applies to payments made in consideration of the termination of a person’s employment. We illustrate the current income tax and national insurance treatment for these payments together with the revised position affecting employers from 6th April 2018. Example An employee receives notice from their employer that they are being made redundant. They are required to work the minimum statutory notice period of 12 weeks during which they continue to receive their salary of £26,000 pa – amounting to £6,000 over this period. They are entitled to SRP of £12,000. In addition, their employer pays them £24,000 compensation for loss of office upon leaving service, making a total termination payment of £36,000.
CURRENT POSITION – UP TO 5TH APRIL 2018 Total payment
£42,000
Income Tax
Employee NICs
Employer NICs
Salary received during notice period
£6,000
Yes
Yes
Yes
Termination payment (above tax-free sum of £30,000)
£6,000
Yes
No
No
POSITION FROM 6TH APRIL 2018
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Total payment
£42,000
Income Tax
Employee NICs
Employer NICs
Salary received during notice period
£6,000
Yes
Yes
Yes
Termination payment (above tax-free sum of £30,000)
£6,000
Yes
No
Yes
The Government consulted on simplifying the tax and national insurance treatment of termination payments in July 2015, subsequently issuing a technical consultation on draft legislation in 6th August 2016. Further changes due to be implemented from July 2018 include:
• Treating all payments in lieu of notice (PILONs) as earnings and therefore subject to tax and national insurance. This is a complex area and one which the Government believe is open to manipulation. Currently PILONs that are contractual are subject to income tax and Class 1 NICs, but non-contractual PILONs are not.
• Employers will be required to tax the equivalent of an employee’s basic pay if their notice period isn’t worked.
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This publication represents Scottish Widows’ interpretation of the law and HMRC practice at the time of writing this publication. The contract terms and the amount and taxation of benefits described assume that there is no change in tax or other law affecting Scottish Widows or its investments and will depend on the investors’ financial circumstances. The information in this publication is based on the assumption that tax legislation is not changed. Tax assumptions are subject to statutory change and the value of any advantages depends on personal circumstances. Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change. However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given. Past performance isn’t a guide to future performance. We’ll record and monitor calls to help us to improve our service. Scottish Widows Limited. Registered in England and Wales No. 3196171. Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number 181655. 15964 01/17
