Pensions Gobbledegook Explained
Well, I have to say this is just about one of the funniest things I’ve ever, ever read. I’ve just got off a train where I’m sure the other passengers must have thought there was something quite wrong with me; I just couldn’t stop laughing; giggling even – almost crying at points.
What was I reading? Don’t laugh; Hansard. I know, but it’s too late for me to get a life now. But everyone involved in pensions in our country should read this too. We’ve reprinted it here for your amusement.
To give you some background the whole thing is about an obscure problem with pensions that a constituent of the MP Barry Gardiner brought to his attention. In the twenty minutes or so of Parliamentary time that explaining this particular pension problem took up Mr Gardiner was able to heroically demonstrate a quite amazing level of knowledge about the post A-Day pension rules and the transitional arrangements that were put in place to protect pre A-Day rights. To the MPs listening to him the point may have been just about intelligible if they too were as well-versed in the intricacies of pension simplification as Mr Gardiner, but even if they didn’t understand a word of it the real message was, to me at least, quite clear; to understand our simplified pension system people these days need a PhD in Pointlessness.
If you don’t believe me, read this…
10 July 2009
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Taxation of Pensions
Barry Gardiner (Brent, North) (Lab): The debate has come about because of an unexpected reduction in the available pension commencement lump sum suffered by one of my constituents, whom I shall refer to simply as Dr. Robert, after he retired. I have corresponded with the Treasury about the matter, and I would not normally seek to detain the House by debating an issue that might otherwise be handled by means of an exchange of letters with the Minister. I do so on this occasion for the following reasons.
First, Dr. Robert’s case has exposed what I believe to be an anomaly in schedule 29 of the Finance Act 2004 as it relates to tax-free pension lump sum allowances. His case cannot, therefore, be remedied at an individual level; it can only be remedied by the will of the House in future legislation. Secondly, although the majority of pensioners will not have been affected by the injustice that I believe Dr. Robert has suffered, his case is far from unique. While I suspect that very few who have been affected by the anomaly in the regulations will have been able to articulate the fact with the same mathematical clarity as my constituent, they will have felt no less bewildered and cheated than he has.
My third reason for raising the matter in the House is that in his letter to me of 19 November last year, my hon. Friend the Economic Secretary to the Treasury acknowledged the real problems that had been created by the lump sum rule. He even acknowledged that my constituent had proposed
Unfortunately, the letter proceeded to justify not adopting those solutions on the grounds that they would add administrative complexity. That cannot be right; injustice cannot be excused on the basis of administrative convenience.
Having set out my reasons for bringing the matter before the House, I must now present the detailed arguments relating to the tax rules. I apologise in advance that they are necessarily technical and complicated, but I will try to reconcile simplicity with accuracy as best I can.
Since what the Government chose to call A-day, 6 April 2006, there has been a lifetime allowance, known as an LTA, of £1.5 million. That is the limit imposed not on an individual’s pension fund itself, but on that element of the cumulative pension fund from which an individual can withdraw or crystallise a lump sum without incurring a lifetime allowance charge. The figures are indexed each year, but if we talk in 2006 money, an individual is entitled to take a tax-free lump sum called a pension commencement lump sum, or PCLS, of up to £375,000, which is 25 per cent. of the standard LTA of £1.5 million.
My constituent had a pension in progress at A-day that had a capital value of £250,000, with 25 per cent. crystallised lump sum rights of £62,500. He also had an NHS pension with a capital value of £1.2 million,
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where, under the NHS scheme, the lump sum entitlement was limited to 13.04 per cent. rather than the Government figure of 25 per cent. He also had four other uncrystallised pension funds totalling £580,000 in capital value, and a scheme lump sum entitlement of 20 per cent. amounting to £145,000. Finally, he had a post-1987 freestanding additional voluntary contribution scheme worth £60,000. That scheme, although allowing him to take a lump sum of £25,000, would under Treasury rules not be allowed to count as part of his VULSR, which is Treasury-speak for valuation of uncrystallised lump sum rights, and could therefore not be calculated towards the total lump sum rights minimum figure of £375,000, at which point he could register for primary or enhanced lump sum protection in accordance with RPSM03105070.
Dr. Robert registered for enhanced—dormant primary—transitional protection of his LTA. His declared LTA if needed later for primary protection was 139.33 per cent., which equates to £2.09 million rather than the £1.5 million. The reason he could not apply for enhanced lump sum protection was that his total lump sum rights on A-day did not quite reach £375,000. We should remember at this point that he had crystallised £62,500 already and had a further £156,480, which represented the 13.04 per cent. of his NHS pension, as well as a further £145,000 which represented 25 per cent. of his four pensions with a capital value of £580,000, and zero from his post-1987 freestanding AVC.
Dr. Robert chose to crystallise his NHS pension shortly after A-day and received a PCLS of £156,480. When added to his pre-commencement pension, this meant he had used up 96.66 per cent. of a standard LTA. However, because he had registered for enhanced—dormant primary—protection, he knew he had, in fact, got 42.67 per cent. of LTA still remaining. On deciding shortly thereafter to crystallise his four private pension plans, he was told that although he had crystallised only 58.4 per cent. of his available lump sum rights, he could now crystallise only £12,500 tax-free—or 3.34 per cent. of £375,000—before he would exceed his PCLS allowance. The Treasury deemed him to have used up 96.66 per cent. of his tax-free lump sum allowance when, in reality, he has used only 58.4 per cent. of it. The reason for that is because the way in which the lump sum rule operates does not recognise that the amount he could take as a lump sum from his national health service pension was limited to 13.04 per cent. of its capital value.
The lump sum rule, as defined in schedule 29(2) of the Finance Act 2004, tracks the decrementing “available portion” of PCLS remaining, after “benefit crystallisation events”, from an individual’s PCLS lump sum entitlement, called the “applicable amount”. The “applicable amount” is not the problem here; the problem is in the way the decrementing “available portion” is calculated after each progressive lump sum crystallisation event. The available portion is initially defined in schedule 29(2) and RPSM09104510 by the formula: “available portion” equals the current standard lifetime allowance indexed to the year in question minus the aggregate of amount crystallised—AAC—for each proceeding benefit crystallisation event, all divided by four.
The rationale behind the formula is that it progressively tracks the decrementing available portion to zero, thus ensuring that no excess PCLS is paid out by pension administrators. However, it makes the extremely unfair assumption that each individual crystallisation that goes
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to make up the AAC actually represents 25 per cent. of the PCLS. That assumption, represented by the use of four as the divisor in the formula, is simply unfounded, as is shown in the case of Dr. Robert, whose scheme did not allow him to crystallise more than 13.04 per cent.
Thus far, I am confident that the Exchequer Secretary to the Treasury accepts that what I have said is accurate, both factually and with regard to the calculations. I say that because her officials have acknowledged as much to me in correspondence. A letter from the Economic Secretary to the Treasury expressed it by saying that
“case illustrates, for members to get an aggregate pension commencement lump sum of less than 25 per cent. of their aggregate lifetime allowance if one or more of their pension schemes chooses to pay a pension commencement lump sum of less than the 25 per cent. maximum”.
“there is no hindrance in the tax rules preventing the maximum pension commencement lump sums from being paid. It is, quite rightly, a matter between pension schemes and their sponsors and members whether they pay out less than the permitted maximum of 25 per cent.”
That claim might have had a brighter ring to it were it not for the fact that the Government’s own civil service pension scheme did not enable full commutation to 25 per cent. until 1 October 2007. Furthermore, the NHS pension authority delayed until 6 April 2008, some two years after A-day.
Those two pension schemes represent the majority of the UK’s public sector employers. In the light of that, I consider the idea that the Government can absolve themselves of a duty to get the lump sum rule right by blaming the pension fund’s sponsors as wide of the mark. The Government have a duty to legislate for the world as it is, and as they know it to be, not to put pensioners on some Procrustean bed and chop them to the same size, regardless of the actual rules of their pension fund, especially when the Government operate two such non-compliant funds themselves, employing millions of public sector workers.
“Under the pre-A-day rules pension schemes did not routinely keep details of tax-free retirement lump sums. And post-A-day pension schemes simply pass on details of the unused lifetime allowance available to an individual, and not this information plus details of pension commencement lump sums paid to date.”
I point out that given that HMRC has already had to develop efficient “application for protection” and “event report” schemes, the additional work involved in tracking the actual rather than the assumed PCLS crystallisations of those individuals eligible for an enhanced LTA over their lifetime should not be greater than that already required for those who register lump sum rights greater than £375,000 in respect of primary or enhanced protection.
My hon. Friend also failed to indicate that pension schemes are also required to maintain precise records of pensions paid, including PCLS, for six years after A-day. Indeed, since A-day, they have been obliged to complete detailed annual electronic returns online to HMRC, using APSS300, which covers 20 wide-ranging event reports pertaining to transfers and payments made from the scheme to individual scheme members. Those events are detailed in RPSM12301010-12301220 and S.I.2006/257. Within APSS300, only event reports 6, 7 and 8 require consideration for the PCLS in relation to the anomaly in the lump sum rule. There is no specific event report at present for a PCLS paid to an individual with enhanced LTA who does not have additional PCLS rights greater than £375,000. A small amendment to the APSS300 reporting requirements of event 6 would go a long way to remedying the anomaly.
My hon. Friend the Exchequer Secretary has had a long day, and I am conscious that this is a detailed and difficult issue. I know that she is aware of all the technicalities of it, because of the correspondence that I have had with her officials, but I urge her to look again at how a very small change in the rules can prevent a continuing and wide-ranging injustice.
The Exchequer Secretary to the Treasury (Sarah McCarthy-Fry): I congratulate my hon. Friend the Member for Brent, North (Barry Gardiner) on securing this debate and on bringing his constituent’s concerns to the
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attention of the House. I know that his constituent has already been the subject of some highly technical correspondence with HMRC, which, I understand, is ongoing. I do not think that this is the place for that detailed technical discussion of the finer workings of the pension legislation, but it would be helpful if I responded to my hon. Friend by considering the issues in broad terms.
As my hon. Friend is aware, under the new pension rules a pension scheme member can receive up to 25 per cent. of their pension fund as an initial tax-free lump sum when their pension starts to be paid. The total amount that individuals can save in a pension tax-free is subject to a lifetime allowance, which currently stands at £1.75 million. That limit is a maximum, within which pension funds may decide how best to provide benefits to their members. However, the Government need to ensure that the system is used fairly and remains affordable for the taxpayer, so there are limits on the amount of tax relief available to an individual.
If there were no limits to the amounts of tax relief available on pension savings, some people might use them as general savings accounts and would put away far more than was necessary simply to provide a retirement income, instead using pensions as a way to avoid income tax. In that case, the cost to the Exchequer in tax relief could be open-ended.
The cap on the size of tax-free lump sums therefore ensures that the tax relief available for pensions is kept to the level intended by Parliament and allows the Government to monitor the cost of tax relief to the taxpayer. As I said, the lifetime allowance is the maximum tax advantaged pension benefits an individual can accumulate, other than under transitional rules. That limit is an optional maximum, within which pension funds may decide how best to provide benefits to their members.
When the individual has more than one pension fund, the maximum tax-free lump sum that an individual can take is based on the lower of 25 per cent. of the money held in a particular pension fund and 25 per cent. of the lifetime allowance available. As each pension scheme comes into payment, the lifetime allowance is reduced by the value of the total benefits taken. Therefore, if one pension scheme pays a lump sum of less than 25 per cent., that will mean that the total lump sum from all schemes will be less than 25 per cent. of the value of all the pension funds as no pension can provide a lump sum bigger than 25 per cent. of the funds held by the individual in that scheme.
Barry Gardiner: My hon. Friend is absolutely right to make that point. However, does she not consider it wrong that there should be an assumption that runs absolutely counter to the fact of what the actual payment is? Is it not wrong that there should be an assumption that the full 25 per cent. has been paid out when, in many cases, it will not have been?
Sarah McCarthy-Fry: There is not a requirement for schemes to allow 25 per cent—I think that that is where we are getting a bit confused—rather it is the maximum tax-free lump sum permitted in tax rules.
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Barry Gardiner: Indeed, that is the case—it is the maximum admissible—but, as my hon. Friend will know, the two pension schemes that I quoted and many others do not allow that and did not allow that. Millions of workers in this country are affected by the limitation of those schemes, and a correction to the regulations could avoid their being penalised.
Sarah McCarthy-Fry: Very few pensioners will have pensions anywhere near the lifetime allowance, and we have to take that fact into account. We must also take into account the fact that it would add complexity, a point that I will develop later. Our rules must balance what will affect a few individuals against the complexity that would affect many more pensioners. The decision about going to the maximum 25 per cent. is a matter for individual pension schemes.
I sympathise with my hon. Friend’s concerns on this matter, but the current rules work well for the vast majority of people. Pension simplification was intended to introduce rules that are simple, clear and certain. Using a scheme upper limit of 25 per cent. achieves that: it benefits pension schemes by reducing administrative burdens, and individuals by making the rules easier to apply.
The Government considered this issue when drawing up the framework that was eventually introduced on A-day, and it was recognised at the time that some individuals may not be able to claim the full 25 per cent. tax-free lump sum. Alternative methods that attempted to measure the size of multiple pension funds and calculate the relevant 25 per cent. lump sum would require pension schemes to maintain records of pensions savings before A-day. Opting for that method would require a complex and unrealistic approach to valuing pensions. Members would have to obtain or retain the values and dates of payment of all lump sum payments over a period that may be five, 10 or more years before April 2006.
That would be a costly and time-consuming exercise. Schemes are required to keep records for only six years, and finding that information would be either impossible or costly. Our experience of other pension law, such as trivial commutation, is that such record keeping would represent significant administrative burdens. Most schemes do not have complete records and it would be unrealistic to expect members to provide that information. That is why a simple formula based on a percentage was used.
It is also important to bear it in mind that the tax rules do not guarantee that the maximum tax-advantaged benefit can always be paid: they simply provide a framework within which a pension scheme and its members are free to order their affairs as they wish. In some circumstances, that will mean that a member will not be able to obtain the maximum tax advantages.
The legislation deliberately does not prescribe the level of the tax-free lump sum. Instead, it provides a framework within which pension funds and individuals must operate, and that means that pension funds have the freedom to determine the appropriate package of benefits that they offer to their members. Legislating that pension schemes must provide a 25 per cent. lump sum, or allowing individuals to take a higher percentage from one fund to make up a lower percentage from another, would effectively remove the ability for pension funds to manage their affairs.
There is nothing to stop the maximum lump sum being paid if the member and pension scheme want to reorder their affairs. It is for the pension scheme to decide what benefits it wants to pay and for the individual to decide how to take them, within the framework that the legislation provides.
As I said, the tax rules have to cater for a large number of individuals and different circumstances. In doing so, they have to balance complexity with catering for different circumstances, and that is what the current lump sum rules do. They are simple, clear and certain, and very generous in allowing most individuals to take the maximum tax-free lump sum that they can. We also
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have to bear it in mind that we are talking about the tax-free lump sum only, and that the underlying pension is not affected.
Of course the Government keep all tax policy under review, but the rules cannot cater for all circumstances and it would be unrealistic to change them to try to do so. The Government want to balance fairness and simplicity, and we think that the rules would become overly complicated if they were to accommodate the circumstances of all individuals.
Source: Commons Hansard, 8 July 2009
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