Annual Pension Allowance (Transferred Workers)
(Limited Text - Ministerial Extracts only)
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The Economic Secretary to the Treasury (Andrea Leadsom)
I congratulate the hon. Member for Chesterfield (Toby Perkins) on securing this debate. It is a complicated subject and he explained it very well. I am sympathetic to the issues that he raised. He will know that the Government greatly value the important work that is carried out by public sector workers and by those who were previously in the public sector.
The hon. Gentleman discussed the effect of the annual allowance rules for tax-relieved pension savings. He will, of course, be aware that we live in difficult economic times and that few households in this country have not been affected in some way by the economic crash of 2008-09. As part of our deficit reduction plans, the Government had to make difficult decisions in 2010 and 2013 to restrict the cost of pensions tax relief by reducing the annual allowance from £255,000 to £50,000 from 2011-12 onwards and to £40,000 from 2014-15 onwards. We put those restrictions in place to ensure that the cost of pensions tax relief remained affordable and sustainable.
The hon. Gentleman raised a number of concerns about the way in which the annual allowance rules work for defined benefit pension schemes in the context of bridging pensions, which can affect individuals who are transferred from the public sector under TUPE. Although I cannot comment on the particular circumstances that he raised, it might be helpful if I give some background to those rules.
The annual allowance rules provide a limit on the amount of tax-advantaged pension savings that can be made for individuals each year in registered pension schemes. Savings in excess of the limit are subject to the annual allowance income tax charge. For individuals in defined contribution schemes, it is straightforward to determine the level of contributions paid into a scheme to be assessed against the annual allowance limit. However, the position is more complex for defined benefit schemes because individuals accrue a right to an amount of annual pension from a set pension age, and the level of contributions made by the individual and the employer does not reflect the increase in the value of the member’s pension rights. We therefore needed a method to calculate the deemed level of contributions to test against the annual allowance. That method would have to be actuarially equivalent to the amount required to fund a similar promise in a defined contribution scheme.
Detailed consultations were held with the pensions sector before the rules were introduced in 2006, and in 2010, when the Government consulted on the reduction in the annual allowance. As a result of the consultations and with support from the pensions sector, the amount of defined benefit pension savings in a year, when measured against the annual allowance limit, is broadly equivalent to the increase in the capital value of a promised pension over that period.
To achieve the method of valuing pension savings under defined benefit schemes, special rules were developed so that for each £1 a year of pension that will be payable, the present capital value of that annual pension benefit is £16. The use of the 16:1 factor to value defined benefit pensions promises was adopted from April 2011 when the annual allowance was reduced, following recommendations by the Government Actuary. Before that, the factor was 10:1. The rules are intended to strike a balance between providing a system that is reasonably simple for individuals to understand and for pension schemes and HMRC to administer, and meeting the Government’s fiscal objectives.
The hon. Gentleman raised concerns about the treatment of bridging pensions under annual allowance rules. Tax relief is provided for pension savings under defined benefit schemes on the understanding that the funds are used to provide an income throughout retirement. To support that aim, scheme pensions must normally be payable for life, and must not decrease except in prescribed circumstances. One such circumstance is where a bridging pension is paid and the reduction occurs between age 60 and state pension age. A bridging pension is a temporary increase to a private pension. Typically, it is provided where individuals retire before reaching state pension age, and where the level of the bridging pension is broadly similar to the expected state pension. When the state pension starts to be paid, the bridging pension is reduced or comes to an end.
Where the bridging pension is offered as a discretionary award, or is a benefit to which the individual becomes entitled only if they choose to retire early, the award of the additional pension may give rise to pension savings in excess of the annual allowance limit. That is because the temporary nature of the increase to an individual’s pension is not recognised in the same way that increases to the pension’s capital value is calculated for annual allowance purposes.
The Government have considered whether special annual allowance provisions should apply for bridging pensions, and that can be found in our response to consultations on the reduction of the annual allowance limit from 2011-12. We recognise that the restriction of relief may create particular challenges for members of defined benefit schemes because of the way promised benefits in those schemes are valued, but we concluded that it would not be desirable to complicate the pensions tax regime by including special provisions for bridging pensions. Instead, we introduced special rules intended to mitigate “hard cases”. Those rules allow individuals to carry forward unused annual allowances from the three preceding tax years, and set them off against pension savings above the annual allowance limit in a single year, providing that the individual was a member of a registered pension scheme during those three years. They also allow individuals to meet annual allowance charges of more than £2,000 from their pension scheme. That is known as the “scheme pays” facility.
The hon. Gentleman raised concerns that when a bridging pension paid to an individual from one scheme comes to an end, future pension payments to that individual from that scheme are treated as unauthorised payments and liable to tax at a rate of up to 55%. As I have set out, scheme pensions can reduce only in certain prescribed circumstances. Where they are reduced in any other circumstances, unauthorised payments will arise and be subject to certain tax charges. The legislation for that is clear, has applied since April 2006, and is set out in schedule 28 to the Finance Act 2004. Those rules support the aim for defined benefit schemes to provide an income throughout retirement while protecting against manipulation of the tax-free lump sum.
This is not a simple area. Although annual allowance rules for defined benefit schemes may appear difficult to understand, they are a necessary part of meeting the Government’s fiscal and policy objectives of targeting tax relief effectively. The rules are intended, as far as possible, to provide a straightforward structure for individuals and schemes, but I recognise that there may be particular cases where the rules do not work as intended. I am grateful that the hon. Gentleman has raised these issues today; he should rest assured that they will be kept under review and that the specific cases he has discussed will be taken into account.
Question put and agreed to.