Defined benefit trustees have been urged to be on their guard against a new interpretation of tax law that could see certain members hit by unexpected tax charges on buyout.
Pensions lawyers have become aware that HM Revenue & Customs now considers the full buyout of a scheme, where individual annuity policies are issued to members, could invalidate their enhanced or fixed protection.
Enhanced protection was introduced in 2004 for people who would be affected by the newly introduced lifetime allowance. If savers had already accumulated more than the allowance, they could gain protection from shock tax charges, provided they did not accumulate any more pension or make certain transfers.
This was followed by fixed protections, available for those immediately impacted by the LTA’s reduction in 2012, 2014 and 2016.
Now, lawyers warn that the UK taxman considers scheme buyouts to void members’ protections in certain circumstances.
“An argument has arisen that when a pension scheme buys out, that’s an impermissible transfer,” said Hywel Robinson, head of the London pensions practice at Clifford Chance and chair of the Association of Pension Lawyers.
At a time when the industry is anticipating more employer failure and wind-up, this issue should be resolved quickly
David Brooks, Broadstone
The APL disagrees with HMRC’s interpretation of UK legislation, according to Mr Robinson, but the small number of members impacted means a court appeal is unlikely, despite the apparent contradiction in the system.
Our whole system of pensions is encouraging [trustees] to buy out with an insurer,” he said. “We’ve been trying to talk to HMRC to try and get them to produce some constructive and helpful guidance and they haven’t really done it.”
For its part, HMRC maintains that this interpretation is nothing new, raising the prospect that buyouts already completed could have voided, or could void in the future, members’ protections.
A spokesperson said: “HMRCs guidance on transfers, including buyouts, has not undergone any changes and none are currently planned.
“If an individual has enhanced protection, fixed protection, fixed protection 2014, fixed protection 2016, or protection of a pension age below 55 a transfer may cause them to lose this protection under certain circumstances.”
HMRC publishes guidance on transfers including buyouts in its pensions tax manual.
Lawyers spot fixes
Workarounds do exist for the problem, which only affects a small percentage of DB members.
“It’s only people whose benefits are already in payment under the scheme that’s being bought out, and then it only affects members if they have got protection and haven’t brought benefits under another scheme into payment,” Mr Robinson said.
He said that contacting potentially affected members might be a workaround.
Another might be for insurers to initially assign individual policies to the trustees, before the board then issues them to members. Some sponsors may simply stop their derisking journey at full buy-in, where the risks of a DB scheme have been fully insured by a bulk annuity, but this policy still sits on its books as an asset corresponding to its liabilities.
“It shouldn’t be necessary and people may not have thought it was necessary in the past,” Mr Robinson said. “I suppose going forward, some schemes may not be aware it’s an issue.”
Advice is essential
Whether this tax quirk will hold up the progression of UK DB’s derisking drive remains to be seen. Several industry insiders told Pensions Expert they are aware of schemes grappling with the issue, although it would not necessarily block buyout.
David Brooks, technical director at Broadstone, said: “It is one of those niche areas of pensions legislation that could have severe consequences for some people if they lose their fixed protection and have further benefits to crystallise.
“If not fixed retrospectively there could be all sorts of issues. HMRC must see sense and work to make a retrospective solution as soon as possible.”
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Mr Brooks added that the tax rules may lead to unnecessary complexity when trying to secure DB members’ benefits: “At a time when the industry is anticipating more employer failure and wind-up, this issue should be resolved quickly.”
Sammy Cooper-Smith, co-head of business development at Rothesay Life, said the bulk annuity insurer is “aware of schemes at the moment who believe that they are able to issue individual policies”, but echoed the warning for trustees to be alert to the issue.
“Trustees need to consult with their legal advisers and think through how they will deal with the issue, in order to protect members’ interests,” Mr Cooper-Smith said.
