Sometimes it’s not as easy as PIE – Part 1: Annual Allowance
Obligations facing sponsoring employers of defined benefit schemes have led many to consider ways to mitigate their liability, and in effect de-risk the scheme. One such method is to offer a pension increase exchange, or ‘PIE’, where an individual is offered a one-off higher pension with no further non-statutory increases. The PIE is in lieu of the scheme’s normal guaranteed increases the member receives for their pension in payment (any statutory increases still occur). If the PIE is accepted, the sponsoring employer of the scheme should be in a better position to manage their future liability to the scheme.
Whilst this might appear a relatively straightforward decision for the member to make, forego an inflation proofed pension for a higher income now, as with many aspects of pension tax legislation it is never quite that simple, for there are areas of the legislation where a PIE impacts. In this, the first of two parts, I will consider how a PIE interacts with the annual allowance (AA).
The AA limits the amount of tax privileges available on pension savings paid to a registered pension scheme by, or in respect of, an individual in a tax year. The method used to calculate whether an individual will incur an AA charge, is to determine how much was saved from the start of the pension input period (PIP) to the end of the PIP; known as the pension input amount (PIA). This is measured against the individual’s AA, plus any unused AA carried forward, and if there is an excess the individual will incur an AA charge.
For active members of defined benefit arrangements the PIA is not, as first might be envisaged, the total monetary amount of contributions derived from the percentage of employer and employee contributions, but rather a notional contribution based on the increase in benefits accrued over the PIP.
In the PIP in which the individual is due to retire, any increase in the starting amount of their pension as a result of a PIE will mean that the closing value, as explained, will be higher; this means the PIE will be tested against their AA in that year.
However, it may be that at the time of the PIE the individual is a deferred member of the DB arrangement. For individuals who satisfy the definition of a deferred member contained in the legislation, they are treated as having no PIA amount for the particular arrangement, provided any increase in their benefits under the arrangement do not exceed:
• the ‘relevant percentage’, plus
• the ‘relevant statutory increase percentage’.
The relevant percentage may be set out in the scheme rules, and for the percentage to be applicable, it had to be part of the rules on certain dates:
• for ‘RPI based’ increases only, 6 April 2012, or
• for any other case, 14 October 2010.
Details for the ‘relevant statutory increase percentage’ can be found in the Pensions Tax Manual page PTM053920.
Ascertaining whether there is a PIA, or not, is a two-part test. Firstly, does the individual satisfy the definition of a deferred member and, secondly, has the increase in benefits remained within the percentages outlined. If they satisfy both criteria, this is referred to in the guidance as a ‘deferred member carve-out’ or ‘carve-out’ and there is no PIA.
A PIE offered to a member, whether this is in the PIP in which benefits are taken or not, who qualifies for the carve-out is likely to mean that the carve-out will cease to apply as the increase will in all probability exceed the relevant percentage. The resulting increase in the deferred pension will ‘generate’ a PIA to be measured against their AA in that particular tax year.
In the case of a retired member of a scheme, HMRC guidance stipulates that an individual, who retired in a previous tax year should not be subject to the AA due to the increase in the pension.
For most individuals there will be little consequence in accepting a PIE. However, advisers should be aware that for a minority, e.g. an individual also accruing benefits in another arrangement, there may be AA repercussions as the PIA generated by the PIE could exceed their AA.
In my next piece I’ll look at the potentially detrimental impact a PIE can have on individuals with certain forms of lifetime allowance protection.
This article first appeared on Money Marketing. Watch this space to read part two.