Key points

• The changes are big news and are very likely to trigger enquiries to trustees from scheme members as well as to employers from workers in group personal pension arrangements. Consider providing an outline of the changes, together with information about how individuals can plan to avoid the impact of future tax charges: contact us for a straightforward factsheet you can customise and use today.
• Employers: do any future pay offers or early retirement/termination/redundancy packages need to be revised in light of the changes. Depending on when your scheme year starts for this purpose, this could have an impact on payments from 6 April 2013 onwards.
• Trustees: do you need to check whether your 'scheme pays' processes (where the member's tax is paid by the scheme) remain appropriate? Are your administrators prepared for a potential increase in enquiries and scheme pays requests from members?
• The standard lifetime allowance will be reduced from GBP1.5 million to GBP1.25 million, also from 2014/15, with a 'Fixed Protection 2014' regime being introduced for those who believe they may be affected by this reduction.

What has the Chancellor announced?

George Osborne announced in this afternoon's Autumn Statement that the maximum amount of tax-relieved pension saving in any 12-month pension input period (PIP) is to be reduced from the current GBP50,000 to GBP40,000 from 6 April 2014, and that the lifetime allowance will be cut to GBP1.25 million at the same time. Yet another transitional protection regime, 'Fixed Protection 2014' will be introduced to help those affected by the reduction from GBP1.5 million. Further details will be published on 11 December.

Who will it affect?

Billed as reducing tax incentives for the rich, the change has the capacity to affect a much wider range of members, particularly in defined benefit (DB) schemes. For example:

• In DB schemes, a multiplier of 16 is used to calculate accrual, so an increase of anything over GBP2500 in a member's promised level of pension between the start and end of a PIP could in future trigger a tax charge. Depending on the member's length of service, a pay rise or promotion could easily do this, unless they can carry forward any unused annual allowance from previous years.
• DB members who receive any kind of enhancement – on redundancy, early retirement or ill-health, for example – are particularly vulnerable to potential tax charges. Accrual in a PIP is counted for the tax year in which the PIP ends, so the entire value of the uplift will be taken into account in a single year.
• There's a particular issue to watch for DB members taking ill-health early retirement. There's an exemption from the annual allowance test where a member retires due to severe ill-health, but this only applies if they are unable to work in any capacity. Your scheme rules may be less strict – it's common to permit incapacity retirement where a member cannot do their own job (or a suitable alternative offered by the employer). If a member qualifies under the scheme rule but is still capable of working in some capacity, the annual allowance test will apply. An ill-health enhancement (for example, basing the pension on assumed years of service up to normal retirement date) could then result in a significant tax liability.

Members of defined contribution (DC) schemes who are looking to bump up their pension savings, perhaps because they are close to retirement or want to contribute a lump sum from a redundancy payment, could also be affected.

When does the change apply?

Although the new GBP40,000 limit comes into effect for the tax year 2014/15 onwards, it could effectively apply to some schemes and members from 6 April 2013. This is because tax is charged based on the tax year in which the PIP ends. Many schemes have aligned their PIP with the tax year, so would keep an allowance of GBP50,000 for the current PIP and for 2013/14. However, where the end date of the current PIP is 6 April 2013 or later (that is, in tax year 2013/14), a GBP40,000 limit will apply for contributions or accrual from the start of the next PIP.

Mitigating the tax impact

A member can roll forward any unused annual allowance from the three previous tax years (provided he or she was a member of a registered pension scheme during those years). For many members, this flexibility could offset the immediate impact of the new restriction, but the scope for rolling forward will diminish as the new GBP40,000 annual limit takes effect year on year.

The ability to offset the charge against pension benefits via the 'scheme pays' regime will soften the blow for members, but is likely to increase costs and administrative burdens for schemes.

Do you need to inform members?

Scheme administrators are required to inform members if they exceed the annual allowance in relation to their scheme by 6 October following the end of the tax year. You'll need to ensure that your systems are updated appropriately to take account of the change.

Members can also ask for details of their pension savings (contributions and/or accrual, as appropriate) in the current and previous three tax years, and this information must be supplied within three months. Remember that the annual allowance applies to savings across all of a member's arrangements, so members may request a statement even if they are not close to the annual allowance in relation to your scheme.

As the change is not being made until the 2014/15 tax year, it's unlikely to have an immediate impact on, for example, any incapacity retirements currently in process, or for members who are considering early retirement or redundancy options. However, if your scheme PIP dates mean that members will be affected by the change sooner rather than later, you should keep an eye on this issue. The Pensions Ombudsman has in the past found employers and trustees guilty of maladministration where they have failed to act urgently in the face of key deadlines (for example, processing an ill-health retirement application before 6 April 2013 if that makes a difference to the member). Remember that a comparatively small uplift in defined benefit rights, when multiplied by the factor of 16, will give rise to an increase in excess of the GBP40,000 limit.

Wider impacts for employers and trustees

Future pay increases or promotion packages might need to be restructured to take account of the changes: a pay offer or early retirement/termination/redundancy package may look much less attractive in light of a potentially significant tax charge.

The media may be overly alarmist in suggesting that this restriction (with its consequent increase in the cost and complexity of scheme pays processes) could push some employers into closing their DB schemes entirely. However, employers who are considering scheme design changes to limit their potential exposure (for example, by capping pensionable pay) might find that the restriction reduces the impact of scheme changes for some members, as it could help them avoid major tax bills in the future. Contact us if you would like to discuss scheme design options further.

Employers with DC schemes also have an interest in avoiding the possibility of non-tax-efficient contributions to the scheme, to ensure that members know they are getting the maximum value for your employer spend. Options might include, for example, capping contributions at the level of the annual allowance, capping pensionable pay or revising flex structures on the next renewal date.

For trustees, a wider review of scheme pays processes could be required: the process and deduction methods you originally chose may need to change to take the needs of a wider band of members into account.

For more information on any of the above, please get in touch with your usual Allen & Overy pensions team contact. We'll update you on other aspects of today's Autumn Statement, including the restriction of the lifetime allowance to GBP1.25 million and the new protection regime, when more details are available.

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