When the concept of a pension input period (PIP) was first introduced as part of the ‘A-Day’ pension taxation regime in April 2006, an opportunity was arguably missed by HM Revenue & Customs (HMRC), to align all PIPs with the tax year.
Instead, a host of PIP permutations were permitted by HMRC; thereby precipitating complication and confusion among individuals, particularly where concurrent pension arrangements each had different PIP-end dates.
Another opportunity was then (partly) missed by HMRC in April 2011. Even though all new pension arrangements opened after 5 April 2011 had a default PIP-end date of 5 April, legislation still allowed an individual to override this, as well as offering scope to make the PIP-length less than, or greater than, a year.
Consequently, confusion continued to reign; particularly with the added complexity of ‘carry-forward’.
But finally, as part of this year’s Summer Budget, the Chancellor has announced that, with effect from 6 April 2016, all PIPs will be aligned with the tax year; both for defined contribution and defined benefit pension arrangements.
Arguably ten years too late, this should make dealing with PIPs far, far easier than has been the case previously.
Before then, however, scheme administrators, advisers and their clients are all going to have to get to grips with a raft of complicated transitional provisions for aligning PIPs to the tax year.
A tale of two PIPs
To date, one of the ‘golden rules’ concerning PIPs is that an individual pension arrangement must not have more than one PIP ending in a particular tax year.
This is because a PIP measures the total amount of contributions paid into that pension arrangement, and compares it with the prevailing annual allowance (AA) for the tax year in which it ends, to see if an excess tax charge has arisen.
Immediately after George Osborne concluded his Budget speech, HMRC released technical note Pensions: Transitional provisions for aligning pension input periods.
And one of the most prominent announcements within it was that, in order to achieve the realignment, the 2015/16 tax year will be split into two ‘mini-tax years’ – called the ‘pre-alignment tax year’ (PrATY) and the ‘post-alignment tax year’ (PoATY) – with the PrATY ending on 8 July 2015 (Summer Budget day) and the PoATY running from 9 July 2015 to 5 April 2016.
This means, therefore, that all existing pension arrangements will have at least two – and possibly three – PIPs ending within the 2015/16 tax year; a complete change from the ‘golden rule’ outlined above.
And then, with effect from 6 April 2016, all PIPs will be aligned with the tax year, with no opportunity to vary the length of a PIP, as has been the case to date.
Suffice to say, the provisions are detailed and complex, and best read with a large gin and tonic within easy reach
On my initial reading of the 17-page technical note, my first thought was, “this has not been peer-reviewed”, as it contained a number of typographical errors, and some of the sentences appeared to contradict others.
Indeed, one main question appeared unanswered to me; namely, did the technical note apply to those whose PIPs are already aligned with the tax year?
After all, they don’t have to go through a transitional process; they’re already where HMRC want them to be.
And yet, the document refers to “everyone” and where this is most important is with respect to the AA amounts within the two mini-tax years.
Whereas the AA for the PoATY is nil, the AA for the PrATY is £80,000.
This is because, for those individuals whose PIP is not aligned to the tax year, it is perfectly possible for them to have contributed two gross amounts of £40,000 (the prevailing AA) within the PrATY before the Summer Budget, based on the ‘golden rule’ belief that the two amounts would be allocated to two separate tax years.
Therefore, if HMRC did not allow an AA of £80,000 within the PrATY, those individuals would be possibly faced with an excess tax charge on £40,000 which would be grossly unfair, as they were basing their contributions on the legislation that prevailed at the time.
Another feature of the transitional rules is the possibility to carry forward up to £40,000 of the AA from the PrATY into the PoATY, depending on how much has already been contributed within the PrATY.
And – because the rules apply to “everyone” – someone with their PIP already aligned with the tax year could unexpectedly find themselves in a ‘double dip’ scenario, where they have already contributed £40,000 gross within the PrATY, in the expectation that any further contributions couldn’t be made until the next tax year (and I’m purposefully ignoring carry forward here).
Instead, they now have the potential to contribute a further £40,000 into their pension arrangement, during the PoATY, with no adverse tax consequences. This may be of particular interest to ‘higher earners’ (see below), who are keen to maximise their contributions, before the tapering of their AA commences from 6 April 2016.
My initial suspicions about the haste in which the technical note was cobbled together were reinforced when HMRC released their “Pension Schemes Newsletter 70” a few weeks later.
This creates a frustrating scenario for advisers and providers when explaining the provisions to their clients
Contained within it were “…a few changes to the technical note as first published”; namely, the correction and embellishment of certain parts of it, and an additional example (“Example 11A”), which – finally – clarified those sentences within the original document that had caused much head-scratching amongst Advisers and providers since Summer Budget day. Initial inclusion of it would have undoubtedly helped.
And space does not allow me to go into detail about the transitional provisions for defined benefit and cash balance arrangements, or for those who – having flexibly accessed their benefits this tax year – are now subject to the money purchase annual allowance.
Suffice to say, the provisions are detailed and complex, and best read with a large gin and tonic within easy reach.
The final point to note is that the legislation which underpins the transitional provisions is still in draft form and, therefore, liable to change until the point where the Finance Bill (No. 2) 2015 receives Royal Assent, which is anticipated to be later this year.
This creates a frustrating scenario for advisers and providers when explaining the provisions to their clients, who are probably keen to know how much they can contribute and by when, as there is currently a risk that, should the draft legislation change during its passage through parliament, unanticipated tax consequences may follow. The need to caveat advice and guidance at the current time is, therefore, paramount.
As promised in the introduction, the reason why all PIPs are being aligned to the tax year, is because of another (widely-trailed) Summer Budget proposal ; namely, the proposed tapering of the AA for – as the government are keen to call them – ‘higher earners’.
From 6 April 2016, individuals with income in a tax year of over £150,000 will have their AA reduced by £1 for every £2 of income that they have in excess of £150,000, up to a maximum tapering of £30,000, which means that those with income of £210,000 gross per tax year, will then be limited to a maximum AA of just £10,000.
And, as an individual will need to know what their income and, by default, their tapered AA is before making a new contribution, their PIP will need to be aligned to the tax year in order to achieve this.
The technical note defines two measures of income, in order to ascertain if an individual’s AA will be subject to tapering; namely, “adjusted income” and “threshold income”.
If an individual’s adjusted income for a tax year exceeds £150,000 their AA will be tapered, using the formula outlined above.
However, if an individual’s threshold income is £110,000 or less, their AA will not be tapered.
Complex sums are outlined to enable the two types of income to be calculated but, in essence, adjusted income includes the value of all pension contributions, while threshold income excludes them.
If enacted, the tapering mechanism will undoubtedly add further complication, and an unintended consequence may be to turn those higher earners away from contributing to pensions altogether (and worse still, reduce their willingness to promote generous pension arrangements to their employees).
In conclusion, clients will be looking to their advisers to help steer them through this extraordinary tax year, and the possible tapering landscape beyond, as someone will need to help them keep tight control over their PIPs.
Where’s Gladys Knight when you need her?
James Jones-Tinsley is self-invested pensions technical specialist at Barnett Waddingham