Clause 65 - Benefits under pension schemes

Finance (No. 3) Bill – in a Public Bill Committee at 5:30 pm on 7th June 2011.

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Question proposed, That the clause stand part of the Bill.

Photo of Jimmy Hood Jimmy Hood Labour, Lanark and Hamilton East

With this it will be convenient to discuss, That schedule 16 be the Sixteenth schedule to the Bill.

Photo of David Hanson David Hanson Shadow Minister (Treasury)

Thank you, Mr Hood, for facilitating discussion of the clause and the schedule at the same time. That is helpful, because they are inextricably linked.

The clause and the schedule amend part 5 of the Finance Act 2004 as it relates to certain tax rules for registered pension schemes that apply to individuals reaching the age of 75. From 6 April 2011, the effective requirement to buy an annuity by the age of 75 will be removed and the alternatively secured pension rules will be repealed. Individuals will be able to leave their pension funds invested in a draw-down arrangement and make withdrawals throughout their retirement, subject to an annual cap. The maximum withdrawal of income that an individual can make from most draw-down funds on reaching minimum pension age will be capped at 100% of the equivalent annuity that could have been bought with the fund value. That is what I want to explore with the Minister.

The maximum capped amount will be determined at least every three years until the end of the year in which the individual reaches the age of 75, after which reviews to determine the maximum capped withdrawal will be carried out annually. Individuals who can demonstrate that they have a secure pension income for life of at least £20,000 a year will have full access to their draw-down funds without any annual cap, which is the key point that I want to discuss with the Minister.

The tax rules require that tax-relieved pension savings must be used to secure an income by the age of 75. That requirement is intended to ensure that pension savings accumulated with the help of tax relief are used to provide an income on retirement. That is a sensible approach to ensure that they are used appropriately, because they have been accumulated with help and support from the state.

Most members of defined contribution schemes secure a retirement income by buying an annuity. Until now, members of defined contribution schemes who do not  want to buy an annuity have been limited to two options: before the age of 75, an unsecured pension arrangement that enables individuals to leave their pension fund invested while drawing down an income, or after the age of 75, an alternatively secured pension arrangement, which is similar to the previous example, but with a lower maximum draw-down limit.

Under the new rules, the concepts of unsecured pension arrangements and alternatively secured pension arrangements will disappear, and there will be a single alternative to an annuity, which is the draw-down pension. The key point about that, which I want to develop with the Minister, is that the maximum withdrawal of income that an individual may make from most draw-down funds will be capped at 100% of the equivalent annuity that could have been bought with the fund value. However, individuals who can demonstrate that they have a secure pension for life of at least £20,000 a year will have unrestricted access to receive their draw-down fund as pension income.

The issues are quite simple. I would welcome some assessment from the Minister of how many pensioners have a guaranteed income of £20,000 a year for the rest of their life. Under the clause, pensioners with that guaranteed income have a beneficial ability to draw down funds from their pension scheme. For everyone else, the amount that they draw down—take out of their pension fund—will have a cap of the equivalent annuity that could have been bought with the fund. In other words, they will be no better off than if they had been forced to buy an annuity.

I want to get some idea from the Minister of how many pensioners he believes will make use of the provisions that allow them to draw down funds based on their income of £20,000 a year. I would also like him to give some indication of the effect that these changes will have on the proposals for saving generally. The Government recently consulted on giving people early access to their pension savings and, as a recent press release from the Treasury states, this is their conclusion:

“While early access has some merits, there is insufficient evidence that to suggest it would act as an incentive to save more into pensions.”

Although I accept that early access to pensions is a different question from using the annuity, the two are obviously related, and the Government have said that there is no evidence that using the annuity will encourage any more saving in pensions either. As well as asking the Minister for his assessment of the number of individuals who will be able to access income of £20,000 a year—not only now, but years hence—I wonder what evidence he has that the proposals will help savings in general to be increased still further.

A third concern is whether these proposals, as they are developed, could be used for avoiding inheritance tax. That is a charged issue and, dare I say it, there are potential differences between the three Liberal Democrat members of the Committee and the Conservative party on the question, although the coalition agreement will smooth those things over for the moment, and the Liberal Democrats will undoubtedly support the proposals today. However, for the benefit of the three Liberal Democrat members of the Committee, I shall explain the potential impact of the clause on inheritance tax.

Ministers have clearly said that they do not want to charge inheritance tax on funds that remain on death and have removed some inheritance charges, but because people would no longer be required to buy annuities there is a risk that the changes could provide a straightforward avoidance route. It is possible that wealthy people could put assets into pension funds, with the usual tax benefits, and leave them there until they die, when they would be passed on to the children with no inheritance tax charge. I would welcome the Minister’s comments on the question of inheritance tax as it relates to the pension proposals before the Committee.

Schedule 16 introduces a tax charge of 55% on lump sums left in pension pots at death by those over the age of 75. That is calculated to be the equivalent of the 40% inheritance tax charge, with an additional 15% to take account of the tax relief given on pension pot accumulations. However, the amount of tax relief can vary hugely, depending on people’s circumstances. The 55% rate will therefore over-recover tax from some and under-recover tax from others. Will the Minister give his view on the impact of the clause on inheritance tax avoidance?

The schedule also provides us with the opportunity to consider inheritance tax generally, on which subject there is a difference between the Liberal Democrats and the Conservative party. When I last counted there were 41 pages of legislation—it may have grown slightly since then—but I believe that those provisions will benefit a few of the wealthiest people while doing little or nothing to encourage more saving.

My questions are as follows. How many people do the Government believe will benefit from the change? Will the Minister put my mind at rest, and tell me that it will not be only the wealthiest? Does he believe that more pension saving will take place, and if so will he give us some evidence of how the measures will encourage pension saving?

Why is there no inheritance charge tax on assets left at death? I give the Minister the benefit of the doubt, but will he assure me that it is not a deliberate attempt to leave a loophole open? I would welcome his explanation of why inheritance tax is not to be charged on assets left at death. That would be in line with the normal use of inheritance tax, and I am sure that the three Liberal Democrat members of the Committee would not wish to encourage inheritance tax loopholes.

What assessment has the Minister made of the impact of lifting the inheritance tax threshold to £1 million, given the incentive for these changes? Is it still the Conservative party’s intention to do that, or has it been sacrificed with trade-offs with the Liberal Democrats? On page 75 of the consultation document, the Government admit that the 55% charge will over-recover tax from some and under-recover tax from others. Does the Minister intend that to be the position? Why have the Government not done anything about those particular issues?

In summary, there are some general questions on which the Minister should reflect to see whether he can satisfy the concerns that have been expressed to me by colleagues both inside and outside the House.

Photo of Mark Hoban Mark Hoban The Financial Secretary to the Treasury 5:45 pm, 7th June 2011

Let me give some further background to the clause before I deal with the right hon. Gentleman’s questions. He will be aware that this has been a hotly  debated topic. It was raised many times in the previous Parliament and not just by Conservative Members in this House and the other place. I recollect that Baroness Hollis, who was a social security Minister under the previous Government, was also a champion of the end to compulsory annuitisation. The requirement to secure an income by the age of 75 has existed since 1976. At that time, the average life expectancy of a healthy 65-year-old male was 13 years. The life expectancy of a healthy 65-year-old male has now increased to 21 years. For a female, it is currently 24 years. As longevity continues to increase and people work for longer, the existing rules will become more restrictive for an increasing number of people. We believe that people should have more say over how and when they use their pension savings to provide an income in retirement.

Removing the requirement to annuitise at the age of 75 will make the tax system simpler by avoiding unnecessarily restrictive and outdated rules. Together with the changes in clauses 66 and 67, this will ensure that the pensions tax regime is both fair and sustainable. It will also give individuals, employers, providers and schemes appropriate flexibility to make arrangements to suit their circumstances and preferences.

Let me set out the changes that have been made by this clause. They will primarily benefit those people who have to find contribution schemes. Let me highlight four types. Individuals with defined contribution pension savings who have yet to take a pension will be able to defer taking benefits from their scheme rather than having to buy an annuity at age 75. Individuals who wish to leave their pension fund invested as part of an income drawdown arrangement will be able to do so beyond the age of 75 subject to the annual drawdown limit to which the right hon. Gentleman referred. Individuals with a lifetime pension income of at least £20,000 a year, known as a minimum income requirement, will be able to gain access to their drawdown pension funds with no cap on the withdrawals that they make. That is known as the flexible drawdown. The age 75 ceiling will be removed from most lump sums to which a member is entitled.

The detail of these changes were subject to extensive consultation last summer. We received 185 responses from a wide cross-section of individuals, pension professionals, advisers, trade bodies and academics. The consultation highlighted the clear preference of most respondents for the new rules to achieve their objectives of minimal complexity, and we listened carefully to those requests.

Simplicity underpins many of the key elements of the clause under debate today. In particular, a single level minimum income requirement will be applicable at all ages, before someone can access flexible drawdown. Where someone is not on flexible drawdown, there will be a single annual withdrawal limit. There will be a single recovery charge on unutilised funds remaining on death of 55%. As the right hon. Gentleman said, the recovery charge can be as high as 82% for those above the age of 75. Perhaps he should also have mentioned that lump sum death benefits relating to individuals who die before the age of 75 and before taking a pension are tax free. Lump sum death benefits relating to individuals who die before age 75 after taking a pension are liable to tax at 35%. That is under measures put forward by the right hon. Gentleman’s Government  when they were in office. Therefore, rather than having no tax, or having tax paid at 35% or up to a rate of 82% on an unutilised pot at death, we have moved to a single tax rate of 55%. I must say that I have received much correspondence from colleagues suggesting that the 55% rate should be reduced, and their constituents have written to them asking for lower rates to be introduced, but I believe that 55% achieves the right balance, and let me say why.

By setting the charge at 55%, we have sought to recover the amount of relief received by a typical individual who may be subject to the charge. The governance modelling suggests that a 55% charge would ensure that there are no tax advantages for pension death benefits compared with other assets on which inheritance tax is payable. Accordingly, it is not appropriate to levy inheritance tax on top of the recovery charge. We recognise that most of the people who will take advantage of the measure will be those who paid the higher rate of tax, and a 55% rate is, therefore, applicable. That would lead to cases in which people received tax relief at the basic rate of an over-recovery, but it is better to have a single simple rate, rather than a variable rate that depends on the rate of tax someone may have paid at some point in their life as they built up their pension pot.

The single rate is appropriate. It means a higher tax charge for those who die before the age of 75 and a slightly lower tax charge for those who die afterwards, but it ensures that the tax relief that the Government have given to encourage people to build up a pension pot is actually fully recovered at the point of death. That is the right way to do it. Of course, if the unutilised pot is used to provide a pension for a dependent, which may be a spouse or a minor, that will be tax-free, as is the case at the moment. That is the right level of protection to ensure that tax relief is recovered by the Government.

The right hon. Gentleman asked about the take-up for the measure, and our assessment is that up to 200,000 individuals currently in a draw-down arrangement could initially benefit from not having to purchase an annuity at age 75. Around 50,000 individuals currently in a draw-down arrangement could initially benefit from flexible draw-down. A further 12,000 individuals a year may be able to access flexible draw-down in a steady state. Recent independent estimates by the Pensions Policy Institute suggest that up to 700,000 people currently between 55 and 75 could benefit from not having to purchase an annuity, and that includes individuals who have uncrystallised pension savings. PPI also estimated that some 200,000 people currently between 55 and 75 could benefit from the flexible draw-down.

The initial Government estimates were published in the tax information and impact notes of 9 December 2010. One of the reasons why there is so much appetite for the measure out there is not so much to address the challenges faced by pensioners today, but, as we all recognise, rather that there has been a significant shift from defined benefit to defined contribution schemes over recent years, and the proposal ensures that people who are in DC schemes can benefit from increased flexibility in the future. They may decide that they want to work for longer. They may wish to put off the date of retirement and not to be required to buy an annuity.  They may have a complex mixture of assets in retirement. By bringing forward the measures, we want to ensure that they are given the maximum flexibility while safeguarding the interests of the taxpayer more broadly.

I must say that I have had correspondence from a whole range of people—from the self-employed to high earners—who are keen about the proposal, because they believe that it will encourage them to save more for the future. They resent having to buy an annuity at 75. They want the flexibility that the measure brings to give them more control over their pensions and their savings. That is one of the themes that run through the Government’s approach to reforming pensions and savings. We want to give people more flexibility not only in the way they accumulate their pension savings and their savings more generally, but also in the way they use the pension pots that they have built up when they have chosen to retire. This measure captures the right balance, ensuring that taxpayers’ interests are safeguarded by clawing back the tax relief given. It also ensures that people have some choice and control over their savings. It will in the long term prove a further reason for people to build up savings.

Question put and agreed to.

Clause 65 accordingly ordered to stand part of the Bill.

Schedule 16 agreed to.