RPSM06109050 - Technical Pages: Annual allowance: April 2011: Paying the tax charge: Scheme pays a member’s annual allowance charge - Adjustment to the member’s benefits
Adjustment to the member’s benefits
[S237E FA04][SI 2011/1791 The Registered Pension Schemes (Modification of Scheme Rules) Regulations 2011]
Where a scheme pays the member’s annual allowance charge, then the benefits for the member must then be reduced by a corresponding amount.
The following, except where specifically noted otherwise, applies whether the adjustment is made to benefits because the member has elected to require the scheme to pay an amount of annual allowance charge or where the scheme is paying an amount of annual allowance charge on a voluntary basis.
RPSM06109030 has more details about when a member can elect to require a scheme to pay an amount of annual allowance charge, or ‘scheme pays’, and when a scheme might decide to pay an amount of annual allowance charge on a voluntary basis.
The form of this adjustment will depend on the type of arrangement in which the adjustment is being made.
Where the adjustment is being made in an other money purchase arrangement, the adjustment will reduce the overall amount of the fund from which the member’s benefits will be provided. Where the adjustment is being made in a defined benefits (or cash balance) arrangement, the adjustment will be to the benefits that the member has accrued under the arrangement. For a hybrid arrangement the different natures of the arrangement types underlying the hybrid arrangement would have to be considered in order to come to an appropriate adjustment.
Note that the annual allowance charge might arise from benefits in one arrangement under the pension scheme but the reduction is applied to benefits be in a different arrangement (and possibly an arrangement of a different type) under the scheme.
Provided the adjustment to benefits complies with the tax law requirement (see next section Just and reasonable adjustment), the adjustment to the member’s benefits will be allowed under DWP regulations which provide an exemption from the inalienability and forfeiture provisions in the Pension Act 1995. In addition, where a pension scheme has a specific rule that means that the member’s benefits cannot be reduced in this way, HMRC regulations nevertheless allow a scheme to make the consequential reduction to benefits without having to modify their scheme rules.
Just and reasonable adjustment
The scheme must make sure that the adjustment made to the member’s benefits is just and reasonable, having regard to normal actuarial practice. HMRC would expect a scheme to be able to demonstrate that the adjustment made was just and reasonable.
Where the adjustment is not just and reasonable (or no adjustment is made at all) the payment of the annual allowance charge on behalf of the member by the pension scheme would be an unauthorised member payment. RPSM04104010 has details about the taxation of unauthorised member payments.
Effect on death benefits and dependants’ benefits
When a scheme pays the member’s annual allowance charge a ‘just and reasonable’ adjustment must be made to the member’s benefits under that scheme.
Such an adjustment might be designed to be made to the member’s own pension alone or the adjustment could apply both to the member’s own pension and to the amount of death benefits that could be paid under the member’s arrangement on the member’s future death. However, it is not possible to apply a reduction to such contingent dependants’ benefits or other death benefits alone to pay the member’s annual allowance charge.
Where the reduction is being made in an other money purchase arrangement, the reduction in the fund value could have an effect on the amount of death benefits that could be paid under the member's arrangement.
In the case of defined benefits arrangements when there is an attaching contingent dependant’s pension payable on the death of the member the value of that dependant’s pension might be considered as part of the overall value of the member’s benefits. Typically this might be the case when there is a dependant’s pension which is a percentage of the amount of pension that the member was receiving or would have received at the time of their death.
For example, suppose the member’s pension before any reduction to take account of the tax paid on behalf of that member is £10,000 per annum and the surviving spouse, on death of the member before or after retirement, will receive a pension of £5,000 per annum (50 per cent of the member’s pension).
An example of a ‘just and reasonable’ adjustment might be (depending on the actuarial assessment of the figures) where the reduction to take account of the tax paid is one of the following
- the member’s pension alone is reduced to £8,750 per annum with the contingent surviving spouse pension remaining £5,000 per annum, or
- the member’s pension is reduced to £9,000 per annum and the surviving spouse pension is reduced to £4,500 per annum.
In the first case, the value of the reduction in the member’s pension is taken into account when judging whether (using normal actuarial practice) the reduction is just and reasonable compared to the tax paid. In the second case, the value of the reductions in both the member’s pension and pension payable to the spouse contingent on death of the member are together taken into account when judging whether the reductions justly and reasonably match the tax paid.
It would not be possible to agree a reduction to a lump sum that might otherwise be payable on the member’s future death.
Timing of the adjustment
Other than the requirement for there to be a just and reasonable adjustment to the member’s benefits, the tax rules in relation to annual allowance charge payments where the member has elected to require the scheme to pay (‘scheme pays’) do not place a requirement on when the adjustment must be made relative to when the tax has been paid. It might be decided by the scheme administrator to make the adjustment before the tax is actually paid over to HMRC by the scheme administrator, at the same time as the tax is paid or after the tax is paid. (Note that there may be a timing requirement related to other issues which might limit the timing of the adjustment - for example it might only be possible to make the adjustment at the time the tax is paid.
If it is decided that the adjustment will be made only at a future event, such as leaving pensionable service early or at retirement, consideration will need to be given to ensure that an adjustment can actually be made to the member’s benefits - in case the member dies before the event at which the adjustment would otherwise be made. Once the member has died, and benefits fall due to recipients, new deductions cannot be arranged from actual dependants’ pensions that arise as there would not have been the required adjustment to the member’s benefits.
What happens if the member dies between asking the scheme to pay and the scheme actually paying?
This depends on whether the pension scheme actually made an adjustment to the member’s benefits before they died.
If the pension scheme had made the adjustment to the member’s benefits before they died, even though the scheme had not yet paid over any tax to HMRC, the scheme can continue to pay as the member gave notice to their scheme before their death.
If the scheme had not made the adjustment before the member’s death it might not be possible for the scheme to continue with the member’s request. This is because the tax rules require that an adjustment must be made to the member’s benefit entitlement when the scheme pays an amount of annual allowance charge on their behalf. If it is impossible for the pension scheme to meet this requirement it can ask HMRC to be discharged from the requirement to pay the amount of tax the member asked it to pay before their death.
The member’s estate would then have to account for the full amount of the annual allowance charge liability that the member had before their death.