GMP guidance ‘helpful’ but ‘could have gone further’ on conversion

Pensions Expert reported on April 4 that the government had promised to publish additional guidance “in the coming weeks”, as the debate on the second reading of the pension schemes (conversion of GMPs) bill concluded in the House of Lords.

Although the Pensions Administration and Standards Association has published its own guidance around conversion, the industry has long called for HM Revenue & Customs to step in to clear up lingering concerns about the tax implications, as conversion exercises can potentially see members suffer tax penalties for breaching annual and lifetime allowance limits.

HMRC’s new guidance published on April 6 covers two topics: top-ups to past transfers and GMP conversion — one of the methods approved for equalisation, where schemes convert GMPs into normal benefits. 

Whilst some will see a glimmer of hope in relation to the reference to the 'potential for any legislative change', there is no certainty as to whether or when any such change will be made and therefore it does not assist those planning bulk conversion exercises now

Chris Widdison, PASA

Legislation needed soon on GMP conversion

The guidance acknowledged that the tax implications of conversion are “complex” and said that, while “work continues”, its aim was to “provide confirmation on those particular aspects of the pensions tax legislation where we can”.

It explained that, for members who are deferred or who have yet to retire, “there are likely to be impacts on the treatment of their annual allowance in the tax year of conversion, as well as in all subsequent tax years up to and including that of retirement. 

“For example, in the tax year of conversion, even if there’s no other change in the member’s benefit entitlement, the removal of the GMP rules may cause the loss of the member’s deferred member carve-out and result in a pension input amount calculation for the tax year, as well as for subsequent tax years”.

It added that it would need to “undertake further work in this area to determine the appropriate outcome and treatment, and the potential for any legislative change”.

Where deferred members are concerned, HMRC also acknowledged that conversion "may also cause the loss of fixed protection", where a saver's lifetime allowance is secured at a certain level.

This is because fixed protection is lost if, at any time in a tax year, a member’s benefits increase by more than a certain amount, HMRC explained.

“Therefore, schemes wishing to use the conversion method should consider the tax implications that may arise for these members in accordance with the existing legislation.”

Pensioner members and those who left pensionable service before April 2006 benefit from greater clarity, and HMRC set out their expected pensions tax position in detail.

For pensioner members, conversion of their benefits would not constitute benefit accrual for annual allowance purposes and so there is “no pension input amount”, while conversion would likewise not impact fixed protection providing all benefits have been crystallised.

It could constitute a benefits crystallisation event for lifetime allowance purposes. These occur when pension in payment increases beyond a permitted margin.

Meanwhile, for pensioners that have recently retired, and where conversion takes place in the tax year of retirement, conversion would still not impact the annual allowance and likewise has no impact on whether the deferred member carve-out applies to the member in that tax year.

HMRC added: “We continue to work through the pension tax issues associated with the GMP conversion method with our Industry Working Group. We will provide further updates in future pension schemes newsletters.”

LCP partner and head of GMP equalisation Alasdair Mayes said: “Trustees will be breathing a sigh of relief that HMRC agree for most members there will not be adverse tax consequences in using GMP conversion to equalise for GMPs. This means that trustees won’t need to seek clearance from HMRC on a scheme-by-scheme basis, saving time and money. 

“The fact that there can be pensions tax issues for some non-pensioners isn’t a surprise. These need to be addressed. What is great news is the suggestion that HMRC are considering the potential for legislative change to resolve the annual allowance issues that can arise.”

Simon Pariser, senior actuarial consultant at Willis Towers Watson, likewise welcomed the government’s apparent intent to legislate on the tax question, but stressed that it “needs to happen quickly". 

“Trustees want to implement the right GMP solutions for all of their scheme members, and HMRC’s latest guidance, together with the GMP conversion bill, move them closer to being able to do so,” he explained.

Chris Widdison, member of PASA’s GMP equalisation working group, was more cautious, however, telling Pensions Expert: “Whilst some will see a glimmer of hope in relation to the reference to the 'potential for any legislative change', there is no certainty as to whether or when any such change will be made and therefore it does not assist those planning bulk conversion exercises now.”

Tom Yorath, Aon’s head of GMP equalisation, suggested the guidance “could have gone further” on conversion, adding that the current tax framework “does not cope well with changing a member’s pension benefits before they have reached retirement. Put simply, it’s the unhelpful consequence of the interaction between two complex areas".

“In our view, legislative change is needed to navigate a simple path through these issues. The challenge is that these are complex areas and there isn’t necessarily a straightforward fix that avoids further unintended consequences.”

Guidance will save trustees 'time and money'

The other half of the guidance concerned top-ups to past transfers, explaining how top-up transfer payments must fit within the definition of a recognised transfer.

The guidance states that top-up payments constitute an accrued right, and that members whose only accrued rights in a transferring scheme is the right to a top-up payment are classed as deferred members for tax purposes.

Registered pension schemes can make lump sum payments of up to £10,000 as an authorised payment, subject to conditions laid out in regulation.

These payments can only follow what is termed 'relevant accretion', which occurs when “the scheme administrator is not regarded as having been aware at the time of the original transfer payment (and is not regarded as reasonably expected to have been aware) that the member was entitled to a benefit under the transferring scheme,” the guidance explains. 

Payments must be made no later than six months after the accretion occurred to qualify as an authorised payment, the six-month period beginning “when the scheme administrator has established that the member has an actual entitlement to a top-up payment and the amount of that payment". 

Payments after relevant accretion are not available in relation to pre-April 2006 transfers, however.

WTW's Pariser said: “Trustees now have a pragmatic way of addressing GMP equalisation for most members who have transferred out their benefits where a further transfer is impossible, impractical, or inefficient to arrange. We hope that HMRC’s further work on potential legislative change includes resolving the barrier to transfers made prior to April 2006.” 

On the tax issue, the right to a top-up transfer payment is classed as an uncrystalised right.

Where payment is made with respect to an uncrystalised right, tax is due on 75 per cent of the lump sum but not on the remaining 25 per cent. Where the lump sum is paid to another person following the member’s death, the lump sum is wholly taxable.

“No further annual allowance implications arise where action is taken by scheme administrators to reflect those adjusted benefits in cases where an individual has previously taken a transfer in relation to their unadjusted benefits, such as where a top-up transfer payment is made or a lump sum is paid to extinguish the right to a top-up transfer payment,” the guidance explains.

Transitional protections, where they exist, may continue to apply in the case of block transfers, but paying an additional transfer for a member “could result in a loss of fixed or enhanced protection if the additional transfer is not a permitted transfer”.

LCP's Mayes said: “GMP equalisation is a complex topic and guidance has been urgently needed to help pension trustees and sponsors navigate two really important pension tax issues, around transfer value top-ups and conversion. This guidance from HMRC is really valuable and will save trustees time and money.”