Finance (No.2) Act 2015


The Finance (No. 2) Bill 2015 (“the Bill”) received Royal Assent on 18 November 2015 and is now known as the Finance (No. 2) Act 2015 (“the Act”). The Act, which introduces a number of provisions that were announced by the Chancellor in his Summer Budget, contains key provisions relating to pensions.

In this Alert

Key points

  • There have been no material changes since the draft Bill was first published, but some errors and inconsistencies have been tidied up.
  • Tax on lump sums paid in respect of individuals who die aged 75 and over will be payable at the recipient’s marginal rate from the tax year 2016/17.
  • The Act will introduce restrictions on pensions tax relief for higher earners, using a tapering mechanism.
  • Employers and trustees should now start to consider the steps they will need to take in respect of these changes.

Taxation of pensions at death

As announced in the 2014 Autumn Statement, the tax rate that applies on certain lump sums paid on death will be amended from 6 April 2016.

Lump sum death benefits can be paid free of tax from a registered pension scheme if the individual was under the age of 75 when they died, subject to certain conditions. For example, such lump sum death benefits are tested against the deceased member’s LTA, so any excess could attract the LTA charge.  In addition, in order to be paid tax-free, the lump sum must be paid (under the trustees’ discretion) within two years of the date on which the scheme administrator (ie the trustees) first knew of the member’s death or “could reasonably have been expected to know”.  Otherwise it will be an unauthorised payment.

A tax charge of 45% currently applies in respect of lump sum death benefits where the individual dies aged 75 or over (prior to 6 April 2015, the tax charge was 55%). The Act will amend the legislation so that, with effect from 6 April 2016, tax will be payable at the recipient’s marginal tax rate, although the 45% rate will continue to apply in limited circumstances.

During its progress through Parliament, the Bill was amended to ensure that there will be no test against the LTA on a payment from a DB arrangement in respect of a member who died before age 75, if that payment would be taxable as a result of being paid outside the two-year period. The change has effect for lump sum death benefits paid on or after 6 April 2016.

The Tapered Annual Allowance

The Act sets out how pensions tax relief will be restricted for those with an “adjusted income” (ie taxable earnings including pension savings, but excluding charitable contributions) above £150,000.

From 6 April 2016, for every £2 of adjusted income over £150,000 an individual earns, that individual’s AA will be reduced by £1, subject to a maximum reduction to the AA of £30,000. Anyone with adjusted income of £210,000 or above will therefore have an AA of just £10,000. However, individuals with income, excluding pension savings, at or below a “threshold income” of £110,000 will not be subject to the new taper.

This means that, for the first time, “income” (and not purely pension savings) will be a factor in assessing an individual’s available AA. A member’s income for this purpose will include, amongst other things, income from employment and self-employment, as well as rental income, dividends, and interest payments.  It will therefore be difficult for employers (and trustees) to know exactly what a member’s income may be and therefore who will be affected by the tapered AA.  Individuals may also find it difficult to pin down their precise income until long after the end of the tax year.


The Act contains two key anti-avoidance provisions.

The first is designed to prevent income being shifted from one year to the next to avoid or diminish the effect of the tapered AA. This could be as a result of reducing the individual’s adjusted income and/or their threshold income for the tax year, the intention then being to redress that reduction in a subsequent tax year. HMRC will simply “look through” any arrangement which has this as its main (or one of its main) purposes.

The Act also includes provisions designed to prevent salary sacrifice arrangements established on or after 9 July 2015 (the day after the Summer Budget) being used to reduce threshold income below £110,000. Whilst it is clear that new salary sacrifice arrangements set up on or after this date will be caught here, employers may wish to check the status of annual renewals of existing arrangements with their legal advisers.

Transitional measures

In order to facilitate the introduction of the taper, the legislation aims to align the period over which pension savings are measured for the purposes of testing against the AA, known as the “pension input period” (PIP), with the tax year by April 2016. The Act therefore sets out transitional rules to protect savers from retrospective tax charges which might otherwise result from aligning PIPs in this way.

Under the transitional provisions, individuals will generally have an AA of between £40,000 to £80,000 inclusive for the 2015/16 tax year only. The transitional rules are complex and the exact amount of available AA will vary from individual to individual, depending on the amount of pension savings made in any PIP ending between 6 April 2015 and 8 July 2015 inclusive.

Money purchase AA

Individuals who flexibly access their pension savings become subject to an AA of £10,000 for DC pension savings (“the money purchase AA”). If the individual exceeds the money purchase AA, they then become subject to a reduced AA (of £30,000) in respect of any (DB) pension savings (known as the “Alternative AA”).

Where an individual is subject to both the new taper and the money purchase AA rules, his or her Alternative AA will be reduced accordingly.

What should employers and trustees do?

In advance of the new tapered AA coming into force, trustees should consider sending a general communication to members informing them about how the new tapered AA works, who will potentially be affected, and the transitional provisions being put in place for the 2015/16 tax year. This should ideally make it clear how “income” is assessed for the purposes of the taper.

Employers should take steps to identify which individuals are likely to be in the tapered AA danger zone, based on the individual’s earnings.  Employers should also discuss with their legal advisers whether any salary sacrifice arrangement could be caught for the purposes of assessing threshold income.

The options for limiting affected scheme members’ exposure to the tapered AA include capping pensionable salary and restricting pension savings (for example, to £10,000).  However, the employer’s automatic enrolment obligations will need to be borne in mind when exploring any options, together with the anti-avoidance provisions outlined above.

Trustees should also establish how their PIPs are affected by the transitional arrangements and whether this has a knock-on effect on any communications to members as to, for example, use of AA.

If you wish to discuss any of these issues with us, please speak to your usual Sackers contact.

Next steps

Related guidance, including HMRC’s technical note on the transitional measures in relation to the AA, is expected to be updated shortly.

As mentioned in our earlier Alert, some changes announced in the Summer Budget will be included in next year’s Finance Bill. These include:

  • the reduction of the LTA from £1.25 million to £1 million from 6 April 2016 and transitional protections for those with pension rights already over £1 million, and
  • measures to introduce the secondary market for annuities in 2017.

The first draft of the Finance Bill 2016 is expected in early December.