Can Drawdown Arrangements be Merged?
There has been much debate between scheme administrators over the possibility of merging drawdown arrangements. I have had occasion to correspond with HMRC in respect of this point and after seven months of toing and froing, and many chasers, I have at last received a response, albeit a partial one.
HMRC’s position is as follows:
It is not possible to merge capped drawdown arrangements, both before and after age 75. This is confirmed in the wording of Paragraph 8(4) of Schedule 28 to the Finance Act 2004, which states:
“If any sums or assets representing the member’s drawdown pension fund in respect of an arrangement under the pension scheme would (apart from this sub-paragraph) come to be taken to represent another drawdown pension fund of his under the pension scheme, or a dependant’s drawdown pension fund of his under the pension scheme, they are to be treated as not doing so.”
Under the Transfer of Sums and Assets Regulations (SI 2006/499), when a drawdown pension fund is transferred from one registered pension to another, it is necessary for the receiving scheme to establish a new arrangement to receive each individual drawdown arrangement transferred, i.e. the new scheme need to replicate the number of drawdown arrangements under the old scheme.
Once an individual attains age 75, with two or more drawdown arrangements, it is possible for one or more of those arrangements to shorten the drawdown year so that the various drawdown anniversaries for each arrangement fall on the same date if so desired. However, it is not possible for them to be merged.
There is no corresponding legislation comparable to Paragraph 8(4) of Schedule 28 to the Finance Act 2004 applying to flexi-access drawdown that precludes arrangements being merged. However, HMRC have confirmed to me that whilst it is therefore possible for two or more flexi-access arrangements to be merged scheme administrators should be aware “that all related factors such as transfer timing and LTA requirements have to be considered in their own right for each particular merger.”
Verbally, HMRC have admitted to me that because of the requirement to be able to undertake the BCE 5A at age 75 (or the earlier BCE 4 if an annuity is secured from the drawdown funds) as if the two or more drawdown arrangements were still held separately, merging arrangements is likely to cause significant administration issues. HMRC can therefore see no reason a scheme administrator would seek to merge funds.
I am aware that several scheme administrators have actively pushed the fact that they are able to simplify flexi-access drawdown for advisers by merging drawdown arrangements. One must question whether it will turn out if matters have in fact been simplified.
The following example will demonstrate this point:
- David crystallised his SIPP in two stages. He first crystallised £800,000 taking PCLS of £200,000 and designating £600,000 into capped drawdown, Arrangement 1. This utilised 50% of his then available LTA.
- A few years later, he crystallised the balance of his SIPP funds, taking PCLS of £187,500 and designating £562,500 into capped drawdown, Arrangement 2. By now the LTA had reduced to £1.5m and David had not elected for fixed protection. This fully utilised David’s remaining 50% of the LTA.
- Shortly after April 2015, he moved both arrangements into flexi-access drawdown.
- When he attained age 75, Arrangement 1 has a value of £700,000 and Arrangement 2, a value of £462,500, a total value of £1,162,500.
- The BCE 5A test will result in a LTA excess liability of £25,000 as there was growth of £100,000 in Arrangement 1 and as David had no LTA remaining to offset this and the BCE 5A is a test undertaken at arrangement level (see section 216 of Finance Act 2004). To be clear, the £100,000 increase in the value of Arrangement 1 is not offset by the reduction of £100,000 in the value of Arrangement 2. There is BCE 5A chargeable amount attributable to Arrangement 2 is nil because of the loss.
- If, after converting the two arrangements from capped drawdown to flexi-access drawdown, they were merged, it would be necessary for the scheme administrator to demonstrate to HMRC that they had the systems and processes in place to attribute the total value between the original two arrangements.
Currently, it is not obvious how a scheme administrator would be able to maintain the record HMRC require to be able to calculate the BCEs as if the arrangements had not been merged.
There is one primary advantage of capped drawdown over flexi-access drawdown, namely the former does not trigger the money purchase annual allowance, which is set to reduce for the current tax year to £4,000 assuming the Finance Bill receives Royal Assent as currently drafted.
However, it follows that when an individual has attained age 75, or once they cease work and are therefore limited not by the £4,000 MPAA but by the £3,600, there would seem to be little reason for retaining drawdown funds as capped drawdown as opposed to flexi-access drawdown.
It will be interesting to see:
- what administration procedures scheme administrators have put in place, where they have merged drawdown arrangements, such that they will be able to satisfy the HMRC requirements;
- HMRC’s response as to the penalties, if any, they propose for scheme administrators who are unable to calculate any post-merger BCEs as required;
- the legislative basis for any penalty.
Meantime, advisers should treat, with extreme caution, any scheme administrator who actively offers to merge flexi-access drawdown arrangements without first ensuring they have procedures in place to meet HMRCs requirements over future BCEs.