The clause makes changes to ensure that the historic pension flexibility measures that we introduced last April are working as intended for everyone. As the Committee will be aware, from April 2015 individuals with defined contribution pension savings have been able to access their entire pension flexibly, subject to their marginal rate of tax. The Government introduced that historic reform because they believe that individuals who have worked hard and saved responsibly throughout their lives should be trusted to make their own decisions with their pension savings. In general, the flexibilities have been working well, and so far more than 230,000 people have benefited from pension flexibility in the first year of operation. However, there are a few minor points in the legislation that have not been working as intended. The Government therefore propose a series of small changes to ensure the new pension flexibility works for everyone.

The first change being introduced by the clause relates to serious ill health lump sums. Serious ill health lump sums are paid when an individual can produce medical evidence that they are expected to have fewer than 12 months to live. Before the introduction of pension flexibility, those lump sums were paid tax-free if the individual was under 75 and taxed at 45% if they were aged 75 or over. That was in line with the taxation of certain lump sum death benefits and was intended to ensure that tax considerations did not drive whether pension lump sums were taken before or after an individual dies.

From 6 April this year, the rules around death benefits have changed. Now, when someone dies having reached age 75, the lump sum death benefit is taxable at the marginal rate of the individual who receives it, not 45%. Under the clause, where someone takes a serious ill health lump sum having reached age 75, it will be taxed at the recipient’s marginal rate instead of 45%. The clause will therefore realign the tax treatment of serious ill health lump sums with that of the lump sum death benefits.

In addition, the clause makes changes to help people with a pension who have become seriously ill. Under the current rules, serious ill health lump sums can only be paid from the pension savings that have not been accessed at all. The current legislation was appropriate for a world in which people could either access the whole of their pension or not access it at all, but it now means that people could be disqualified from taking a serious ill health lump sum if they take a small lump sum from their pension and then become seriously ill later in life. The clause will remove the rule that prevents serious ill health lump sums being paid from the unaccessed portion of partially accessed funds. The changes bring the taxation of such lump sums into line with the treatment of comparable lump sum death benefits, while ensuring that there is flexibility in the system.

The second change relates to charity lump sum death benefits. Under current rules, when a pension scheme member dies leaving certain unused pension savings and uncrystallised funds, a lump sum death benefit can be paid to any beneficiaries, including a charity. That is tax-free if the member is under 75 at death, but the payment needs to be made within a two-year period, or it is taxed at a separate rate of 45% if paid to a charity. The changes being made by the clause will ensure that unused funds at the member’s death can be used to pay a charity lump sum death benefit completely tax-free, whatever the age of the member or length of time taken to pay.

The third change relates to dependants’ flexi-access drawdown funds. Before pension flexibility was introduced, children of a deceased member who wanted to claim funds from a drawdown account had to use all of this fund by the age of 23. Any remaining funds paid to them after reaching that age would be taxed at rates of up to 70%. The reforms last year enabled any nominated beneficiary, including a member’s child aged 23 or over at their parent’s death, or a member’s step-child of any age, to inherit their parent’s pension and receive drawdown pension payments at any age. However, the current legislation still means that children aged under 23 at their parent’s death have to draw all of their funds before they turn 23 in order to avoid paying 70% tax on those funds. Schedule 5 will amend legislation to allow dependants with drawdown accounts to access their funds as they wish without incurring a 70% tax charge from their 23rd birthday.

The fourth change relates to trivial commutation lump sums. Before pension flexibility, the option of trivial commutation existed for both defined-contribution and defined-benefit pensions. That allows individuals aged 60 or over with total pension savings of £30,000 or less to withdraw all of their savings as a lump sum, with the first 25% of any previously untouched savings paid tax-free. Since April 2015, pension flexibility changes allow anyone aged 55 or over to withdraw some or all of their funds that they have yet to access as a lump sum, 25% of which is tax-free. Trivial commutation was therefore removed for defined-contribution pensions and limited to defined-benefit arrangements, which were not affected by the introduction of pension flexibility.

Under the defined-benefit arrangement, the only kind of pension possible is a scheme pension, although some people have scheme pensions that come from a defined-contribution fund. As such, under current rules, if a defined-contribution scheme pension is already in payment, it cannot be taken as a trivially commuted lump sum. Schedule 5 will allow defined-contribution scheme pensions that are already in payment to be paid as a lump sum, if they satisfy all the other requirements of trivial commutation.

The fifth change brought about by this legislation relates to the top-up of dependants’ death benefits. Some pension schemes specify a minimum amount that dependants are entitled to receive when the member dies. If there is not enough money in the member’s pension pot when they die, their employer will top it up to ensure that it reaches the minimum amount. Under current rules, certain lump sum death benefits funded by an employer top-up will count as an unauthorised payment and be taxed at rates of up to 70%. Schedule 5 will address that issue by allowing employer top-ups to fund certain dependants’ death benefits to be paid out as authorised payments and therefore not be taxed at those rates.

The sixth and final change introduced by the clause relates to inheritance tax in respect of alternatives to annuities for dependants. At present, some schemes can pay an annuity to a deceased member’s surviving spouse, civil partner or dependant if the deceased had the option for a lump sum to be paid to personal representatives instead. The lump sum is not included in the estate of the deceased member for inheritance tax purposes. Pension flexibility changes mean that, after an individual’s death, an annuity may be paid to someone other than a spouse or partner or dependant, such as a nominee. However, nominees are currently not included in the inheritance tax exclusion, so if an annuity is payable to a nominee, any alternative lump sum payment could be subject to inheritance tax. The changes made by the clause will provide for the same treatment as in April 2015 and keep annuities for nominees out of inheritance tax.

Government amendment 134 to schedule 5 clarifies that the sums or assets available to fund a lump sum death benefit are valued immediately after the member’s death. The change is a minor, technical one to provide clarity and to ensure that the legislation works.

To conclude, the Government introduced pension flexibility because we believe that individuals who have worked and saved responsibly throughout their life should be trusted to make their own decisions about their pension savings. The changes made in the clause will help to ensure that the flexibilities work for everyone. I hope that it may stand part of the Bill.