From 6 April 2011, the annual allowance (AA) for "tax-privileged" pension saving will reduce from its current level of £255,000 to £50,000. Even after considering the scope for utilising carry forward (see Aries article), it is possible that a few individuals - mainly high earners and long servers in generous DB schemes - will be unable to avoid exceeding this limit, nor be able to meet ensuing tax charges from their current income.

The Government intends that the AA regime should make provision to enable those individuals to meet AA charges from their pension benefits in certain circumstances: the controversial "scheme pays" solution. On 30 November, HM Treasury launched a consultation to identify the least-burdensome way to meet this objective. The discussion document outlines two options, either of which the Government will take forward:

1. meeting the AA charge in real time, while pension benefits are still accruing; or
2. rolling up the liability, deferring payment to when the pension benefits crystallise.

It would seem that option a) is the frontrunner given the Government's stated "preference for minimising any delay to tax payments". It is also hoped whatever mechanism is finally chosen will minimise complexity and administrative impacts and only be taken up in extreme circumstances.

The Government believes it fair that everybody who exceeds the AA should pay some of the liability from current income. There would likely be a threshold between £2,000 and £6,000.

Although the Government believes the need to meet AA charges from pension entitlements will almost always arise in relation to defined benefit schemes, it welcomes views on this and whether the facility is needed in DC schemes.

Where entitlements are spread over several schemes, there is a proposal that individuals can elect to meet the tax liability from a single scheme; although where the AA is exceeded in a single scheme in a given year, only that scheme can be elected.

Whilst the Government will likely not require payment of an administration charge, it will leave it for schemes to determine their "own terms of engagement with members". It believes that there will be a role for schemes to encourage affected members to consider their options early.

In the case of option b), the Government believes it beneficial to ensure relevant individuals are kept informed of what the delayed liability might mean for their projected pension income and any tax-free lump sum.

The proposals suggest schemes will be given flexibility in calculating the pension offset required, provided the terms are not actuarially disadvantageous to the individual. The policy intention is that the real value in each proposed approach should be the same. So, interest will have to be applied if the Government goes with option b).

Provided any AA tax liability is settled with HMRC during the tax year following that when it would ordinarily be due, no interest will be payable.

Under both options, the scheme will report and pay HMRC via the existing Accounting for Tax system. The individual will report the AA charge via the Self Assessment tax return. The condoc contains a timeline illustrating the broad steps understood to be involved in both potential implementations.

Clearly, option b) carries with it certain ongoing obligations to retain information about deferred charges and must also be sensitive to changes in life circumstances or scheme design.

Towards the end of the condoc, a variant on option b) is mentioned: rolling-up the value of contributions in excess of the AA, rather than AA charges. Whilst the Government is disinclined to favour this solution - as it is complex to understand and could lead to either over- or under-charging - it welcomes views.

Whatever the mechanism, the government intends to legislate for individuals to meet AA tax charges from their pension in the Finance Bill 2011. Draft clauses are to be published in February. Achievement of this tight schedule is made harder by the need the Treasury has acknowledged for changes also to DWP legislation regarding the surrender of pension rights, ie s. 91 et seq PA 1995.