Making contributions to a pension scheme is a highly tax efficient way to save for retirement. It is important to be aware of what is permitted and to keep up to date with any changes in the system in order to best make use of the rules.
The Coalition Government has announced that from 2011/2012 onwards significant changes are to be made in the amount of tax relief available for pension contributions. In particular it is important to be aware of the following:
- A reduction in both Annual Allowance and Lifetime Allowance for Pension Contributions
- Employer Contributions to be included and counted towards the Annual Allowance limit
- Permitted 3 year roll-over of Annual Allowance limit.
- Tax relief for Pension Contributions to be in line with current tax bands
- A series of Transitional Arrangements for individuals affected by the change in particular individuals whose Pension Input Period falls during the period of change.
- Information requirements on pension providers and employers
The changes are listed below in more detail.
Former Government’s Approach
As part of the Finance Act 2010 The Labour Government introduced restrictions to higher tax relief on pension contributions for high earners. These new restrictions were set to start from April 2011 and involved a complex claw back of tax relief on pension contributions at a phased rate for individuals with an annual income in excess of £150,000. Also at this time, the Labour Government introduced ‘anti-forestalling’ rules to stop individuals accelerating their pension contributions ahead of April 2011 as a means of side-stepping the new provisions. The anti-forestalling rules were enacted with immediate effect and are currently in force.
In June 2010, the Coalition Government repealed the provisions introduced by Labour, other than the anti-forestalling rules, and undertook to review the whole contribution scheme with a view to simplifying the system for pension tax relief. The outcome of this review is outlined below. The draft clauses of Finance Bill 2011, issued on 9 December set out the changes to the statutory framework. Unless otherwise stated the date of implementation is April 2011.
£50,000 Annual Allowance Limit
A new annual allowance of tax free contributions of £50,000 per tax year will apply to everyone irrespective of their earnings. Previously the limit was the lower of earnings or £255,000. This new limit is a significant reduction for high earners that is targeted to affect an estimated 100,000 pension savers, 80% of whom will have incomes over £100,000.
Contributions in excess of £50,000
Contributions made by or on behalf of individuals that are in excess of £50,000 will trigger an annual allowance charge. This charge effectively completely removes tax relief on pension contributions in excess of the annual allowance. The penalty must be calculated and paid by January 31 following the end of the relevant tax year.
Potential Windfall for people aged over 55
From April 2011 the £50,000 Annual Allowance applies every year including the year in which benefits comes into payment.
However before 6 April 2011 the Annual Allowance charge is not applied in any year in which an individual takes the full benefits of his or her pension fund. This new provision means that there is a potential windfall for individuals aged 55 or over by April 2011. Please contact us if you wish to discuss this opportunity in more detail.
Employer Contributions taken into account in calculating Annual Allowance
Both employee and employer contributions will be taken into account in determining whether the annual allowance has been exceeded. Accordingly notwithstanding the fact that an individual does not contribute to his pension fund, his employer may well be doing so and so he may still be affected by the new limit. If the employer makes contributions in excess of the available annual allowance then a tax charge will be due by the employee on the value of the contribution at their marginal rate.
Exceptions to Annual Allowance Limit for ill health
The Coalition Government also announced changes to the ‘vesting’ exception whereby the annual allowance is overlooked for the tax year when an individual becomes entitled to all the benefits available under the scheme on account of ill health or redundancy. This provision is to be removed and replaced with a new exemption for a tax year in which an individual becomes entitled to a lump sum for serious ill health. Therefore from April the £50,000 limit will apply for cases of redundancy or ‘ordinary’ ill health.
Defined benefit scheme
Specific provisions will be introduced to apply the rules to defined benefit (final salary) schemes. Although some of the provisions are still in consultation with regards to practical difficulties stemming from their implementation, the following changes are likely to be made:
Potential Increase in Deemed Pension Benefit.
There will be an increase in the multiplication factor used to calculate deemed contributions. This will increase from 10 to 16 times the increase in the annual pension benefit together with the increase in value of the lump sum during the pension input period.The draft legislation does however allow for an inflationary increase on salary to be ignored in determining the increase in the value of an active scheme member’s pension fund.
This change could be significant for some individuals who make significant personal contributions or individuals who have a decent increase in pension benefits in one year (for example, those who have a significant promotion or pay rise) as the increase in deemed contributions could bring them over the £50,000 threshold and therefore in line for a charge. The Government therefore intends to consult on the impact of this increase and discuss options for allowing such individuals to pay the charge out of their pension entitlement.
Tax Relief Band 20%, 40% or 50%
Individuals will receive tax relief at their highest tax band rate (i.e. 20%, 40% or 50%) on all contributions within the annual allowance. This will not be restricted to 40% as originally suggested.
Roll over of Annual Allowance
Permitted 3 year carry forward of Allowance
Any unused amount of annual allowance can be carried forward for up to three tax years. This provision operates with effect from 2008/2009 but assumes that the annual allowance was only £50,000 in those earlier tax years. However this provision is only available if an individual was a member of a registered pension scheme in the tax year from which the relief is to be carried forward. Please contact us to discuss how this can benefit high earning individuals.
Reduction from £1.8 million to £1.5 million
From April 2012 the ‘lifetime allowance’ for tax relievable pension saving will be reduced from £1.8 million to £1.5 million. Any funds taken that exceed this limit when pension benefits are taken will suffer a penalty charge of 55% on the excess if the excess is taken as a lump sum or 25% if taken in the form of a pension.
The Government however, in recognition of the fact that some individuals already may have more than £1.5 million or have planned for more than this new limit, have introduced transitional provisions. Please contact us to discuss how these may impact on you.
Pension Input Period (PIP) - Transitional Arrangements for new rules
Pension Input Period is the term used to describe the amount of pension contributions made by and on behalf of an individual over a 12 month period. PIPs can start and end at any 12 month period over a year.The Government has decided not to force pension providers to align all PIPs with the tax year.
Transitional Arrangements for new rules
The start and end date of a PIP will affect how the new rules apply to certain individuals. In particular if an individual is considering making a significant pension contribution, it is important to be aware of the end date of his PIP. A contribution made now for example, may trigger an unexpected annual allowance charge for the 2011/12 tax year if the scheme has a PIP ending after 6 April 2011.
To minimise the potential difficulty the Government has decided that transitional rules should apply where a pension scheme’s PIP began before 14 October 2010 and ends after 5 April 2011.
For individuals who are members of more than one pension scheme which may these may have different PIPs, this new system could cause some practical difficulties. These individuals will need to work out what their pension input amounts are for each PIP that ends in the tax year and add these together to get their total pension input amount for the tax year. Please contact us to discuss how these may impact on you.
Obligations on employers and pension providers
Requirements to provide information
Pension provider is required to advise the member of the amount of contributions within six months of the end of the tax year where an individual has contributed (or is deemed to have contributed) more than the annual allowance into a particular pension scheme in a particular PIP.The individual must also be provided with information regarding contributions in the previous three tax years so that the individual can determine whether he is able to make use of the carry forward mechanism.
Employers will be required to provide information about employees’ pensionable pay and benefits and length of service to defined benefit schemes by 6 July following the end of the tax year.
These new requirements impose significant compliance burden for pension providers and employers. The government recognises that some will not be able to change their systems in time for the first year in which this requirement comes into force. It has therefore decided that for the first year only they will be given an additional 12 months i.e. until 6 April 2013 or 6 October 2013 respectively to provide this information. Individuals that do not receive the required information to complete their 2011/2012 tax returns in time will have to use estimated figures and submit amended returns within 12 months from the filing date once they are notified of the correct figures.
Anti Forestalling Rules
Anti forestalling rules remain until April 2011.
Anti-forestalling rules as introduced by the Labour Government remain in force until April 2011. These rules affect any individual whose income exceeds £130,000 in the current or previous two tax years and whose total pension contributions (including employer contributions) are more than £20,000 per tax year unless they are regular contribution which are ‘protected. This means that these high earners will continue to have restrictions on their contributions until April when the £50,000 is introduced.
Summary and conclusion - Impact of the new scheme
It is important to be aware of the changes that will be implemented in the new tax year. Taxpayers who are likely to be affected should revisit their personal tax planning for 2011-12 with some urgency. There may still be other planning opportunities that can be utilised to maximise an individual’s pension fund and minimise the impact of loss of personal allowances, in particular for those of a retiral age. Further for employers and pension providers it is important to keep up to date to ensure compliance with the new requirements.This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.