Are you ready for pension tax changes?
The personal pensions landscape is about to undergo a serious makeover.
In October 2010, secretary to the Treasury Mark Hoban announced plans to ditch the previous government's hideously complex proposals for the reform of pension tax relief, which would have come into force from April 2011.
He outlined instead what's widely viewed as a neat and tidy alternative, which is expected to save the Treasury £4 billion.
From April 2011, the annual allowance for tax-privileged pension saving will be reduced from £255,000 to £50,000. This is a significant reduction targeted to affect 100,000 pension savers, 80% of whom will earn more than £100,000.
The current situation is one of limbo. Since pensions were last 'simplified' on 'A Day' in April 2006, people have been able to make annual contributions of whichever is greater: up to the annual allowance (currently £255,000 a year), or 100% of their salary. If employers contribute, the £255,000 allowance also applies, but without any salary-based limit.
But when, in April 2009, the Labour government decided to work on reforming pension tax relief for high earners by April 2011, it announced 'anti-forestalling measures' designed to prevent people stuffing their pension pots to the max in the run-up to the changes.
These measures, which are currently in force, mean that if you have earned more than £130,000 a year in any of the past three years and you pay more than £20,000 a year into your pension, you'll probably be taxed on the excess contributions above the £20,000 cap.
In practice, Chris Lee, tax partner at Thames Valley accountants James Cowper, points out: "I've seen very few people affected by this rule - they don't want to be caught, so they're just not contributing."
There is one important exception to the anti-forestalling rules: people who were making regular contributions - at least quarterly - before April 2009 can continue to contribute at the same level without a tax penalty.
The new, simpler approach
Labour's convoluted plans for the new regime after April 2011 were deeply unpopular with just about everyone facing the prospect of working with them. They involved the progressive removal of higher-rate tax relief on all future pension contributions of those earning more than £150,000.
The coalition's new rules are simple and (in pension terms at least) relatively easy to understand. The current annual allowance for what's known as 'tax-privileged pension saving' will be slashed from £255,000 to £50,000 a year. Pay in more than that in a year, and you'll receive no tax relief on the extra.
However, every pension holder, no matter how much they earn, will receive full tax relief - up to 50% for the highest earners - on the whole of their contribution below £50,000.
"That's a considerable improvement for £150,000-plus earners, who would have been receiving only basic-rate tax relief on anything they put in under the Labour plans," adds Lee.
Moreover, there is some leeway for taking account of good and bad years, in that you're allowed to carry forward unused tax relief from your £50,000 allowances of the past three years (which could be handy, say, if you receive a windfall and want to pay in some extra one year). We'll see later how that could work in light of April's changes.
Time is ticking before the new pension system takes effect. So what impact will the changes have, and what should those who might previously have made substantial annual contributions to their funds do in the countdown to April?
As noted, the changes are expected to affect 100,000 pension savers, but there are several different groups to consider.
There may be people with earnings below £130,000 in any of the preceding three years, who are in the happy position of being able to put in more than £50,000, perhaps because of an inheritance, windfall or particularly generous bonus.
"If you can afford to put in more than you'll be allowed to after April, and you're not caught by the anti-forestalling rules, then you should do so," says Lee.
Pension input periods
The current system's tax relief cap on pension contributions in such cases is 100% of earnings - or, up to the full annual allowance of £255,000 if your employer contributes the balance, says Tom Barnett, financial planning manager at accountancy firm Reeves & Co.
One vital consideration is the issue of 'pension input periods'. Companies' pension scheme year ends don't necessarily coincide with the standard April tax year end, so your contributions for a pension scheme year (pension input period) count as being in the tax year in which that period ends.
"Thus, if your pension scheme year end is on 31 December, then a contribution made in, say, February 2011 will count towards the 2011/12 tax year and you'll be taxed in the usual way on everything over the new £50,000 annual allowance," explains Richard Harwood, divisional director of financial planning at Brewin Dolphin.
"The company therefore needs to establish a new scheme for that contribution and can arrange for a short pension input period, ending by 5 April 2011, to ensure all contributions before then fall in the 2010/11 tax year."
In practice, those able to top up before April are a relatively small group: owners of small businesses making some profit, who pay themselves maybe £100,000 or so but certainly aren't into the high earnings league. "For them, it's 'act now' time - the business can put in up to £255,000 before April," adds Harwood.
"After 6 April, £50,000 will be the maximum annual contribution; people may never again have the chance to put in up to £255,000."
But as Andy Cumming, managing director of Scott-Moncrieff Wealth Management, points out: "We have 2,000-plus clients, and just two earning £130,000 whose companies are cash-rich enough to exploit this opportunity. It's not mainstream for high net worth individuals."
Carrying relief forward
The 'mainstream' opportunity for high earners won't in fact occur until the new regime takes force, he adds. For the current tax year, they should contribute their £20,000 limit (or £30,000 if they are making 'recurrent single premiums' - effectively regular contributions on an annual rather than a monthly basis).
After April, they will be able to pay in the full £50,000 for the new tax year - but they also have the capacity to carry forward unused relief (out of a retrospective £50,000 annual maximum) from the past three years. If they have contributed £30,000 in each of those years, then that's an additional £20,000 for each.
In other words, says Cumming: "Earners above £130,000 will then be able to pay in a total of £110,000 in the new tax year, and receive tax relief at their highest marginal rate - possibly 50%. We believe this may represent a last great opportunity for the wealthy to exploit tax reliefs on pensions."
Jeremy Woodley, UK director of the Fry Group, agrees. "Pension payments will be limited to the total of relevant earnings, but for many this remains a very beneficial opportunity," he says.
And if you can't afford to make use of previous years' allowances this year, don't worry - the 'carry forward' rule is an ongoing feature of the new system, so if things are looking rosier in the future you may be able to take advantage of it at that point.
Overall, experts welcome the imminent changes as a sensible compromise. "As far as the annual limit goes, high earners will get full tax relief, but they won't be able to get silly with contribution levels," Harwood says.
"The £50,000 allowance covers almost everyone, it's much simpler, and it allows carry forward of spare allowance to smooth the impact of good and bad years."
This article was originally published in Money Observer - Moneywise's sister publication - in February 2011.
An unexpected one-off financial gain in cash or shares, generally when mutual building societies convert to stock market-quoted banks. Also windfall tax, a one-off tax imposed by government. The UK government applied such a measure in the Budget of July 1997 on the profits of privatised utilities companies.
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