Important changes to pension contributions and the tax relief available

Frances colour

Important changes to pension contributions and the tax relief available

On 8 July 2015 the Chancellor of the Exchequer gave his Budget to Parliament. Within it were important announcements relating to pension legislation, which will impact significantly the future ability for high earners to mitigate income tax through pension contributions.

This article highlights the main points and the action that should be taken as soon as possible.

Reduction to the Annual Allowance from 6 April 2016 onwards

The annual allowance is the maximum contribution an individual can make to a UK registered pension scheme; and/or the increase in the value of annual pension under a final salary arrangement. Currently it stands at £40,000. Payments in excess of the annual allowance will trigger an income tax charge at your highest marginal rate of tax.

From April 2016 anyone whose total “adjusted income” exceeds £150,000 a year, will see their annual allowance reduce by £1 for every £2 of income over £150,000. The maximum reduction in the annual allowance is £30,000. So anyone whose “adjusted income” exceeds £210,000 a year their annual allowance cannot be less than £10,000.

Individuals will still be able to make use of rules which allow you to “carry forward” any unused annual allowance from the previous three tax years.

Whilst we await clarification of exactly what “adjusted income” will comprise; it appears to be your taxable income plus the value of any pension contributions (both personal and employer) and/or the increase in the value of future pension under a final salary arrangement. For example a salary of £110,000 plus a gross pension contribution of £40,000 will add up to £150,000 of “adjusted income”.

Changes to Pension Input Periods

Most individuals will be unaware that their pension arrangement has a “pension input period”, which for most schemes is the same as the tax year. The relevance of the PIP is that it is used to test the total contributions paid against the annual allowance.

In the past it has been possible to “change” the PIP in order to increase the sum that can be paid into pension in the same tax year; thereby maximising income tax relief without exceeding the annual allowance. This was especially useful if an individual had an exceptionally high level of income in any one tax year.

The Chancellor has announced that with effect from 6 April 2016 all PIPs will cover a 12 month period, aligned with the tax year. It will not be possible to vary or amend the PIP.

The Budget detailed transitional rules that came into force on 8 July 2015. All PIPs open on 8 July 2015 ended on that same date. The subsequent PIP would start on 9 July 2015 and end on 5 April 2016.

HMRC refer to these as the “pre alignment tax year” and the “post alignment tax year”.

Annual Allowance for 2015/2016

For the “pre alignment tax year” the annual allowance is £40,000 plus any carry forward of unused allowance from the previous three tax year.

For the “post alignment tax year” the annual allowance is also £40,000 plus any carry forward of unused allowance from the previous three tax years.

It is very much a case of the “early bird catching the worm”, as the new rules reward any individual who promptly paid their maximum contribution of £40,000 to their pension between the start of the tax year, and the date of the Budget (6 April to 8 July 2015). As they now have another bite at the cherry and, provided they have sufficient income, can pay a further £40,000 into pension before 5 April 2016.

Carry forward

The ability to carry forward any part of the unused annual allowance, from the previous tax years, will continue. However to be eligible the individual must have fully used the annual allowance in the current tax year; and have been a member of a registered UK pension for the tax years in question, although they do not need to have paid any contributions.

Reduction to the Lifetime Allowance

George Osbourne also confirmed that the Lifetime Allowance will further reduce, to £1m, from April 2016.

If your total pension fund value is likely to exceed £1m it will be possible to apply to HMRC for some form of protection against a tax charge being levied on the excess value up to £1.25m when you come to draw benefits.

 

Planning Points

It is important to note that this article details the position for an individual who is in good health, and has not yet accessed their pension benefits using flexible access rules.

The new legislation also awaits Royal Assent and so could change.

If you are a higher rate tax payer you should consult with your financial advisor, as soon as possible, to discuss and consider your pension funding options for 2015/2016 and beyond.

 

Frances Noons

Wealth Manager