Pension Tax Relief Changes Post 2011

Regulation & legislation focus

The Treasury and HMRC recently announced their future plans for the restriction of pension tax relief. In this article I provide a summary of the Government’s draft regulations. 

Annual Allowance and Tax Relief

The annual allowance determines what level of pension contribution can be paid by an individual for tax relief purposes. The changes specific to the annual allowance are as follows:

> Annual allowance will be reduced to £50,000 (from £255,000) for the tax year 2011-12. The Government plans to review the rules and consider options for indexation and apply to both Defined Benefit(DB) and Defined Contributions (DC) pensions. Tax relief will continue to be available at the individual’s highest marginal rate of tax.

> The annual allowance tax charge to recover any undeserved tax will be tailored according to the amount of tax relief the individual has received.

> A flat factor will continue to be used to value Defined Benefit pension accrual, although this will being increased to £16 for every £1 of additional pension (an increase from 10:1).

> Unused annual allowance for up to 3 years may be carried forward where pension contributions/savings for the current year exceed the annual allowance. This will include being able to carry forward from the tax years 2008/09,2009/10 and 2010/11 using an assumed annual allowance of £50,000 for each of those years.

> The new ‘carry forward’ facility will be available to members of both DB and DC schemes.

> The Government will consult on possible options, for those who see a very significant increase in pension savings in a year, for the annual allowance tax charge to be paid out of their pension entitlement rather than their current income. This could include the scheme paying the tax charge on the individual’s behalf(commonly known as ‘scheme pays’) or the liability being rolled forward and paid out of pension benefits once they are taken at retirement.

> Increases in deferred benefits under DB schemes will not be tested against the annual allowance.

> For active members of DB schemes, the previous year’s benefits will be re-valued with the aim of ensuring that only pension benefits arising from salary increases and additional years’ service are tested against the annual allowance (the rate of revaluation has not been confirmed).

> No annual allowance test will take place in the year of a member’s death or where serious ill-health benefits are paid.

> In addition, exemption may be given in certain circumstances where ordinary ill-health benefits are taken(details on how this additional exemption will operate will be published later in 2010).

> Measures will also be taken to include unreasonable increases in pensions in payment to the annual allowance assessment (further details are awaited). However, there will be no other exemptions from the annual allowance test – this means the current exemption for the tax year in which benefits are taken will no longer apply and there will be no exemption for redundancy situations.

Pension Input Periods

The pension input period determines the timescales for an individual’s annual allowance. The changes specific to the pension input period are as follows:

> The existing rules regarding setting:- Pension Input Periods will not change – i.e. pension schemes will generally continue to determine the period and it does not need to be aligned with the tax year. For money purchase arrangements, members will still continue to be able to determine their pension input periods.

> Transitional rules will be put in place for those schemes where the period started prior to 14 October 2010 and will end in the 2011/12 tax year, to reflect the reduced annual allowance for the period from 14 October 2010.

> Those whose pension input period starts on or after 14 October 2010 will be subject to the reduced annual allowance of £50,000 for the whole of the input period.

Lifetime Allowance (LTA)

The lifetime allowance is the maximum pension accrual that can be accumulated without additional tax charges ordinarily applying. The changes specific to the lifetime allowance are:

> It will be reduced from £1.8m to £1.5m, intended to be effective from April 2012.

> The valuation factor for DB accrual will remain at 20:1 (25:1 for pre A-Day benefits in payment).

> The LTA tax charges will remain unchanged – i.e. 55% where the excess is taken as a lump sum and 25% where it is taken as an income (with the income subject to tax at the individual’s own rate of tax).

> Maximum tax-free cash (pension commencement lump sum) will remain at 25% of the member’s available standard lifetime allowance.

> The link between the LTA and trivial commutation will be removed from April 2012 – instead of the limit being 1% of the LTA, it will instead remain at £18,000.

> Protection will be given to those who have ‘already made pension savings decisions based on the current level of the LTA’.

> Government will consult on the detail of the protection regime, but proposes that:

>Those with pension benefits in excess of £1.5m receive protection (subject to a cap on protection of £1.8m).

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