Restriction on tax relief for pension contributions
The new tax regime for pension contributions will take effect for the 2011/12 tax year. The legislation is included in Finance Bill 2011.
The basic proposal is that an annual allowance (AA) will be set at £50,000. Any contributions in excess of the AA would be charged to tax on the individual as their top slice of income. Contributions include contributions made by an employer.
The rules will apply for the 2011/12 tax year and, in particular, to pension input periods (PIPs) ending in the tax year 2011/12 but beginning earlier.
Anthony is a director/shareholder of a family company and has taxable income of £120,000 in 2011/12. For several years, the company has been paying monthly contributions into a pension scheme for his benefit totalling £60,000 per year. He does not make any pension contributions himself.
The charge will be:
|Pension contribution in 2011/12||£60,000|
|Taxable at 40%||= £4,000|
A PIP does not have to be the same as the tax year and if a person has several schemes, each scheme can have a different PIP. Special transitional rules may apply to pension savings made before 14 October 2010 that fall into 2011/12 PIPs.
Care is needed if payment of significant contributions is being considered in the current tax year. If a PIP does not coincide with the tax year, an amount paid this year may result in a charge under these new rules in 2011/12.
Carry forward of unused AA
To allow for individuals who may have a significant amount of pension savings in a tax year but smaller amounts in other tax years, a carry forward of unused AA will be introduced.
The broad effect is that unused AA of up to £50,000 per year can be carried forward for the next three years. When looking at whether there is unused AA to bring forward from 2008/09, 2009/10 and 2010/11, the AA for those years is deemed to have been £50,000.
Bob is a self employed builder. In the previous three years Bob has made gross contributions of £40,000, £20,000 and £30,000 to his pension scheme. As he has not used all of the £50,000 AA in earlier years, he has £60,000 unused AA that he can carry forward to 2011/12.
Together with his current year AA of £50,000, this means Bob can make a contribution of £110,000 in 2011/12 without having to pay a tax charge.
Members of defined benefit schemes
In a defined benefit scheme, individuals accrue a right to an amount of annual pension when they retire. This right does not necessarily equate with the contributions made by themselves and their employers. Therefore the proposals require a notional value of contributions to be computed. The notional contributions should reflect the amounts needed to be invested in a money purchase scheme to deliver the extra annual pension accruing in a defined benefit scheme. A ‘flat-factor’ method will be used and will be set at 16.
The flat-factor of 16 means, broadly, that an increase in annual pension benefit of £1,000 would be deemed to be worth £16,000. So if an individual is in a final salary defined benefit scheme and has a promotion resulting in a pay rise, the deemed contribution may be very high.
In some situations, the individual will be able to require the tax bill to be met by the pension fund (with a commensurate reduction in the pension entitlement).
The lifetime limit
The lifetime limit sets the maximum figure for tax-relieved savings in pension funds and rose to £1.8m for 2010/11. The government has announced that the limit for 2012/13 will be reduced to £1.5 million. Those with savings above £1.5 million or who believe the value of their pension fund will rise above this level through investment growth without any further contributions or pension savings, will be able to apply for a new personalised lifetime allowance of £1.8 million, providing they cease accruing benefits in all registered pension schemes before 6 April 2012.
The lifetime limit has to be considered when key events happen such as when a pension is taken for the first time. If the value of the scheme exceeds the limit a tax charge of 55% of the excess is due if the excess is taken as a lump sum.
Requirement to buy an annuity
Legislation will be introduced in Finance Bill 2011 to remove pensions tax rules that currently create an obligation for members of registered pension schemes to secure an income, usually by buying an annuity, by age 75.
It will involve changes to annuitisation requirements, pensions tax treatment and rules applying to income drawdown arrangements.
The legislation will have effect from 6 April 2011. In summary, from that date:
- it will enable individuals with defined contribution pension savings from which they have not yet taken a pension to defer a decision to take benefits from their scheme indefinitely
- it will enable individuals with a lifetime pension income of at least £20,000 a year to gain access to their drawdown pension funds without any cap on the withdrawals they may make
- the age 75 ceiling will be removed from most lump sums to which entitlement arises
- the tax rate on lump sum death benefits will be 55%
- the altered withdrawal limits will have effect for all new drawdown pension arrangements and some drawdowns made before 6 April 2011 where the individuals 75th birthday falls within certain dates.
The main cost to the individual of the increased flexibility offered is the 55% charge on lump sum death benefits. The charge will not apply however to death benefits for those who die before age 75 without having taken a pension. In addition inheritance tax changes are proposed (see below).
Inheritance tax (IHT) and drawdown
With effect from 6 April 2011:
- IHT will not typically apply to drawdown pension funds remaining under a registered pension scheme, including when the individual dies after reaching the age of 75.
- IHT anti-avoidance charges that apply to registered pension schemes and Qualifying Non UK Pension Schemes where the scheme member omits to take their retirement entitlements (eg a failure to buy an annuity) will be removed.