New pension rules - for individuals

Impact of pension changes from 6 April 2011

(further to the Government announcement of 14 October 2010)

The Government recently announced plans to amend the rules for pension tax relief from 6 April 2011. These new rules will replace those previously proposed by the Labour government to restrict pension tax relief to the basic rate for those with incomes above £180,000 which were widely criticised for their complexity. In the meantime, and until 5 April 2011, the pensions forestalling rules to restrict tax relief on certain contributions made by those with incomes above £130,000 continue to apply.

Annual allowance change

The new legislation will reduce the already existing Annual Allowance (AA) for pensions purposes from £255,000 to £50,000 from 6 April 2011. Pension contributions above this level (by an individual and/or their employer) will result in a tax charge on the individual at their marginal rate of income tax.

A new concession has been introduced to allow unused allowance from up to three previous tax years to be offset against the excess pensions savings. This carry-forward will be available against an assumed AA of £50,000 for the tax years 2008/09, 2009/10 and 2010/11, meaning tax relievable contributions of up to £200,000 gross (income permitting) could be made in 2011/12 where contributions were not previously made. This is equally good news for those affected by the pensions forestalling rules in 2009/10 and 2010/11 where pension contributions may have been restricted to prevent tax charges.

There has also been a change to valuing contributions into a defined benefit scheme, such that the valuation factor will be increased from 10 to 16. This factor is applied to the increase in benefits under the scheme in order to determine if the £50,000 limit is breached. This is likely to impact many members of defined benefit schemes, particularly where an employee has many years of service and receives a pay increase. Due to the potential cost of the new rules applying to individuals while funds are tied up in their pension scheme, the Government is considering options to pay the charge out of pension entitlement, rather than from current income, although details have not yet been provided.

Individuals are required to self assess their AA tax charge, but pension schemes will be responsible for providing information to individuals on their pension savings for each tax year where the individual has pension savings greater than the AA in that scheme (or alternatively at the request of the scheme member). The earliest date that information has to be provided is usually six months after the end of the tax year to which the information relates but, for the first year, schemes will be given an extra 12 months to provide 2011-12 information.

It is also important to note that contributions made from 14 October 2010 (i.e. before 6 April 2011) could be affected by the new rules, depending on the Pension Input Period (PIP), as the new rules apply to PIPs ending in the 2011/12 tax year.  A transitional relief has been introduced for PIPs beginning before 14 October 2010 and ending in 2011/12 such that:

  • for defined contribution schemes, the old limit of £255,000 will continue to apply, although relievable contributions post 14 October 2010 will be capped at £50,000;
  • for defined benefit schemes, it will be necessary to split the PIP into the period before and after 14 October in order to apply the old and new valuation factors;

Action required

It will be important to review your pension provision to see how you are affected:

  • those on higher incomes who have benefitted from protection under the pensions forestalling regime in 2008/09 and 2009/10 may need to reduce the level of their pension provision in 2011/12 or face additional tax charges.
  • in contrast, those affected by the £20,000 annual limit under the pensions forestalling regime may be able to increase the level of their contribution in 2011/12.
  • individuals with defined benefit schemes who expect to see the level of their final salary pension increase in 2011/12 will need to take particular care. The higher the number of years past service and the higher the salary increase, the lower the level of pensionable salary at which a charge may apply.

Lifetime allowance change

From April 2012, the lifetime allowance will also be reduced from £1.8m to £1.5m. Those with pension funds in excess of the lifetime allowance suffer additional tax charges when benefits are taken, at 55% if taken as a lump sum, or at 25% if paid as an annual pension (on top of the marginal rate of tax on pension income). Although detailed guidance has not yet been provided by the Government, which is expected to include various protections (eg. for those with pension funds already in excess of £1.5m), this change will reduce the amount that can be taken tax-free from a pension by up to £75,000 (assuming 25% of the fund will continue to be available as a tax-free lump sum in the future).

Unapproved pension schemes

The Government's consultation paper has also highlighted again their plans to introduce legislation to ensure funded Employer-financed retirement benefit schemes (EFRBS) are less attractive than other forms of remuneration. This is confirmation of a previously announced intention by the Government to 'crack-down' on perceived tax avoidance using employee benefit trusts. Draft legislation can be expected later in the year. 

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