The 2016/17 tax year will herald a ‘two pronged attack’ on the pensions of higher earners, with a couple of big changes taking effect; a reduction in the annual amount that higher earners will be able to save into pensions and claim tax relief on (the ‘annual allowance’), combined with a further reduction in the pension ‘lifetime allowance’ to £1 million.
With less than one month remaining until the changes take effect, those that will be affected by them should start planning immediately. There might never be a more crucial time to reconsider your retirement savings as the pension tax relief system is about to be reinvented.
In the Summer 2015 Budget the Government announced their intention to cut pensions tax relief for high earners by introducing a tapered annual allowance from 6 April 2016 for individuals with income (including the value of any pension contributions) of over £150,000, and who have an income (excluding pension contributions) in excess of £110,000.
The good news is that until April 6 there is a window of opportunity. As things stand the tax relief on offer to higher earners is very generous, therefore it makes sense to maximise your pension contributions while you still can.
What is the situation now?
Currently, all pension contributions made from earnings qualify for tax relief at your highest income tax rate – up to an annual limit. The cap on contributions that qualify for tax relief in one tax year, known as the annual allowance, is £40,000. This encompasses contributions to defined contributions plans, employer pension contributions and benefits built up in final salary schemes.
How high earners will see their pension tax relief restricted
From 6 April 2016 the current annual allowance of £40,000 will be tapered to a minimum of £10,000 on contributions made by those earning between £150,000 and £210,000.
Rather than move to a flat rate of tax relief for all from 2016/17 onwards, George Osborne has instead opted to preserve tax relief at the highest marginal rates, but restrict pension contributions for those earning over £150,000 per year on a tapered basis – a reduction in annual allowance of £1 for each £2 of ‘adjusted income’ over £150,000 per year, as illustrated in the following table:
[[Earnings Annual contribution allowance Amount of tax relief available (up to 45%)
£150,000 or below £40,000 £18,000 £170,000 £30,000 £13,500 £190,000 £20,000 £9,000 £210,000 or more £10,000 £4,500]] - Table
This would mean, for example, that a person earning £190,000 would have a £20,000 annual allowance while someone earning £210,000 and over would have a £10,000 annual allowance. The immediate cost to someone earning £210,000 will be £13,500 in lost tax relief.
It’s not all doom and gloom
As a perhaps unintended consequence of the Government’s decision to taper down annual allowances from April 2016, transitional legislation has had to be introduced to allow the alignment of the dreaded ‘pension input periods’ much to the delight of Accountants and Financial Planners (as with many company accounting periods, some pension schemes have contribution years or pension input periods that do not correspond to the standard tax year).
From 2016/17 onwards, all pension schemes will follow the tax year and, to avoid detriment to those with unusual input periods, the 2015/16 tax year has been sub-divided into two ‘mini tax years’, with a maximum overall annual allowance of £80,000, assuming that you had already contributed at least £40,000 before the Budget on 8th July 2015.
This means that, for those that had already made 2015/16 pension contributions prior to the July Budget, up to a further £40,000 ‘extra’ annual allowance will now be available, all of which will attract tax relief up to the highest marginal rate. For those who did not contribute before the Budget, the annual allowance for 2015/16 will be effectively the same as before the Budget announcement i.e. £40,000.
You should consider contributing the maximum amount you can into your pension before April. This could be a substantial amount as it is possible to ‘carry forward’ any unused annual allowance from the previous three years. Last year, the maximum annual contribution was £40,000, while in 2013-14 and 2012-13 it was £50,000. This means the maximum amount for this tax year could be as much as £180,000.
However, if you already have a substantial pension pot you must take care. The lifetime allowance, the maximum amount the government allows you to hold in your pension pot over your entire lifetime, will be reduced to £1 million from £1.25 million in April. Savers who amass a pot that exceeds this limit and do not take preventative action could be forced to pay as much as 55% tax on the surplus.
Likewise, there will be protection available for those that may be affected by the reduction in the lifetime allowance to £1m. Fixed Protection 2016 will allow you to preserve the current lifetime allowance of £1.25 million, although as a condition of this, you must cease all pension contributions and relevant accrual in final salary schemes by the end of the 2015/16 tax year.
For those that will have pension benefits valued in excess of £1 million on 5th April 2016, but wish to continue making pension contributions thereafter, Individual Protection 2016 will provide you with a lifetime allowance equal to the value of benefits on 5th April 2016, with just the additional benefits liable to a lifetime allowance charge when they are crystallised.
What shall I do now?
Given the ever increasing complexity of pension and tax legislation, and even recent speculation over ‘the death of the 25% tax free cash’, it has never been more important to make use of expert financial planning advice. At Hugh James Independent Financial Advisers, we will be carefully considering the implications of all of these changes upon your financial position and will advise you accordingly as part of our review process and service.
For further detail regarding the proposed changes, how could they affect you and what can be done to mitigate their effects, please contact 029 2066 0565.