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Pensions – Tax relief on pension contributions
Friday, December 18th, 2009
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Summary
From 2011/12, a “high income excess relief charge” will be imposed on “high income” individuals, i.e. those with annual gross income (including employer pension contributions) of £150,000 or more and who, in addition, have gross income (excluding employer pension contributions) of not less than £130,000. The effect of the charge will be to restrict the tax relief on employee pension contributions to 20%.
The “special annual allowance charge”, introduced from 22 April 2009 as an anti-forestalling provision to prevent large pension contributions being made before 2011/12 in order to obtain 40% tax relief, is amended from 9 December 2009 so as to include individuals with incomes of £130,000 or more.
Detail
Budget 2009 announced that, from 2011/12, the tax relief on pension contributions will be restricted to the 20% basic rate where an individual’s gross annual income is £150,000 or more. The full restriction will only apply on gross income of £180,000 or more and a taper will apply between £150,000 and £180,000. Currently tax relief at this level of earnings is given at 40%.
To prevent large sums being paid into pension funds in advance of April 2011 in order to obtain tax relief at 40% while it is still available, transitional “anti-forestalling” provisions were introduced by the Finance Act 2009 in the form of a “special annual allowance charge”. These provisions took effect from 22 April 2009 and impose a 20% income tax charge on pension contributions and benefits accrued in excess of a special annual allowance of £20,000 (or £30,000 in some specific situations) for individuals whose relevant income is £150,000 or more.
The charge does not apply to those who have never earned in excess of £150,000 a year, or continue with their regular, at least quarterly, pattern of contributions or normal benefit accrual.
The 2009 Pre-Budget Report (PBR2009) made the following announcements in relation to this tax relief restriction:
- an individual’s gross income for the purpose of the tax relief restriction will include both employee and employer pension contributions
- the tax relief restriction will only apply if gross income is £150,000 but, in addition, is not less than £130,000 when employer pension contributions are ignored
- the income threshold for the “special annual allowance charge” is reduced to £130,000 from 9 December 2009.
These changes have the effect of removing individuals with earnings of less than £130,000 from the effect of the tax relief restriction.
Other changes were also announced to the tax charges on short service lump sum refunds and on payments from employer-financed retirement benefits schemes (EFRBS).
High income excess relief charge, from April 2011
Published at the same time as the PBR2009 was the draft text of the legislation that will appear in the 2010 Finance Bill to restrict the tax relief on pension contributions to 20%. The restriction is to be known as the “high income excess relief charge” and takes the form of a charge, at either 20% or 30% depending on whether the person pays tax at the 40% higher rate or the 50% additional rate, on the total pension savings amount in a tax year. It will have effect from the 2011/12 tax year.
The charge will apply to individuals with “high income” in a tax year, i.e. with
- “gross income” for the tax year of £150,000 or more, and
- “relevant income” for the tax year of not less than £130,000.
An individual’s “gross income” is
- the total income for the tax year,
- plus any pension contributions or any payroll giving donations not included in (a) because they have already enjoyed tax relief,
- less any other permitted income tax deductions and reliefs,
- plus the “total pension savings amount” for the tax year after deducting any pension contributions paid by, or on behalf of, the individual.
An individual’s “relevant income” is
- the total income for the tax year,
- plus any pension contributions or any payroll giving donations not included in (a) because they have already enjoyed tax relief,
- less any other permitted income tax deductions and reliefs,
- plus any employment income that has been given up under a salary sacrifice scheme in return for contributions to, or increased entitlement to, benefits under a pension scheme, which sacrifice was made on or after 22 April 2009.
The manner in which an individual’s “pension savings amount” is determined for each type of pension arrangement is defined precisely in the draft legislation.
If the employee is a “high income” employee, as defined above, the “high income excess relief charge” is calculated by multiplying the “total pension savings amount”, or the appropriate part of that amount, by 0%, 20% or 30% according to the relevant amounts of the individual’s total pension savings that were relieved at the 20% basic, 40% higher or 50% additional rates of tax.
If the individual’s gross income is less than £180,000, the charge rates are between 0% and 20% (or 30%) in proportion to the amount by which the gross income exceeds £150,000 but does not exceed £180,000. The taper mechanism is not finalised in the draft legislation but, for example, it could be a reduction of 1% for each £1,500 (in the case of the 20% charge) or each £1,000 (in the case of the 30% charge) by which gross income is less than £180,000.
Special annual allowance charge
To accommodate the reduction in the lower threshold for the tax relief restriction from the £150,000 to £130,000, the rules for the special annual allowance charge are changed from 9 December 2009, the date of PBR2009.
From that date, the special annual allowance charge will apply to individuals with incomes of £130,000 or more who change
- their normal pattern of regular pension contributions; or
- the normal way in which their pension benefits are accrued;
and whose total pension savings exceed the special annual allowance of £20,000 a year (or, in some circumstances, £30,000). In these circumstances, the special annual allowance tax charge will apply only to additional pension savings over and above the individual’s normal regular pension saving made on or after 9 December 2009.
From 6 April 2009, the rate of the special annual allowance charge will be either 20% or 30%, as appropriate, of the amount by which pension savings exceed the special annual allowance, in order to restrict tax relief on that excess to the basic rate of income tax.
Other pension-related tax charges
When a registered pension scheme repays pension contributions that have enjoyed tax relief to scheme member who is leaving the employment with less than two years’ service, the scheme deducts tax at the rate of 20% on the first £10,800 of the refunded contributions, and 40% on the remainder. From 6 April 2010, refunds will be taxed at 20% on the first £20,000 and 50% on the remainder.
When an employer-financed retirement benefits scheme pays certain lump sums or gratuities to entities that are not individuals, tax is charged at 40%. From 6 April 2010, the rate will be 50%.
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