Government replaces Labour’s pension tax restrictions with reductions in the annual and lifetime allowancesWednesday, October 20th, 2010
The Coalition government has announced that the annual tax relief allowance for pension savings will reduce from £255,000 to £50,000 from April 2011 and the lifetime allowance will reduce from £1.8 million to £1.5 million from April 2012.
The Labour government’s solution to limiting the amount of tax relief available to high earners making large pension contributions was to impose a tax, known as the “high income excess relief charge”, on the total pension savings amount in a tax year. This would have the effect of limiting the tax relief on those contributions to 20%, instead of their personal marginal 40% or 50% rates. Those provisions are already set in law, having been introduced by the Labour government’s Finance Act 2010, and would have come into effect from 6 April 2011.
Also, in order to prevent large pension contributions being made in advance of April 2011, a temporary “special annual allowance charge” was introduced from April 2009. This is a tax charge, at 20% or 30%, on the amount of pension savings above £20,000 in a year for individuals with annual earnings of £130,000 or more who change their normal pattern of regular pension contributions or their normal method of pension accrual. These measures were introduced by the Finance Act 2009, amended by the Finance Act 2010, and apply only for the 2009/10 and 2010/11 tax years.
The Coalition government’s first Budget on 22 June 2010 included announcements that the legislation introducing the “high income excess relief charge” from April 2011 would be repealed and replaced by a significant reduction in the annual allowance, one of the two existing control measures (the other is the lifetime allowance) for limiting the tax relief that is available for pension contributions. The proposal at the time was for a reduction from its current level of £255,000 to between £30,000 and £45,000.
The Coalition government’s Finance (No. 2) Act 2010, which became law on 27 July 2010, included powers to repeal the “high income excess relief charge”, all long as this is done before 31 December 2010.
In July 2010, the Government published a discussion document entitled “Restriction of pensions tax relief: a discussion document on the alternative approach” and held meetings with interested parties. The Government received 238 written responses to the ideas raised in the discussion document, 183 of which were from organisations. Most of the responses to the discussion document welcomed the approach of reducing the annual allowance and, on 14 October, the Treasury confirmed that the previous government’s legislation will be repealed and replaced by
- a reduction in the annual allowance from £255,000 to £50,000, from April 2011, and
- a reduction in the lifetime allowance from £1.8 million to £1.5 million, from April 2012.
The decision to fix the annual allowance at £50,000 means that the change will affect around 100,000 pension savers, 80% of whom have incomes over £100,000. Conversely, it also means that the majority of pension savers will not be affected and can, if they wish, contribute an amount equal to their annual earnings into their pension scheme.
An additional measure, to protect individuals who exceed the annual allowance due to a one-off “spike” in accrual (a particular issue with defined benefits schemes), will allow the excess to be offset against unused allowance from the previous three years. Discussion are also to be held to consider the idea of tax charges arising from the lower annual allowance being met from the individual’s pension fund rather than directly from the individual.
The legislative changes have been published in draft form, in advance of their inclusion in the Finance Bill to be published after the Chancellor presents his four-year Spending Review on 20 October. The changes to the annual allowance must be enacted before the end of December.
The principle changes made to the annual allowance rules are as follows. References to the “pension input amount” are to the increase in the individual’s pension rights in the year, calculated according to specified rules for each different type of pension scheme. References to the “pension input period” are to a period of (normally) a year, as specified for each type of scheme, for which the pension input amount is determined.
- Instead of the excess pension input amount over the annual allowance being taxed only at the higher 40% rate of tax, the applicable rate will be the basic 20%, higher 40% or additional 50%, in order to apply the tax at the individual’s marginal rate of tax.
- Any unused annual allowance for the three years preceding the current year may be added to the annual allowance for the current year to determine whether an annual allowance charge is applicable for the current year. Unused annual allowance is only available to carry forward where it arises during a tax year in which the individual is a member of a registered pension scheme but applies to a tax year even if the pension input amount for that year is nil.
- The annual allowance is set at £50,000.
- In addition to death, there is no pension input amount in a year in which
- an individual is entitled to a serious ill-health lump sum from the pension scheme, or
- an individual is a deferred member and the pension input amount increases by not more than the percentage specified in the scheme rules or, if not so specified, the percentage increase in the consumer price index.
- In the case of defined benefits schemes, the factor used to calculate the opening and closing values of an individual’s rights in a pension input period is increased from 10 to 16.
- In the case of defined benefits schemes where the rights do not accrue during the pension input period, the opening value of the individual’s rights are increased by the percentage increase in the consumer price index, instead of the greater of 5% and the percentage increase in the retail price index.
- The changes apply for the 2011/12 tax year and beyond, but also for the pension input periods that end during 2011/12 but start in the previous tax year. Transitional rules allow two pension input periods to apply where a pension input period ends during 2011/12 but starts before 14 October 2010 (the date on which the announcement about the reduction in the annual allowance was announced), so that the benefit of the £255,000 allowance applies proportionately to the period before 14 October 2010. Transitional rules also define how, in those circumstances, the amounts of unused annual allowance are to be carried forward to the following tax years.