High earners - loss of pension contributions tax relief (01/2010)

Following the April Budget announcements, further clarification of the tax reliefs for high earners' pension contributions from 2011 was given by the Chancellor in his Pre-Budget Report in December. Alistair Darling also moved to widen the anti-forestalling provisions that apply until 2011.

Before April 2009, tax relief was provided on pensions contributions at an individual's marginal tax rate. So for 40% taxpayers, contributions would attract 40% relief, regardless of income. This had the benefit of a substantial uplift in the value of contributions. Since April 2006, the only restriction has been the annual limit on contributions of 100% of earned income, subject to an annual limit (set at £245,000 for 2009/10).

This article summarises the new rules and provisions.

Pensions tax relief from April 6th 2011

The main provisions are as follows:

• Gross incomes of more than £180,000

Higher-rate tax relief will be completely eliminated for those with gross incomes in excess of £180,000. For this purpose, the definition of gross income includes all pension contributions made by or on behalf of the individual i.e. it includes employer pension contributions/benefits.

The tax relief will be restricted by applying a high income excess relief charge through self-assessment. So for those earning in excess of £180,000 any employer pension contributions will result in a tax charge on the individual. The level of the charge will be such that the pension contributions enjoy only basic rate tax relief. Where the total charge exceeds £15,000 the individual will have the option of asking the scheme to pay the charge out of their pension funds. Where this is not possible, the charge may be spread over three years.

• Gross incomes between £150,000 and £180,000

For those with gross incomes between £150,000 and £180,000 the higher rate relief will be tapered away. The precise taper mechanism is the subject of current industry consultation which is to be concluded in March 2010.

• "Relevant Incomes" of £130,000 or less

An income floor has been set so that anyone with "relevant income" of less than £130,000 before employer pension contributions will still get full higher-rate tax relief. "Relevant income" is defined as taxable income plus personal pension contributions through net pay, plus any salary sacrifice made to provide pension benefits to the individual that was agreed after 22nd April 2009.

So an individual with relevant income of £125,000 will not be subject to the high income excess relief charge even where the employer makes pension contributions on their behalf in excess of £25,000. And where an individual with relevant income of £135,000 has an employer contribution of £12,000, no excess relief charge will apply either because the gross income threshold of £150,000 has not been breached. But an individual with relevant income of £135,000 and an employer pension contribution of £20,000 will be subject to a relief charge on £5,000 of their pension contributions.

The Government has stated that there are no plans to increase these income thresholds, meaning that more and more people will be caught by the restrictions as their incomes increase over time.

"Anti-forestalling" provisions and arrangements up to April 6th 2011

While preparing for this new regime, the Government has also introduced measures to prevent pension contributions being uplifted and gaining higher rate relief, ahead of the loss of tax relief in April 2011.

These so-called "anti-forestalling" provisions involve examining the contributions of those with "relevant income" over £130,000 in any of the tax years from 2007/08. In essence, higher rate relief will be restricted immediately for these people if:

• They increase pension contributions from 22 April 2009 above their regular level[1], and
• Their total pension contributions for the year exceed £20,000 (or the lower of £30,000 and average contributions over the past three years if contributions are less regular than quarterly). This is known as the Special Annual Allowance. Total pension contributions will include any made by employers.

Pre-existing regular contributions will not be tested against the Special Annual Allowance. These regular contributions are known as "protected pension input amounts".

If someone earning over £150,000 exceeds the Special Annual Allowance, tax will be charged on the excess contributions at 20% (2009/10) and collected through self-assessment.

Under the anti-forestalling provisions, the testing and subsequent tax calculation for those accruing pensions in defined benefit (DB) schemes is rather more complicated. However, if the scheme does not improve the benefit accrual rate and the member makes no other pension contributions, there should be no further tax charge.

And finally...

Anyone with "relevant income" of more than £130,000 should at least ensure they use their Special Allowance limit of £20,000 over the next two years. And with less than three months of the current tax year to go, now is the time to act.

In the longer term, the loss of tax relief may well lead some to switch away from non-pension investments. But any such move should be considered within the overall financial plan for retirement. For the foreseeable future the 20% relief will remain in place. That enhancement, along with the potential to take 25% tax-free cash on retirement, still makes saving in pension schemes highly advantageous compared with other retirement-focused investments.

Derek Miles
Managing Director, Aspira Corporate Solutions LLP
January 2010

[1] Regular pension contributions are defined as normal, regular, ongoing contributions or accruals of benefit in place at 22nd April 2009. A regular contribution must be one which is made at least every three months.