More pension relief changes

PETER HARRUP of PKF explains the Government’s planned changes in tax relief on pension contributions

LAST month, the Government issued definite proposals to reform the system of pension tax relief from 2011/12 onwards.

They will simplify the rules eventually although they will be less generous. However, for now, there remain both opportunities and complexities for pension savers, particularly those aged 55 or more by April 5, 2011.

From 2011/12, the maximum annual amount that individuals (and employers contributing on their behalf) can pay into a pension scheme without incurring a penalty charge will be reduced from �255,000 to �50,000. Maximum personal contributions continue to be limited to 100% of the individual’s earnings. Although a charging mechanism on excess annual contributions has existed since 2006, the size of the annual allowance (AA) has meant that charges rarely occur in practice. However, with the AA at �50,000, charges will be more commonplace and business owners will have less scope to build tax-efficient pension savings.

Tax relief on personal contributions will be available at the individual’s marginal income tax rate, i.e. up to 50%, and Corporation Tax relief for company contributions is unchanged. However, if the AA is exceeded, the new charge will be at the full marginal rate of relief that an individual would otherwise have obtained, i.e. up to 50%.

For members of defined benefit schemes, calculating if the new AA has been exceeded is complicated. A deemed contribution value is calculated at 16 times (currently 10 times) any increase in the individual’s pension benefit entitlement during the year. Where any individual’s pension savings exceed the AA in a given year, any unused allowances from the three previous tax years will be available to offset against the excess.

Currently, contributions are not tested against the AA where an individual dies in the tax year or becomes entitled to all the benefits available under the scheme concerned, i.e. on retirement. The second of these exemptions is to be removed from April 6, 2011, so individuals aged over 55 have one last chance to contribute a large amount and take their pension benefits without incurring an AA charge. However, the last Government’s anti-forestalling rules still apply for 2010/11 and may limit the net tax relief available to 20%.

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From 2012/13, the lifetime allowance will also be reduced from �1.8m to �1.5m. The Government is to consult on ways to create a protection regime for individuals who already have substantial pension funds.

So what should you do about your pension? Depending on your level of income, available funds and intended retirement date, there may be advantages in either advancing contributions to take advantage of the higher contribution limit available until April 5, 2011, or delaying contributions so that higher rates of tax relief are obtained after April 6, 2011. Advice should be sought from from a suitably qualified Independent Financial Adviser.