The focus for new pension legislation in the last few years has been the development of personal accounts and the reform of state pensions. The simplified tax regime introduced from 6 April 2006 had been bedding down quietly, with minor adjustments regularly made in each Finance Act.

However, the relative peace in the land of pension tax has now been completely shattered. The first rumblings were heard in the 2008 Pre-Budget Report. This contained an announcement of a freezing of the lifetime allowance and the annual allowance at their 2010/11 levels for the following five years. Most experts had been expecting inflation-plus-a-little rises.

The Budget proper brought the earthquake of restrictions to higher rate income tax relief for contributions. In the week before the Budget there had been assorted leaks that something would happen to higher rate relief, but nobody predicted anything as complex as what finally arrived.

The Chancellor plans to restrict the value of tax relief on all pension contributions (including those made by employers) from 2011/12 for those with income of £150,000 or more. This will be achieved by tapering relief down from that income threshold to 20% for those with income over £180,000. Thus nobody will be able to obtain pension contribution tax relief at the new 50% tax rate from 2011/12.

The 2011/12 starting date is justified by ‘the importance of consulting on this measure'. However, the Chancellor has found no need to consult on a raft of complex ‘anti-forestalling' measures, designed to limit the opportunity to make large pension contributions before 2011/12. These measures, which will last for just two years, will only affect you if:

•  Your ‘relevant income' is £150,000 or over in the current tax year or either of the two preceding tax years;

and

•  You increase your ‘normal regular ongoing pension savings'

and

•  Your ‘total pension savings' during a tax year exceed £20,000 (the special annual allowance).

‘Relevant income' is defined as your total income less normal deductions and reliefs (eg trading losses) and Gift Aid, but with any deduction for pension contributions limited to a maximum of £20,000.

‘Normal regular ongoing contributions' to a pension arrangement are:

For money purchase schemes, such as personal pensions

•  The total annual amount of your contributions to the arrangement, provided that the contributions were made at least quarterly before 22 April 2009;

plus

•  Any increase in your regular contributions that was agreed before 22 April 2009.

For an individual pension arrangement, such as a personal pension, a ‘normal regular ongoing contribution' must be made to the existing (pre-22 April 2009) arrangement. If you keep the total level of your total regular contributions the same, but pay them to different arrangements, then such contributions are not ‘normal regular ongoing contributions'.

For defined benefit arrangements, e.g. final salary pension schemes

•  All your pension savings (which are measured by reference to the change in value of your accrued benefits from one tax year's end to the next). This is subject to the proviso that the way your benefits are calculated under the scheme rules does not change on or after 22 April 2009, except in certain limited circumstances.

The money purchase scheme requirement that contributions are made quarterly or more frequently means that no account is taken of annual payments or one-off lump sums, even though this is the typical method of paying contributions by high earners.

‘Total pension savings' are all of your pension savings (from whatever source) that receive UK tax relief, including employer contributions. The pension savings value placed on your benefit accrual under a final salary scheme is 10 times the increase in pension plus any increase in a separate cash lump sum. For example, an extra £5,000 pension accrual is deemed to be £50,000 of pension savings.

If you are caught by the ‘anti-forestalling' rules, then:

•  You will receive full tax relief on your ‘normal regular ongoing contributions';

but

•  Any additional pension contributions (from whatever source) or the value of any additional benefit accrual will effectively be restricted to basic rate to the extent that your ‘total pension savings' exceed £20,000 in the tax year.

Relief is restricted by the application of a special annual allowance charge (at 20% in 2009/10) to the additional contribution. This will be collected via your self assessment return.

HMRC recognises that these new rules may result in pension contributions being made inadvertently. The Finance Bill therefore will include legislation that allows individual (not employer) non-regular contributions to personal pensions and AVC arrangements that attract a special annual allowance charge to be refunded, subject to scheme consent. The refund, which can only be made after the end of the tax year to which it relates, will be subject to a 40% deduction made by the scheme. As a result, any special annual allowance charge already declared on a tax return would have to be amended.

The forestalling rules include a crop of anti-avoidance measures, some of which are very broadly defined. Any ‘scheme' to exchange salary for pension contribution is likely to be ineffective.

The Special Annual Allowance Charge in Practice High income, no special annual allowance charge Ann has gross income of £158,000 in 2009/10 and made an individual pension contribution of £10,000, to which her employer added another £15,000. Her gross income in earlier years was under £150,000. Although her gross income exceeds the £150,000 threshold in 2009/10, her ‘relevant income' is under £150,000 after deduction of her £10,000 pension contribution, so Ann is not subject to the special annual allowance tax charge. High income, special annual allowance charge David has ‘relevant income' of £170,000 in 2009/10 and has a self-invested personal pension to which total pension contributions of £50,000 were made by himself and his employer. The contributions were David's regular monthly contribution of £2,000 (as in previous years) and a single employer payment of £26,000. David's income exceeds the £150,000 threshold and his ‘total pension savings' are more than the £20,000 special annual allowance. His ‘normal regular ongoing contributions' of £24,000 are not subject to the special annual allowance charge. However, the additional employer contribution of £26,000 will be subject to a special annual allowance tax charge of £5,200 (£26,000 x 20%). David will pay this via his 2009/10 self assessment tax return on 31 January 2011. High income, special annual allowance charge Eric has ‘relevant income' of £250,000 in 2009/10, of which only £22,000 is earned income. He has a personal pension to which he has regularly contributed £500 a month. In 2009/10 he makes an additional contribution to the plan of £16,000. Eric's income exceeds the £150,000 threshold and his ‘total pension savings' are more than the £20,000 special annual allowance. His ‘normal regular ongoing contributions' of £6,000 are not subject to the special annual allowance charge. However, the additional single contribution brings his ‘total pension savings' up to £22,000 and £2,000 of this (£16,000 + £6,000 - £20,000) will be subject to a special annual allowance tax charge of £400 (£2,000 x 20%). If Eric had limited his additional contribution to £14,000 he would have avoided the tax charge.

Two Years in One

For 2009/10, the annual allowance is £245,000. This is often interpreted to mean that the maximum that can be placed in your pension plans during the tax year is £245,000. However, such a statement is an oversimplification of the rules. The general principles are:

•  There is no limit on how much your employer can contribute. However, pension contributions have to be justified as allowable business expenses if they are to be tax relievable for the employer and their tax relief may be spread when their total pension contributions are £500,000 or more.

•  If you make gross personal contributions which total more than 100% of your relevant UK earnings (or £3,600, if greater), the excess will not be eligible for income tax relief.

•  If your total income is more than £150,000, you may be caught by the new ‘anti-forestalling' rules which limit higher rate tax relief.

•  If the total contribution input to all your pension arrangements during a tax year exceeds the annual allowance, the excess is subject to a 40% annual allowance charge. This can only be avoided by drawing all benefits from the relevant pension arrangements in the same year or, more drastically, death.

The calculation of contribution input is not straightforward. What matters are the contributions made during each pension arrangement's ‘pension input period' ending in the tax year. For example, if you have two pension schemes, one with a pension input period ending on 30 June and another with a pension input period ending on 31 December, were your employer to make contributions to both in August 2009:

•  for the first plan the contribution will count towards the £255,000 annual allowance for 2010/11 (ie. for the input period ending 30 June 2010)

•  for the second plan this will count towards the £245,000 annual allowance for 2009/10 (ie. for the input period ending 31 December 2009).

This complexity means that by manipulating pension input periods, if you are not caught by the ‘anti-forestalling' rules it is possible for contributions of up to £500,000 to be made in 2009/10 without falling foul of the annual allowance charge or special annual allowance charge.

Beating the Special Annual Allowance Charge

The new special annual allowance charge can never apply if your ‘relevant income' (see above) for the current and two preceding tax years is under £150,000. If your relevant income is below the £150,000 threshold for 2007/08 and 2008/09, then it could pay you to keep your ‘relevant income' down in this tax year (and the next) if you want to make substantial pension contributions. Stay below the £150,000 threshold and there is no risk of losing higher rate tax relief.

There are a number of ways you can limit your ‘relevant income', for example:

•  Transferring income-generating assets to your spouse. Such transfers would be beneficial, even if you both pay higher rate tax.

•  Restructuring investments to produce less taxable income.

•  Making Gift Aid contributions.

•  If you are self-employed, taking advantage of the £50,000 annual investment allowance to buy plant and machinery, possibly bringing forward planned investments from later years.

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The contents of this Bulletin are based on the proposals put forward by the Chancellor in his Budget speech and explained in documents subsequently published by HMRC and the Treasury.
All Budget proposals may be subject to change before the Finance Act is passed. References to spouse, husband and wife and married couples include references to registered civil partners and civil partnerships.
This Bulletin is provided for general consideration only and no action should be taken or refrained from based on its contents alone. Accordingly, no responsibility can be accepted for any loss occasioned as a result of any such action or inaction.
Professional advice must always be taken.

This news item is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at July 2008. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.

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