A change to the rules on pensions tax relief announced in the Summer Budget on 8 July will have major consequences for those earning more than £150,000 pa, and will also affect some with earnings between £110,000 pa and £150,000 pa.
The basic position currently is that an individual is entitled to tax relief on the value of his pensions saving up to £40,000pa, the annual allowance, regardless of his income level. From tax year 2016/17 the annual allowance will be reduced for those with annual incomes over £150,000. For every £2 of income over £150,000, an individual’s annual allowance will be reduced by £1, down to a minimum of £10,000.
Notably, the value of pension contributions is taken into account when assessing whether an individual has an annual income over £150,000, so an individual with annual earnings of less than £150,000 (subject to a minimum of £110,000) could be caught.
Where an individual’s pension savings exceed the annual allowance, the excess is subject to a tax charge which effectively negates any tax relief on that pensions saving. Liability for the tax charge rests primarily with the individual, but in some circumstances the individual can require the pension scheme to meet the tax charge on his behalf and reduce benefits accordingly.
Employers will not be liable for the tax charge themselves, but the impact of the tax charge will mean that for affected employees, pension benefits may be much less valuable than previously. Senior employees may therefore look to their employers to restructure benefit packages for example by replacing pensions savings with work based ISAs.
In connection with the annual allowance changes, the rules are being changed so that, from tax year 2016/17, the value of an individual’s pension benefits will be tested against the annual allowance for the tax year in which the contributions are paid (for defined contribution) or the benefits accrue (for defined benefit). Whilst this may sound obvious, under the pre-Budget rules an individual could accrue pension benefits in one tax year that were not tested against the annual allowance until a later tax year. This is because the amount tested against the annual allowance in a tax year was the amount that accrued in a “pension input period” ending in that tax year. So for example if the pension input period was 1 July to 30 June, the amount that counted for the annual allowance in tax year 2015-16 (before the announced changes) would have been the amount accrued from 1 July 2014 to 30 June 2015.
The system will be more straightforward from 6 April 2016 onwards. But the transitional rules announced at the Summer Budget are complex, with an £80,000 annual allowance to 8 July 2015 and special rules for the period 9 July 2015 to 5 April 2016. Schemes will need to update their systems and provide additional information. Employers will therefore need to take care to ensure that they understand the tax implications. If any pensions changes are being made, the tax implications will need to be given particular thought.
More radical change ahead?
As a separate measure, the Summer Budget announced a consultation on whether the tax treatment of pension saving should be fundamentally reformed, possibly by removing tax relief altogether at the point when pension contributions are made and replacing this with some other form of Government “top up” and tax exemptions at the point when benefits are taken. The Government has made clear that it has not yet made a decision on this issue, but employers considering remuneration strategies should be mindful of the potential for fundamental changes to the pensions tax regime.