High earners should act now to avoid unexpected tax bills from pension contributions.
From 6 April 2016, the annual allowance (the amount that can be paid into a pension scheme over any one year) will be tapered from £40,000 for those with earnings of £150,000 and less to £10,000 for those with income of more than £210,000. If pension contributions are made over these limits the member will be taxed at 45% on the excess.
There are ways of mitigating the impact of this for example by carrying forward any leftover allowance from previous years or taking advantage of the transitional pension input period. A pension input period is the period over which the value of pension savings is measured for annual allowance tax purposes. The tax year 2015/16 has been split into two “mini tax years” so taxpayers effectively have a total annual allowance of £80,000 for the period 6 April 2015 to 5 April 2016.
Another major change being introduced is the reduction in the lifetime allowance from £1.25 million to £1 million with effect from 6 April 2016. Any excess will be charged at 55% if taken as a cash lump sum and 25% if taken as income. This will be on top of any tax payable on the income in the usual way. It may be possible to claim protection against the decrease in the annual allowance by preserving a previous higher limit. Individual Protection 2014 affords to individuals who had pension savings of more than £1.25 million on 5 April 2014 a personalised lifetime allowance equal to the value of their pension savings on 5 April 2014 up to a maximum of £1.5 million. Further pension saving is possible without losing this form of protection. Claims for individual protection 2014 must be made before 6 April 2017.
With effect from April 2016 two new forms of 2016 protection will be available to protect against reduction of the lifetime allowance to £1m, these will operate in a similar way to the 2014 protections.
It is also rumoured that in the forthcoming budget in March the Chancellor is planning to scrap the current system which allows individuals to claim tax relief on their pension contributions at the same rate as they pay income tax. It is predicted he will replace this with a single rate perhaps between 25% and 33%. Arguably this may make pension saving more attractive for basic rate tax payers but less attractive for higher and top rate tax payers.
If you are a high earner now may well be a good time to review your pension provision and consider whether to make pension contributions before the allowances change. You are of course recommended to seek independent financial advice as part of that review.