Tax privileged pension saving is being reformed to restrict relief. This was inevitable, given the Coalition Government's confirmation that reform was a necessary part of its commitment to tackling the fiscal deficit (see HM Treasury - Restriction of pensions tax relief: a discussion document on the alternative approach, July 2010). Following the invitation to the pensions world to comment on alternative proposals, HM Treasury has now published its decision on the way forward.
The headline: reduced allowances
The annual allowance (AA) will reduce from £255,000 to £50,000 on 6 April 2011 for at least five years (and there's no promise of indexation in future). This is more than the £30,000 suggested in July, but to pay for it the Lifetime Allowance (LTA) will reduce from £1.8 million to £1.5 million in April 2012.
Tax relief will continue at marginal rates (but then charged at the same rate)
Tax relief on pension savings will be at an individual's marginal tax rate. However, if he/she exceeds the AA, that individual can expect a charge aligned to their marginal rate of tax. The expectation is that individuals will be able to manage their affairs to avoid exceeding the Annual Allowance.
Valuing pension savings
For defined contribution schemes, contributions are simply what you put in.
For defined benefit schemes it is more complicated. The cost of accrual will be deemed based on a flat rate factor of 16, irrespective of scheme design or age. So, extra pension of £3,125 a year will be equivalent to a £50,000 contribution. Negative accruals will be treated as zero.
Deferred members will be excluded, but some revaluation of accrued benefits will count towards the Annual Allowance. It is not exactly clear yet how this will work and that could be significant for defined benefit schemes which have closed to accrual but maintained a link to future salary increase.
The existing exemption from the AA in the year benefits come into payment will disappear.
If you die or are diagnosed with serious and terminal ill–health you won't have to worry about exceeding the AA, assuming it is on your mind in the first place. The Government is also looking at further exemptions for ill health benefits.
There is no exemption for redundancy.
Interaction with enhanced protection
There is a recognition of the need to avoid retrospective unfairness for those individuals who already benefit from the enhanced protection regime. There is a consultation to determine how this can be achieved.
Is there any real good news?
Some individuals may exceed the allowance only in circumstances such as redundancy. It will be possible to carry-forward unused allowances from the three previous years to assist in these situations. The carry forward will apply automatically.
Those incurring a tax charge might be able to pay it out of their pension entitlement in some way (either because the scheme pays or because they can delay payment until benefits start to be paid – the precise mechanism is not yet decided).
Next steps and implementation
The new provisions will be in the Finance Act 2011 and regulations. Most of the draft legislation is intended to be available by the end of 2010.
There is an ongoing consultation about the protection of existing enhanced protection members and how tax charges can best be levied on individuals who exceed the Annual Allowance because of large historic benefits.
There is some recognition of the potential implementation burden for pension schemes and some flexibility has been retained around pension input periods and the information to be given to members.
Some are breathing a sigh of relief, given that the Treasury suggested an AA as low as £30,000 back in July. On the other hand, an AA set at £50,000 still means that many people who would not ordinarily consider themselves "high earners" could now easily fall within the new charge to tax.
The Government promises draft legislation by the end of the year, in time for implementation through Finance Bill 2011, at which point, the intricate details of the new regime will be unveiled in all their glory. Some proposals are not yet entirely clear and the detail will emerge over the next few months.
Finally, a word to the wise: the Government has also promised legislation aimed at ensuring vehicles such as employee benefit trusts and funded employer-financed retirement benefits schemes do not pose a more attractive alternative than other forms of remuneration. The stated objective of such legislation is "to address the use of these intermediary vehicles to disguise remuneration and avoid, reduce or defer payment of tax: and to maintain the principle that there is a limit on the level of tax-advantaged retirement saving the Government is willing to support".
Short term manoeuvring and avoidance generally is also of course within the Government's sights.