The Finance Act 2009 (which received Royal Assent at the end of last month) contains key provisions impacting on high earning members of pension schemes. In this August edition of Pensions E-Bulletin, we set out key details of these complex changes and comment on potential implications for high earning scheme members.

These changes may not impact the majority of scheme members, but there are compelling reasons for keeping high earners in mind. One of the reasons the Finance Act changes have been fraught with controversy is the argument that they jeopardise pensions saving for high earners (who may well be key decision makers in organisations with occupational schemes). If pension saving ceases to work for high earners, the National Association of Pension Funds (NAPF) has argued there is a risk that it could "destabilise pension saving for lower earners in the company".

What do the changes mean for high earners?

Alistair Darling, the Chancellor of the Exchequer, made the announcement about the changes to higher rate pensions tax relief during his Budget Day speech earlier this year. In this announcement, the Chancellor explained that from 6 April 2011, higher rate tax relief on contributions to registered pension schemes would be restricted for individuals earning more than £150,000 per annum. For such individuals, tax relief will be tapered down from 40% at £150,000 so that anyone earning £180,000 per annum and above will only receive 20% tax relief.

Anti-forestalling measures

Special "anti-forestalling" measures have now been put in place relating to any contributions made by high earners prior to 6th April 2011 - these measures have retrospective effect dating back to Budget Day (22nd April 2009). These anti-forestalling measures are intended to prevent individuals making extra pension contributions now (over and above their regular pensions savings pattern already in place on 22 April 2009) to take advantage of existing tax relief prior to the changes in 2011.

The anti-forestalling measures have been structured by putting in place a Special Annual Allowance of £20,000, which is applicable during each of the tax years 2009/10 and 2010/11. (Note: in certain limited circumstances, this Special Allowance may be increased to £30,000 where an individual has made irregular pension contributions which also qualify for protection through the anti-forestalling measures.) In tandem with this allowance of £20,000, a Special Annual Allowance Charge of 20% is in place which operates to recover the additional tax relief (over and above basic rate tax relief) which anyone earning more than £150,000 would otherwise be entitled to receive.

The Special Annual Allowance of £20,000 restricts the higher rate tax relief available to those earning above £150,000 per annum – this operates differently depending on the type of pension scheme involved:-

  • Defined contribution schemes - where a member makes contributions exceeding the special allowance, that individual may then become liable to pay the Special Annual Allowance Charge;
  • Defined benefit schemes – where a member receives further benefit accrual worth more than the Special Annual Allowance, the individual may become liable to pay the Special Annual Allowance Charge.

Importantly, the anti-forestalling measures still permit those earning more than £150,000 per annum to receive higher rate tax relief on contributions or an increase in value of pension rights exceeding the £20,000 Special Annual Allowance limit. This is possible when the high earner’s contributions or value of their pension rights fit with their regular pattern of pensions saving or benefit accrual in place before 22 April 2009.

Regulations have been laid before Parliament to add to the list of prescribed tax avoidance schemes any new type of avoidance scheme (involving accrual or expected accrual of pension benefits) where the main purpose is to avoid liability to the Special Annual Allowance Charge.

Impact of changes for defined benefit schemes

Sponsoring employers and trustees of defined benefit schemes (with any members earning more than £150,000 per annum) should be aware that amending the scheme rules (for example to change the calculation of pensionable salary or to increase the accrual rate) could impact on high earners' regular pattern of pensions saving and therefore have tax implications for these individuals. This is a complex area and we would be happy to provide tailored advice to individual schemes on this issue if required – other situations where specific advice may be required include the implications of high earners changing jobs and joining a new employer's pension scheme or commercial reorganisation of pension schemes.

There are numerous other areas where the changes to the Finance Act have consequences, including:

Redundancy/Termination payments - In these challenging times, when redundancies are sadly a relatively common occurrence, individuals who do not normally earn as much as £150,000 per annum may find themselves hit by the anti-forestalling measures if they receive a substantial one-off pension payment as part of their redundancy package.

Where an individual whose employment is being terminated is already earning more than £150,000 per annum, there could also be an impact for them on receiving a one-off lump sum payment into their pension scheme - this additional money may be unlikely to be protected (even if agreed before 22 April 2009) because it will not form part of a regular pattern of pension saving.

Flexible Benefit packages - There is uncertainty relating to the application of the new regime to flexible benefit packages which some employers offer their staff. Members of pension schemes may opt to vary their rates of pension contributions through their flexible benefit packages. This may have implications for determining high earners' regular pattern of pensions saving and we can advise further if required.

Can high earners still buy added years? - High earning members of defined benefit schemes may, subject to certain restrictions, still be able to make additional voluntary contributions to buy added years. The associated increase in value of pension rights may be protected if certain criteria are met including that the contributions are being paid under an agreement which was already in place on 22 April 2009 – again, we shall be happy to provide further advice if required.

What if individuals have made an overpayment? - In certain limited circumstances, where an individual member makes additional voluntary contributions to an occupational scheme or to a group money purchase scheme and it then becomes apparent that these payments will be hit by the Special Annual Allowance Charge, a refund of contributions by the scheme administrator may be permitted. Such refunds are known as contributions refund lump sums (CRLS) and whether they are permitted will depend on the scheme rules. Schemes may also wish to amend their rules to permit CRLS if these would not be possible under current rules.

UK based high earners paying into non-UK based schemes - The anti-forestalling measures have even been extended to apply to high earners working in the UK who receive UK tax relief in relation to pension contributions to schemes established outside the UK.