As explained in the February review, new tax rules are expected to apply to “high earners” for pension saving after 5 April 2011. A framework for the new rules was set out in the Finance Act 2010. And as part of Alistair Darling’s April 2010 Budget, the Treasury and HMRC issued a paper, Implementing the restriction of pensions tax relief: a summary of consultation responses, explaining in more detail how the new rules were then expected to operate – though final details were still to be clarified in further regulations.
The Conservatives originally opposed this new tax, but in the end their manifesto contained no promise to scrap it. The best bet now seems to be that it will indeed come into force in April next year, with only slight modifications.
The new rules are expected to provide for a “high income excess relief charge” on high earners’ pension savings, which will reduce the rate of tax relief they enjoy. The paper confirmed that relief for high earners will be tapered away from the maximum of 50% tax relief down to 20% tax relief (the basic rate of tax). The rate of loss of tax relief will be 1% for every £1,000 of relevant income above £150,000. Therefore, individuals with relevant income above £180,000 will only receive tax relief at the basic rate of tax.
For this purpose, high earners are individuals with a pre-tax income (including their own pension contributions) of £130,000 or more, but only if that income plus the value of their pension saving paid for by an employer in the year adds up to £150,000 or more.
For defined contribution arrangements, pension saving is basically the amount of employer and employee contributions to the scheme. Contributions will be disregarded in the year in which the member dies or becomes entitled to a serious ill-health lump sum under the scheme. HMRC has indicated that it is considering whether to allow them to be disregarded in any other circumstances, particularly in other cases of ill-health retirement or on redundancy.
For defined benefit arrangements, the calculation is much more complicated.
The Finance Act 2010 provides that, in order to ascertain an individual’s pension saving under a defined benefit arrangement over a tax year, the scheme should calculate the annual rate of the pension to which he or she was entitled, on certain assumptions, at the start and the end of the tax year. The difference between these two figures will then be multiplied by an age-related factor to place a capital value on the increase in the member’s pension over the year. That capital value will be deemed to be the member’s pension saving. (Again, pension saving will not be taxed in a year where the member dies or receives a serious ill-health lump sum, and the position on early retirement due to ill-health or redundancy is under review).
The age-related factors which will be used to value pension saving in defined benefit arrangements are not set out in the legislation which has been published so far. But the legislation makes it clear that they will be two-way factors: in other words, different multiples will apply depending on both the member’s age and the scheme’s normal pension age. HMRC has indicated that, except in extreme cases, the factors applied will not be affected by the different rights individuals may have to pension increases.
In most cases HMRC expects to claim the new tax charges from high earners themselves through the self-assessment process. However, where a member incurs a charge in excess of £15,000, HMRC indicates that he or she may be able to require the scheme to pay it directly. However, details of how this will work in practice are conspicuously missing from the published legislation.
Some schemes will already have been planning for next April. However, three areas for schemes to focus on are:
- work out which individual members are likely to be affected by the new rules. Individuals affected by the new rules may wish to opt-out of the scheme before April 2011;
- plan how their administrative systems will be able to provide information to members on a timely basis so that members can accurately work out what tax is payable. Schemes will be required to provide details of an individual’s savings within three months of a request. The systems will need to be tested to ensure that information is accurate to avoid individuals paying the wrong rate of tax; and
- plan how the scheme would be able to pay for the tax relief. Schemes may choose to go through a process similar to pension sharing on divorce.