The last Government planned to restrict pensions tax relief to the basic rate for those earning over £130,000 per annum but would have allowed tax relieved payments into schemes, albeit with the relief restricted to the basic rate, up to the current annual allowance of £255,000. The coalition Government proposes not to restrict the rate of pensions tax relief, which will continue to be available at the taxpayer’s marginal rate, but from 6 April 2011 to restrict the annual allowance to £50,000. In other words, tax relief of up to 50 per cent will be available on the first £50,000 of pension contributions and defined benefit accrual, but no tax relief will be available above that amount.

The new and much lower limit is potentially a problem for members of defined benefit schemes, including members of the NHS pension scheme, because they will suffer a benefit in kind charge to income tax to the extent that the deemed capital value of any year’s accrual exceeds £50,000. The deemed capital value will not be related to the amount paid into the scheme, but will derive from the increase in the member’s pension rights during the year. For example, if the member’s accrued pension at the beginning of the year is £20,000 and at the end of the year is £23,000, the increase of £3,000 is multiplied by 16 to produce a deemed capital value of £48,000. That amount is less than £50,000, so no tax charge would apply, but an increase of more than £3,125 in any year would attract an annual allowance charge (£3,125 x 16 = £50,000). The 16 x multiplier will apply irrespective of the age of the member.

The trigger for the tax charge will be a big increase in accrued rights, so a charge is most likely to be suffered by a member with long pensionable service who has a significant promotion and therefore a large increase in pay. It is not necessary for the member to be particularly highly paid because it is only the increase in value which is relevant. HMRC give examples of how the new rules will work here.

Unlike someone who realises a capital gain on the sale of an asset, a member of the NHS pension scheme who suffers an annual allowance charge will not have the cash from which to pay the tax. The Government is therefore considering allowing the charge to be borne by schemes, with a consequent reduction in pension for members, or for the charge to be rolled forward until members retire, at which point it could be paid, ironically, out of the members’ tax free cash.