The Budget on 22 April 2009 announced a number of changes which will affect pension provision for high earners from 6 April 2011. The key change to pensions is the restriction of tax relief to the basic rate on pension contributions for individuals with income of £150,000 or more. Our understanding is that the way this will work will be by means of a benefit-in-kind tax charge equal to the difference between basic and higher rate tax on all employer contributions to DC schemes or the value of accrual in DB schemes, but the detail is to be set out in a consultation document. The Budget guidance notes and technical notes can be found on the HMRC and Treasury websites.
Before looking at the changes in more detail, the changes to income tax rates and personal allowances should be noted. These come into effect from April 2010, a year before the introduction of the above measures:
- There will be an additional higher rate of income tax of 50 per cent for taxable income above £150,000;
- The basic personal allowance for income tax for individuals with incomes above £100,000 will be reduced by £1 for every £2 until the allowance is reduced to nil.
From April 2011, when the restrictions on tax relief on pension contributions for individuals with income of £150,000 or more are introduced, tax relief will be given on employee contributions at the marginal rate of 50 per cent for individuals earning £150,000 but this will be tapered down until it becomes 20 per cent, i.e. basic rate, for those earning over £180,000; and a benefit-in-kind tax charge on employer contributions will apply.
It will not be possible to circumvent the restriction by paying in large contributions or changing DB accrual rate now: "anti-forestalling" measures, starting on Budget Day, prevent large additional pension contributions from being made by or in respect of an individual before 6 April 2011 in order to benefit from the current higher rates of tax relief. This applies to both employer and member contributions and to further accrual in DB schemes; the latter will be protected only if there has been no material change to the way that benefits are calculated under the arrangement on or after 22 April 2009 (e.g. changes in the calculation of pensionable salary or an increase in the accrual rate).
A “special annual allowance charge” will be payable if:
- the individual's income is £150,000 or higher; and
- his normal ongoing regular pension savings (to be known as ‘protected pension inputs’) are increased compared to previous years and that increase was not agreed before 22 April 2009, and
- his total pension savings (not just the excess over previous years), i.e. employer and member contributions/further DB accrual (calculated over the relevant pension input period using a factor of 1:10) exceed £20,000; this is the amount of the “special annual allowance”: full tax relief at the higher rates will be given up to this limit; above that, tax relief will be at basic rate only; the special annual allowance tax charge - the difference between the highest rate of income tax and basic rate – will be levied on the individual, collected via the self-assessment tax return.
The special annual allowance will be additional to the existing annual allowance (but there will be no double recovery of tax relief) and the value of an individual’s pension savings for the special annual allowance will be calculated in a similar way to that for the existing annual allowance (DC contributions/ DB increase in the value of accrued rights).
It will not be possible to avoid the anti-forestalling measures in the period up to 6 April 2011 by means of salary sacrifice arrangements agreed on or after 22 April 2009, as the amount of the sacrifice will be "added back"; nor can they be avoided by means of any other type of arrangement which has as its main purpose (or one of its main purposes) to secure that an individual's income is less than £150,000; in these circumstances the Individual's income will be deemed to be £150,000.
As noted above, it will also not be possible to avoid the anti-forestalling measures by employers making additional employer contributions or increasing the rate of DB accrual, e.g. from 1/60 to 1/30 or generally by augmenting benefits in a DB arrangement.
Where the special annual allowance is exceeded, scheme administrators will, scheme rules permitting, be able to make a contributions refund lump sum’ (but not before the end of the tax year, or it will be an unauthorised payment) and account to HMRC for the tax charge on it. However, they will not otherwise have to report to HMRC that they have members who exceed the special annual allowance.
Comment: The combined effect of all these measures is a significant reduction in the advantages for high earners of saving for retirement in a registered pension scheme; and the anti-forestalling/anti-avoidance measures have not left scope for additional pension saving before the new restrictions take effect in 2011. In practice this means it may then no longer be tax-advantageous for many senior executives to continue to accrue benefits in a registered pension scheme, and employers may wish to consider introducing alternative remuneration strategies.
For those earning between £100,000 and £150,000, salary sacrifice or increased employee contributions may still be tax-effective, especially for those earning just over £100,000, who will have a very high marginal tax rate owing to the withdrawal of the basic personal allowance.
Another point to watch in relation to the anti-forestalling measures is that those who are currently earning less than £150,000 but who have earned at least that amount in either of the two previous tax years will be affected, as will the self-employed who make significant contributions once a year rather than on a monthly or quarterly basis. We understand that the latter point is being looked at as part of the consultation.
For those individuals earning £150,000 or more in respect of whom there are either no or minimal existing pension arrangements it may be advantageous to fully utilise the £20,000 special annual allowance while it exists.
If major benefit design changes are being contemplated which could affect executives earning £150,000 or more, it will be necessary to consider whether they result in adverse tax implications. Generally, if the change is to apply to at least 50 active members, this should not be the case.
Tax treatment of FAS and FSCS compensation
Provisions in the Finance Bill 2009 will ensure that compensation payable by the Financial Assistance Scheme (FAS) and Financial Services Compensation Scheme (FSCS) will be treated for tax purposes in the same way as payments by a registered pension scheme. Thus, for example, lump-sum commutations payable by the FAS will be tax free.
Other pensions measures
Pensions Update November 2008 noted the key changes to pension scheme allowances and NICs set out in the November 2008 Pre-Budget Report; these amounts were confirmed in the 2009 Budget, as was the freezing of the 2010/11 lifetime and annual allowance rates for a period of five years, up to and including 2015/16.