Pensions Tax Relief
Changes from 6 April 2011
Final Salary Schemes
HM Treasury has announced changes that are to be made regarding tax relief for pension scheme contributions and benefits.
Annual allowance
- For final salary schemes the annual allowance is compared to the increase in the pension scheme to reflect an additional year’s pension accrual.
- The additional year’s pension is multiplied by 16 to provide a notional contribution which is compared to the annual allowance.
- The annual allowance has been set at £50,000 and will be fixed for at least five years.
- From 6 April 2011 an individual will be able to carry forward unused contributions from the previous three years. The carry forward will apply a maximum contribution of £50,000 for each of the three preceding years even though the annual allowance had previously been higher.
An example of the calculation for final salary schemes is as follows:
- Assume a member has a pensionable salary of £40,000 and has already completed 20 years in the scheme which provides 1/60ths.
- The accrued pension is therefore 20yrs x 1/60 x £40,000 = £13,333 pa
- The accrued pension can then be re-valued in line with inflation so if we assume that inflation is 2% the increase in pension is (£13,333 + 2%) = £13,599 pa. This amount can be ignored when calculating the annual allowance.
- Should the member receive a 5% salary increase and complete another year in the scheme the accrued pension would be:
21yrs x 1/60 x £42,000 = £14,700
- Apply the annual allowance factor of 16 to the increase in pension ignoring the inflation increase:
£14,700 - £13,599 = £1,101 x 16 = £17,616
- As £17,616 is below the annual allowance of £50,000 the member does not suffer a tax charge.
Lifetime allowance
- The lifetime allowance is the total value of pension savings which an individual can accrue during their lifetime.
- The lifetime allowance will be reduced from £1.8million to £1.5million from 6 April 2012.
- The government will consult on how to protect individuals who have already accrued pension values in excess of £1.5million.
Comment
The changes are a practical method for over-turning the very complicated regulations introduced in 2009 to cap tax relief for those with income of over £130,000. The new annual allowance gives each individual a clear cap on pension contributions/pension accrual with full tax relief. The government estimates that 100,000 people in the UK will be affected by the change in the annual allowance.
The final salary scheme administrator will be required to inform a member, within six months of the end of the tax year, if their increase in benefit over the previous year resulted in the annual allowance being breached. The member could carry forward any unused allowance from the three previous years. If, after carry forward, the increase in benefit is still over the annual allowance the member would be taxed on the excess.
It is anticipated that the annual allowance is most likely to be breached by high earners and those who have salary rises in excess of inflation, particularly if they also have substantial number of past years’ membership of the final salary scheme.
Wentworth Employee Benefits Limited