In his Autumn Statement on 5 December 2012, the Chancellor announced the following proposals affecting pension contributions:
•the annual allowance for tax relief on pensions savings will be reduced from £50,000 to £40,000;
•the standard lifetime allowance for pensions tax-relieved savings will be reduced from £1.5 million to £1.25 million; and
•a transitional fixed protection regime (referred to as ‘fixed protection 2014’) will be available for those who believe they may be affected by the reduction in the lifetime allowance.
The legislation governing these changes will be introduced in Finance Bill 2013 and is expected to take effect from 2014-15 onwards.
The annual allowance is the maximum amount of an individual’s annual pension savings that can benefit from tax relief. So, for 2014-15, the maximum amount an individual can pay into a pension, and receive tax relief on those contributions, will be £40,000. If annual pension savings exceed the annual allowance limit, income tax is charged on the excess at the investor’s marginal rate of tax.
Broadly, individuals will only be affected by the proposed change if their total pension savings made in a tax year exceed the annual allowance plus any available unused annual allowance that can be carried forward from the three previous tax years.
The lifetime allowance is the maximum amount of pension saving can be built up on which tax relief may be obtained. From 2014-15 the maximum amount on which tax relief can be obtained will be £1.25 million. When pension benefits are eventually taken, if they are worth more than the lifetime allowance, the investor will pay a tax charge (the lifetime allowance charge) on the excess. The charge is paid on any excess in the value of pension benefits over the lifetime allowance limit. The rate depends on how this excess is paid by the investor. If the amount over the lifetime allowance is paid as a lump sum, the rate is 55%. If it is paid as taxable pension, the rate is 25%.
Fixed protection 2014
Individuals who apply for fixed protection 2014 will have a lifetime allowance of the greater of £1.5 million and the standard lifetime allowance (£1.25 million from April 2014), provided that from April 2014:
•if they are in a defined contribution (money purchase) scheme, they make no further pension contributions to the scheme and nor are any contributions paid on their behalf – including any by their employer; or
•if they are in a defined benefit or cash balance scheme, they stop accruing benefits above a ‘relevant percentage’. This is broadly defined as either the annual rate specified in scheme rules for the revaluation of accrued rights, or CPI (if no rate is specified).
There are a number of other circumstances when fixed protection 2014 can be lost, for example where there is an impermissible transfer.
Individuals will be able to apply for fixed protection 2014 after the legislation comes into force, which is expected to be in summer 2013. A simple form will be available on the HMRC website after the legislation comes into force and the signed form must be received by HMRC by 5 April 2014.
It is proposed that individuals with fixed protection 2014 will be able to take a tax free lump sum at the time they take a pension. The maximum lump sum that can be taken is up to 25% of their pension rights, subject to an overall limit of 25% of £1.5 million. However, some scheme rules may only allow a smaller tax free lump sum to be taken.
There has been wide speculation that tax relief on pension contributions may be severely restricted or even abolished, but for the time-being, subject to certain limits, tax relief on contributions remains in place. Paying into a pension policy continues to be one of the best ways of reducing liability to income tax whilst planning for your future retirement. Regardless of whether you pay tax or not, you can get tax relief on payments of up to £3,600 per year. This means that you can pay £2,880 into your pension and the pension company actually invests £3,600 on your behalf.