More unexpected was the announcement that from 6 April 2011, the ability of high income individuals to obtain higher rate relief on pension contributions is to be restricted. In addition, measures to prevent forestalling were introduced from Budget day (22 April 2009). These measures are examined further below.
Restriction of Relief from April 2011
It is the government’s intention to restrict the availability of higher rate tax relief for contributions to a registered pension scheme from 6 April 2011 for individuals with an annual income of £150,000 or more. Relief will be tapered away so that for those earning over £180,000 relief will be worth 20 per cent, the same as to a basic rate taxpayer.
Measures to prevent forestalling are to be introduced from 22 April 2009.
New Rules from 22 April 2009
To prevent taxpayers from making additional pension contributions to take advantage of higher rate relief whilst still available, special rules are introduced from Budget Day (22 April 2009). The rules only bite where a person:
• has income of at least £150,000 a year
• increases his or her pension saving from 22 April 2009 beyond their normal amount; and
• makes total pension savings in excess of £20,000 a year.
Where these circumstances apply, `additional pension savings’ are subject to a special annual allowance charge. This charge effectively recovers higher rate relief on certain additional pension savings such that those savings only receive tax relief only at the basic rate.
Where the special annual allowance charge bites, it will be paid through self-assessment.
Special Annual Allowance
The special annual allowance applies only to those with relevant income of £150,000. This is normally the income for the tax year in question. However, if a person has income of less than £150,000 for the tax year in question, but income of at least £150,000 in either of the two preceding tax years, that person is regarded as having income of at least £150,000 for the purposes of the special annual allowance charge.
Broadly, relevant income is income before pension contributions, personal allowances and other reliefs and deductions, less any deductions for reliefs such as trading losses and deductions for pension contributions to a maximum of £20,000 less any gift aid deductions.
As stated above, where the person has relevant income of at least £150,000 the charge only bites where the individual increases his or her pension savings from 22 April 2009 beyond their regular pension savings and where total annual pension savings, including any increases from 22 April 2009, are at least £20,000. Both conditions must be met for the charge to apply. Thus, where a person simply continues to make his or her normal pension savings from 22 April, the rules are not in point, even if that individual has income of more than £150,000 in each of the relevant years and his or her total pension savings are more than £20,000. The charge is only designed to catch those high income individuals who increase their pension savings in light of the Budget day announcement to maximise the benefit of higher rate relief whilst still available.
The special annual allowance is set at £20,000. This means that an individual with relevant income of at least £150,000 can only receive higher rate tax relief on contributions to registered pension schemes to a maximum of £20,000, unless they made regular contributions in excess of this prior to 22 April 2009 and continue to make contributions at this level.
The rules are complex and the following examples illustrate the circumstances in which they apply.
Andrew has income of £120,000 in 2009/10, £115,000 in 2008/09 and £110,000 in 2007/08.
As his income in 2009/10 and in the two preceding years was less than £150,000 the special annual allowance does not apply.
There is no restriction on relief on any contributions he makes to registered pension schemes in 2009/10.
Bella has income of £200,000 in 2009/10. Thus, her relevant income is more than £150,000 and it is not necessary to consider her income for the previous two years.
In 2009/10 she makes contributions to registered pensions schemes of £18,000. As her contributions are less than £20,000 she is not affected by the special annual allowance.
Catherine has income of £175,000 in 2009/10. She makes contributions to her registered personal pension plan of £2,000 per month throughout 2009/10. Thus her total contributions in 2009/10 are £24,000.
She has made monthly contributions at this level for the previous three years.
Although Catherine has income in excess of £150,000 and makes contributions to registered pension schemes in excess of £20,000 in 2009/10, she has not increased the level of her pension savings beyond 22 April 2009. Therefore, the special annual allowance charge does not apply and she remains entitled to higher rate relief on her normal pension contributions of £2000 per month.
David has income of £160,000 in 2009/10. He makes regular pension contribution of £1000 per month (£12,000). He also makes a one-off payment of £15,000 on 1 May 2009.
David’s total contributions for the year are £27,000, while his regular pension savings are £12,000. He will be subject to the annual allowance charge to the extent that his pension savings exceed £20,000. This relief will be clawed back on pension savings of £7,000 (a charge of £1,400 (20% of £7000).
Regular Pension Savings
High income individuals will still be able to obtain higher rate relief on pension savings in excess of £20,000 for 2009/10 and 2010/11 provided that these represent their normal ongoing regular pension savings.
What constitutes normal regular pension savings (also known as `protected pension input’) depends on the type of scheme to which contributions are made. In some respects the rules are quite harsh. For example, for a money purchase scheme, the contributions must be made a least quarterly. This means if a person makes an annual contribution following receipt of a bonus and has done for several years, this will not be regarded as `regular’ and protected from the special annual allowance charge.
Where contributions are made as a percentage of salary to a final salary scheme, provided that the accrual rate for calculating benefits does not change, contributions are protected if the absolute amount increases as a result of a pay rise, as long as the percentage stays the same. Contributions are also protected if, under the scheme, they increase by the same amount each year.
These rules not only restrict the availability of higher rate relief for pension contributions, they also limit tax planning opportunities and value of making additional pension contributions to reduce income so as to retain entitlement to personal allowances and escape the additional higher rate of 50% from 6 April 2010.