21 May 2009

Pension tax relief

The removal of personal allowances and higher rate tax relief for higher earners were announced in the April 2009 budget by the chancellor, Alistair Darling.

The effect of these changes appears relatively straight-forward - but only on the surface. Those earning in excess of ?100,000 a year will soon see the benefit of their personal allowance disappear at a rate of ?1 for every ?2 earned in excess of this earnings threshold. For those earning in excess of ?150,000 a year (including benefits in kind, interest and so on) tax relief on pension contributions will be limited to 20%, rather than the 40% applicable to other higher rate taxpayers on more 'modest' earnings. In addition, the highest rate of tax will be increased to 50%, for those earning ?150,000 a year or more.

To prevent higher earners from boosting their pension contributions in advance of these changes, anti-forestalling arrangements now limit the ability of those with earnings in excess of ?150,000 a year from increasing their pension contributions (or having increased contributions made on their behalf by an employer) in excess of modest limits.

In effect this means that if annual contributions are greater than ?20,000 a year for the 'high earner', a tax charge will apply at 20% to the employee on employer contributions (or tax relief limited to 20% on personal contributions). The only real exemption is where higher contributions arise out of salary increases / promotions and contributions represent a fixed percentage of income. This is a much shortened version of the
anti-forestalling arrangements and it is essential to ask how they might affect you personally.

The long term impact
By limiting higher rate tax relief on pension contributions for those earning in excess ?150,000 a year, the Chancellor is setting a precedent. We can expect the limit gradually to be reduced over future budgets - it will certainly never be increased, so the effect of fiscal drag will extend the impact of this change to more and more of us.

Another aspect that may affect many higher earners where employers make pension contributions on their behalf is that a 'benefit in kind' charge could apply at 20% (or 30% where the 50% tax rate applies). It should be noted, however, that while this is the interpretation put on the draft legislation by the pensions industry; HM Revenue and Customs does not (it appears from a recent industry forum) seem so far to have put this construction on the issue and clarification is being sought.

Pay more now, pay even more later ...
Of course, thanks to this change, higher earners will soon be receiving less tax relief on their pension contributions and potentially paying tax at 40% or even 50% on their pension income, when they retire. 

A missed opportunity
It is a shame that the opportunity was not taken to reinstate the tax reclaim on franked investment income for pensions and ISAs.

One thing is clear; the need for professional advice in pension planning is even more important than before. In fact, it is important always to seek independent financial advice before making any decision regarding your finances. If you would like to discuss whether your current arrangements are suitable, or require any other information about employee benefits, please contact us.

YOU SHOULD ALWAYS SEEK PROFESSIONAL ADVICE BEFORE TAKING ANY ACTION IN CONNECTION WITH YOUR PERSONAL FINANCES. THE VALUE OF INVESTMENTS IS NOT GUARANTEED AND WILL FLUCTUATE; YOU MAY GET BACK LESS THAN YOU PUT IN.

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE.