Changes to the rules on taxation on pension provision

Rules on pension taxation change all the time, so what’s new?

Since their introduction, the government has been changing the rules on the Lifetime Allowance (LA) and Annual Allowance (AA) limits. The LA is a limit on the amount of pension benefit that can be drawn from pension schemes, whether lump sums or retirement income, and can be paid without triggering an extra tax charge. The AA is a limit on the total amount of contributions that can be paid to defined contribution pension schemes and the total amount of benefits that you can build up in defined benefit pension schemes each year, for tax relief purposes. 

From April 2016, the LA will be reduced to £1m and the AA available to a person earning an adjusted income of £150k (see below for what counts towards the £150k) will be tapered down from its standard amount of £40k to £10k. The latest changes will severely curtail a person’s ability to make adequate pension provision for their retirement through their current pension arrangements. The general perception is that the changes affect only high earners but critics of these changes say that reducing tax incentives to save for old age is a bad idea (and counterintuitive to government policy) because it sets a limit on people’s ambition to get a decent pension.

Who does it affect?

The new rules will not apply to anyone with a “threshold income” of less than £110k (for the 2016-2017 tax year). The threshold income is generally calculated as follows:

• net income PLUS
• the amount of any salary sacrificed for pension provision (on or after 9 July 2015) MINUS
• the gross amount of any relief-at-source pension contribution.

If an individual has a threshold income of at least £110k, then the tapering will kick in if their “adjusted income” is £150k or more. The adjusted income is generally calculated as follows:

• net income PLUS
• any relief given as net pay arrangements PLUS
• any relief for overseas pension contributions PLUS
• the value of any employer pension contribution.

The three year carry forward mechanism that enables individuals to set unused annual allowance against one-off spikes in benefits will be retained. That, however, may be of limited benefit to high earners who might have used up all of their allowance in the preceding years.

How does the tapering work?

The taper will reduce a person’s AA by £1 for every £2 by which their adjusted income exceeds £150k, up to a maximum £30k reduction. For example, a person with an adjusted income of £210k (and who has not flexibly accessed any DC pension rights) will have an annual allowance fixed at £10k, whereas someone with an adjusted income of £180k in the same example will have an AA of £25k.

What else will be changing?

The Pension Input Period (PIP) which is generally the 12 month period assessed for pension inputs for final salary accrual and money purchase contributions will be aligned with the tax year, rather than individual scheme years. All PIPs will end on 8 July 2016, but there are transitional arrangements.

What are the transitional arrangements?

The transitional arrangements are complex. There are transitional PIPs and AA arrangements for the pre-alignment tax year (6 April 2015 to 8 July 2015) and the post-alignment tax year (9 July 2015 to 5 April 2016). Post 6 April 2016, the new PIP will be aligned with the tax year.

What are the implications?

Whilst these changes primarily affect a high earner’s ability to pension save, by using such a low threshold income the government has increased the number of people who will be affected. Individuals affected or potentially affected should consider taking advice including independent financial advice. Employers may wish to determine whether any of their employees are affected by the new threshold (taking into account the impact of any salary sacrifice arrangements) and consider any alternatives. 

For further information please contact Andrew Campbell, Head of Pensions.