Pension Reform

Pension reform: the impact of recent changes on your pension and retirement plans

In April 2006, Her Majesty’s Revenue and Customs (HMRC) ushered in a new set of tax rules for pensions, which were boldly branded as ‘simplification’. A little over four and a half years later, more than a few pensions experts have found a new word for the pension tax regime: ‘complification’. What had started off as (relatively) straightforward legislation has become increasingly complex, as successive governments have attempted to reduce the revenue lost to the various pension tax reliefs.

The latest revisions to the tax rules were revealed in October, although they had been trailed in June’s emergency Budget and a subsequent ‘discussion’ paper. These new rules replace the High Income Excess Relief Charge (HIERC) put in place by Alastair Darling just before the Election. The HIERC was due to replace the special annual allowance charge from April 2011, but had been widely criticised as overly complicated, even by pension standards.

Mr Osborne’s solution is generally agreed to be more user-friendly. However, since it aims to raise as much for the Exchequer as the HIERC – about £4bn a year – if you are affected, it is not that friendly. The main features of the latest changes are:

  • The annual allowance, which effectively sets your maximum tax efficient total pension contribution in a tax year, will be reduced to £50,000 from 2011/12. The current level is £255,000, but in most instances this is somewhat theoretical because you are likely to be caught first by Mr Darling’s special annual allowance.
  • The calculation of the notional worth of a year’s accrued final salary benefit will alter. This will have little effect if your salary increases are close to inflation, but will make the notional contribution up to 60% higher if your salary enjoys a quantum jump, eg on promotion.
  • You will be able to carry forward any unused annual allowance for up to three years.  This opportunity will apply from 2011/12, but the unused allowance carried forward from 2007-10 will be based on the new £50,000 limit and the revised calculation basis outlined above.
  • If your total contributions exceed your available annual allowance, the excess will be taxed as if it were the top slice of your income. The end result is that any excess contribution receives no tax relief. In contrast, the special annual allowance rules still give basic rate relief.
  • From 2012/13, the lifetime allowance will be cut from £1.8m to £1.5m, its original level in 2006. There is no indication that this will be subsequently index linked, although the Government has said it ‘will consider options for indexing the level of the annual allowance’ after 2015/16. A new set of transitional rules will be introduced to protect your benefits if you are adversely affected by the cut.

While the new, lower annual allowance does not begin until next tax year, it could affect your contributions or final salary accrual now because of the complex way in which contribution years (known as pension input periods) are assessed.

If you have any questions about your retirement planning, pensions or SIPPS, please do get in touch on 020 3865 2379.

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