We have written quite a bit about this fundamental change and complication of our pension rules, but yesterday we received final proposals as to how pensions will be funded for higher earners from 6th April 2016. However transitional arrangements take effect now.
At its simplest, the annual allowance relates to the greatest contribution (or deemed contribution for final salary schemes) that can be made to a pension without tax penalties. For the 2015/16 tax-year it has been £40,000, with the ability for most people to “Carry Forward” up to three years of unused allowances.
However for those with ‘adjusted income’ of more than £150,000 they will see their annual allowance (AA) reduced from 6th April 2016. The standard annual allowance by £1 for every £2 of ‘adjusted income’ over £150,000 in a tax year, with a maximum reduction of £30,000. This means those with ‘adjusted income’ over £210,000 will only be able to pay a gross contribution of £10,000 (at a personal net cost of £5,500 for most). Carry Forward of unused allowances will be available, with the potential for fluctating allowances as only the adjusted allowance (as defined above) can be brought forward.
‘Adjusted income’ Is broadly defined as:
- the individual’s income (before deduction of personal contributions); plus
- the value of any employer pension contributions
Provisions have been made for those earning £110,000-£150,000 where the above test is still needed, but for those with net income (plus the value of any ‘salary exchange’ arrangement entered into after 8th July) less than £110,000 no test is required.
At the same time, the pension input period (PIP) will be effectively abolished. The PIP relates to the period where contributions have been made for the purposes of the annual allowance. The PIP has nothing to do with tax relief, but does mean, for example, a contribution made into a PIP that runs any other period than tax years can be assessed against the following year’s annual allowance. This hase been thought of as an unnesccesary complication, as explained below.
Consider, John, who has a PIP running 1st June-31st May each year. Contributions are always made 6th of every month of £100. For tax relief purposes John can claim higher or additional rate relief for the contributions made 6th April to 5th April, but for the purpose of the annual allowance contributions made 6th April and May fall in the same tax year, but all contributions made from June through to March actually go into the following years allowance! It will be good to see the back of this complex rule, but it has provided many of our clients a good tax planning opportunity.
In terms of actions, anyone earning £110,000 or more should be considering making a significant contribution, where affordable, this year. Pension freedoms now make it easier to access the fund (for those over 55) if there is an emergency (though pensions are clearly a long-term plan) and also the drop in the lifetime allowance (LTA – the largest fund value, or deemed value, that can be accumulated, without ‘protection’, without risking tax charges) to £1m may also mean for many individuals this could be the last year of pension savings – even a modest level of growth could hit £1m+ on a multi-hundred thousand pound fund, and the reduction in net contributions to £5,500 per annum for higher earners is very rarely likely to be worth the risk of breaching the LTA.
At its simplest, most individuals should have a pensions’ Annual Allowance of £80,000 for 2015/16, but restricted to £40,000 after 8th July 2015.