As things turned out, the government’s proposals for restricting tax on pension contributions were not as severe as we expected. They are certainly easier to understand than those proposed by its predecessor.
The annual allowance
The annual allowance is applied to registered pension scheme input for an input period. The relevant annual allowance is determined by the tax year in which the input period ends.
Under a money purchase scheme, the input is the contribution. Under a defined benefit scheme a factor is applied to the increase in benefit accrual over the period.
Input periods can be varied from time to time and can differ for different arrangements and different members.
The features of input periods are:
- They must not be longer than 12 months, but there is no minimum period (subject to below)
- For an arrangement there must be no more than one input period end in a tax year (although it is possible to have different input periods and input period ends for different arrangements)
- There cannot be a gap between one input period ending and another starting in respect of the same arrangement
The latest proposals for change are due to be implemented from 6 April 2011. This means that they will apply to any input period ending from that date so their impact will be felt before then.
The new rules in brief
The annual allowance tax charge will be the member’s marginal rate of tax after adding the excess contribution to the individual’s ‘reduced net income’ for the tax year in which the relevant input period ends. Until 5 April 2011, the rate is 40%.
The annual allowance will be £50,000. There is provision to increase this figure. Until 5 April 2011, the annual allowance is £255,000 and was frozen at that level. It had been trailed that it was going to be no more than £40,000.
In order to convert defined benefit accrual to input for these purposes, the increased accrual (after an inflation adjustment) will be multiplied by 16. Under the original rules the multiplier was 10, but we had been ‘primed’ to expect that this would change to between 15 and 20.
To recognise that earnings patterns can be irregular, any unused allowance (£50,000 less any allowance used in the year) may be carried forward for up to three years in order to supplement a later annual allowance. The main condition is that the individual must have been a member of a registered pension scheme in the year from which the unused allowance is to be carried forward even if their input amount was zero. In theory this allows a ‘one-off’ contribution of £200,000. There is no carry forward facility under the original rules (and no real need for one)
The allowance is unlimited in the tax year in which the member dies or becomes entitled to a serious ill-health lump sum under the arrangement. Until 5 April 2011the allowance was unlimited in the tax year in which all benefits were taken from an arrangement or the member died.
There are transitional provisions that deal with contributions made before 6 April 2011 and how to carry forward unused allowance from before that date.
Transition
The new rules cannot apply to an input period that ends before 6 April 2011. If the input period ends in the tax year 2011/12, then the annual allowance will be restricted to £50,000.
However, if the input period started before 14 October 2010 and ‘straddled’ that date and the following 5/6 April then the draft legislation requires that the input period be treated as if it ended on 13 October and a new input period started the next day.
This means that a contribution of up to £255,000 could have been paid before 14 October, but that any contribution paid after that date is restricted to the difference between £255,000 and what was actually paid, but subject to a maximum of £50,000.
For the purposes of determining how much unused allowance can be carried forward from 2008/09, the assumed allowance for each of those years is £50,000.
Health warnings
As with all these technical changes it is crucial to see the wood for the trees:
Remember that the anti-forestalling provisions of the special annual allowance apply until 5 April 2011.
Remember that the annual limit for relief on personal contributions (i.e. 100%/£3,600) is unchanged.
Remember that employer contributions are only deductible if wholly and exclusively incurred for the business. This may be relevant if unused allowance is being used.
The above is based on our understanding of the draft legislation announced in the Emergency budget on 14 October 2010.It should be noted this could be amended. DP Pensions Ltd do not accept any liability for the above information and would suggest that you seek legal advice before proceeding