AFTER allowing time for a review and a consultation of existing legislation, in October 2010 the Government announced a significant overhaul of all pension contribution limits and allowances.
While the first of these changes took effect from the tax year starting this April, it can affect contributions dating back to October 14, 2010. To avoid unexpected tax charges, special care needs to be taken to ensure these revised limits are not exceeded.
For high earners making new pension contributions, the last government introduced legislation to restrict tax relief to only the basic rate of tax, thus removing the opportunity to secure tax relief at up to 50%. The coalition Government has significantly changed the previously proposed contribution limits and allowances by introducing new ones. The first of these took effect on April 6 this year.
What is the maximum payment you can now contribute to a pension plan? To secure full tax relief for defined contribution schemes, also called money purchase schemes, the maximum permitted contribution from all sources (your own, employer and third party) in the current tax year is £50,000. This is called the annual allowance.
This is a large reduction on the previous limits that allowed for a payment of up to £255,000. The Government has indicated the lower annual allowance will remain at this reduced level for the next few years.
For defined benefit schemes, also called final salary schemes, there is a restriction in your maximum benefit accrual increase over the tax year. The increase in your defined benefit entitlement is multiplied by a factor of 16. To secure full tax relief, this sum cannot exceed £50,000.
But what if you exceed the annual allowance in a tax year? If your total pension contribution in the current tax year is greater than the annual allowance, you could incur an annual allowance tax charge of up to 50% of the contribution in excess of the annual allowance.
You can now carry forward unused annual allowances from earlier tax years.
The Government has introduced new rules to assist anyone whose pension provision is normally within the annual allowance, but with an unusually high level of pension savings in a tax year, for example where a member of a defined benefit scheme has a spike in their pension accrual due to a promotion.
It may be possible to carry forward any unused annual allowances, up to the limit of £50,000 for each tax year. Unused allowances from up to three earlier tax years may be carried forward to the current tax year. This can allow for pension contribution payments in the current tax year above the standard annual allowance, without triggering an annual allowance tax charge.
The Pension Input Period is the period of time (usually 12 months) over which your contributions to a pension arrangement are measured for the purpose of assessing any liability you may have to an annual allowance tax charge. When calculating your contributions against the annual allowance, the period measured is the pension input period and not the tax year.
It is possible to change the date of a pension input period and this could assist with avoiding an annual allowance tax charge. The procedure for changing a pension input period does not involve HM Revenue & Customs, but you should seek specialist advice before making any changes.
What is the maximum benefit that you are allowed to hold within a pension plan?
Without any transitional protection of your pension benefits from existing legislation (known as enhanced protection or primary protection), the maximum permitted benefits that can be held within a defined contribution pension arrangement is £1.8m in the tax year 2011/12. This is called the lifetime allowance. From tax year 2012/13, the lifetime allowance will be reduced to £1.5m and is expected to remain at this level until at least 2016. For anyone who has built up pension funds of between £1.5m and £1.8m by the end of tax year 2011/12, or if your pension fund is likely to exceed £1.5m when you take retirement benefits from your pension, the Government will allow you to apply to HM Revenue & Customs for fixed protection. This must be applied for by April 5, 2012, at the latest and your ability to fund future pension provision would then be restricted.
It is essential that you carefully review the level of contribution payments (money purchase) or benefit accrual (final salary) within your pension plan to ensure you do not inadvertently incur an unexpected tax charge.
:: Roy Davidson is a wealth management expert at the region’s leading law firm, Dickinson Dees