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19 May 2012, Time:16:53

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Pension Tax Relief

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You will have heard the government regularly announcing changes to policies in an attempt to help reduce the financial deficit. As part of this, they are proposing to make changes to pension tax relief. There are two initial changes that you need to be aware of and we have outlined our understanding of these changes below, along with examples.

At present, almost all employees that contribute to a pension scheme, receive full tax relief on their contributions. This means, their pension contributions are deducted from their pay before the remaining amount has tax deducted from it. In the past, a very small number of people received a tax charge if the value of their pension increased by a very large amount in a single year (above the 'annual allowance') or if the total value of their pension, when they reached retirement age exceeded a certain limit (the 'lifetime allowance').

Changes have been made to both these limits from April 2011 and April 2012 respectively, and we anticipate that a much larger number of people will now be affected. This is explained further below, although please note that some aspects of this are still under consultation.

Prudential, our AVC provider, has offered to run employee presentations on these changes and we anticipate a number of these presentations will be organised and advertised by employers in the months leading up to the changes.

Important: The information provided below is based on our understanding of HMRC legislation as at October 2010.

It is designed to be a general summary of the changes and the information is not intended to constitute financial advice. We accept no liability for any errors or omissions. If you wish to discuss these changes in greater depth and how they will affect you personally, we recommend that you speak to an independent financial advisor.

1. Reductions in the Annual Allowance (AA)

From April 2011, the annual allowance will be significantly reduced from £255,000 to £50,000. The 'annual allowance' refers to the amount of money that the total value of your pension is allowed to increase by in a single year before it is taxed. However, unused allowance from the previous three years (still at the £50,000 limit) can be added up and carried forward to increase this amount. Where a member's pension exceeds this limit, after carrying over any unused allowance, they will be liable to pay a tax charge at their marginal tax rate. The member's marginal tax rate is the rate of tax they would need to pay if the exceeded amount was added on to their yearly pay less their employee contributions during that year.

Nationally, HM Treasury estimates that the changes will affect 80% of those members with salaries of over £100,000. Members on lower salaries may also be affected from a large one-off increase. You are most likely to be affected by this change if your salary increases significantly (possibly due to a change in jobs), you have a high salary and/or you have a large amount of pensionable service. There is some protection for people that have a one off 'spike' in their salary by allowing them to bring forward allowance from the previous three years.

It is clear that a reasonably significant number of members could be affected by this change, although because this change tends to occur in line with medium to large jumps in salary, it appears that a high percentage of these members will be able to carry forward a sufficient amount of unused allowance from previous years to avoid a tax charge altogether. The Government are also considering allowing members to deduct the charges from their pension at retirement age, instead of paying it through tax self-assessment.

How to calculate whether someone exceeds the Annual Allowance

A summary of the method and calculations are shown below but we have also produced an online calculator which you can use to gain an idea of whether you are likely to be affected now or sometime in the future, and if so, by how much.

Method:

Using

Total Increase = (B - A with inflation added) x 16 + (D - C with inflation added) + any AVC contributions made or private pension costs

Example:

A member with a salary of £120,000 and 25 years pensionable service as at 6 April 2011, has a pension worth £39,000 per year and a lump sum of £99,000. They do not have any AVCs or private pensions.

By April 2012, the member salary has increased to £130,000 and they now have 26 years pensionable service. Therefore their pension is now worth £44,417 per year with a lump sum of £107,250.

We will assume inflation to be 2.5%

Calculation against the annual allowance:

= £(44,417 - (£39,000 + 2.5%)) X 16 + £107,250 - (£99,000 + 2.5%)

= £4442 X 16 + £5775

= £76,847

Therefore, the member has exceeded the annual allowance by £26,847.

If the member had £26,847 or more of unused annual allowance from the previous three years, they could bring this forward and there would be no tax charge due. If the member had some unused allowance, but less than £26,847, whatever they brought forward would reduce this amount. The remaining excess would be charged at the member's marginal tax rate. In this case, it would appear that the member would need to be taxed at 40% on the whole amount.

What happens next?

Following the end of each tax year starting from 2011/2012, we will notify all members whose LGPS benefits (excluding AVC contributions and any other pensions held) exceed the annual allowance. We will provide an estimate showing how much they exceed this limit. This information will either be included in a section on the member's Annual Benefit Statement or we will write out individually to anyone affected. The information we provide will be based on data supplied by the member's employer. We are required to supply this information by the October following the end of the relevant tax year.

If you are affected we can assist you in analysing whether there is any unused allowance which you can bring forward to negate the effect of exceeding the allowance.

At present our understanding is, if the member is affected they will need to go through the HMRC self assessment process, however the exact details of this are yet to be confirmed and we will update this page when we have further information.

Latest update: HMRC have created a webpage entitled "How does the reduced annual allowance affect me?" The page has a brief preamble on the new annual allowance (AA) regime followed by more than 30 questions and answers in which HMRC indicate how the new regime will work.

2. Lifetime Allowance (LTA)

From April 2012, the lifetime allowance is due to reduce from £1.8million to £1.5million. The 'Lifetime Allowance' refers to the total value of your pension. This is calculated at retirement age by considering the amount of annual pension and lump sum due. It takes into account all pensions you will have in payment except the State Pension and any dependent or spouse's pensions.

Where a member exceeds the lifetime allowance, the member will be taxed at either 55% or 25%, depending on whether it is paid for by using the lump sum (which would normally be tax free) or the annual pension (taxable above the personal allowance) to pay the amount due.

Even with this change we believe very few members of our scheme will be affected. However, for anyone that is affected, the Government is considering providing some elements of protection that were in place when the initial lifetime allowance was introduced in 2006.

A new fixed protection has been introduced for pension scheme members with significant pension savings. You must apply for fixed protection by 5 April 2012.

You can find more information in our leaflet Changes to Tax Free Allowances

For further information on these changes, you can read the HM Treasury document Restricting Pensions Tax Relief.

We understand the information on this page is correct as at 22 November 2010.

If you require further information regarding Additional Voluntary Contributions please follow the link AVCs

Wiltshire Pension Fund, Wiltshire Council - Bythesea Road,Trowbridge, Wiltshire, BA14 8JN.
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