The Chancellor’s budget statement last month confirmed and clarified the detail of the rules restricting pension tax breaks for high earners from 2011/2012 as originally outlined in the 2009 Pre-Budget. Nothing like laying the foundations to confuse the tax system for years to come!
This new regime replaces the interim ‘anti forestalling’ rules introduced in the Finance Act last year after a three month consultation exercise.
From 6th April 2011, individuals with a ‘high income’ will face a tax charge (known as the ‘high income excess relief charge’) on any pension provision made by or for them. In the current interim ‘anti forestalling’ rules there is a £20,000 special annual allowance or protection for established regular funding. Under the new rules this will not be available.
HIGH INCOME INDIVIDUALS
An individual will be regarded as having a ‘high income’ if they have both the following in a tax year:
- ‘Gross income’ of at least £150,000; and
- ‘Relevant income’ of at least £130,000
This means that if an individual’s relevant income in a tax year is below £130,000, they cannot have high income for that tax year regardless of their gross income.
Unlike the interim measures, there will be no reference back to income earned in previous tax years – except in any tax year in which benefits are taken, when income in the previous tax year will be tested.
There are important changes from the interim anti-forestalling rules when it comes to calculating an individual’s income:
- Gross income: Any part of an individual’s ‘total pension saving amount’ funded by their employer will be included in the calculation of their gross income. In order words, employer pension contributions (and the deemed value of defined benefit accrual) will be added to an individual’s other income to test it against the £150,000 high income limit.
- Relevant income: It will no longer be possible to deduct an individual’s own pension contributions, or gift aid donations, from their total income when calculating their relevant income.
These changes reduce the individual’s and business owners scope to manipulate their circumstances or reward packages to get round the new rules.
VALUING PENSION PROVISION
An individual’s ‘total pension saving amount’ will be calculated as the value of the pension provision made for, or by, them over the tax year itself.
- Money purchase: where money purchase pension provision is concerned, an individual’s ‘total pension saving amount’ will be valued in the same way as their pension input amount is calculated for the purposes of the annual allowance test (i.e. as the amount of contributions paid over the tax year).
- Defined benefit: For defined benefit pension provision, however, the total pension saving amount will be valued as the increase in accrued pension over the tax year multiplied by an age-related factor (ARF) – not the fixed 10:1 factor used for the annual allowance test. Details of these ARFs. which will vary depending on the individual’s age and their normal pension age under the defined benefit scheme, will be set out in regulations.
To help affected individuals, pension schemes will be required to provide details of a member’s pension saving amount within three months of being asked for them.
THE TAX CHARGE
The precise rate of the ‘high income excess relief charge’ for an individual, known as the ‘appropriate rate’, is determined by adding the individual’s total pension saving amount to their ‘reduced net income’ for the tax year and treating it as the top slice of that income.
For those with ‘gross income’ of at least £180,000, the tax charge is calculated as:
- 20% on any amount between the basic and higher rate income tax limits: plus
- 30% on any amount above the higher rate income tax limit.
For those with ‘gross income’ of £150,000 to £179,999, these tax charges will be reduced on a taper basis to avoid a cliff-edge in the tax system at the £150,000 gross income level. This will be achieved by reducing the appropriate rates by 1% for each £1,000 of ‘gross income’ below £180,000. For example, someone with gross income of £175,000 would face a 15% or 25% tax charge (as appropriate) rather than the standard 20% or 30% tax charge that applies for those with gross incomes of at least £180,000.
PAYING THE TAX CHARGE
As with the interim anti-forestalling rules, the high income excess relief charge will always fall on the individual regardless of who made the pension provision.
The tax charge will normally be collected from the individual through the self-assessment process.
However, if the charge is over £15,000:
- It can be paid off over (up to) three years (subject to interest charges on the deferred payments); or
- The pension scheme can pay the charge (subject to a corresponding reduction in the individual’s rights under the scheme).
There is no proposal to change the way the pension relief system works at present.
The high income excess relief tax charge will not apply in any tax year where an individual:
- Draws a serious ill-health lump sum; or
- Dies before drawing their pension.
The Government is also considering an exemption where individuals retire early on ill-health grounds, subject to suitable anti-avoidance controls being agreed.
Please see BN33 on the revenue’s website
Thanks to our colleagues at Standard Life for the examples in this blog