After much speculation in the build up, the summer Budget of July 8 2015 contained three important changes to pension regulation:
- tapering the tax relief that high earners can claim on their pension contributions
- changes to pension input periods, resulting in a planning opportunity for some individuals to make additional contributions this year
- changes to death benefits – the way tax is charged on a pension pot that is passed on after a person dies.
Tapered annual allowance
The Emergency Budget confirmed the Conservative Party’s manifesto pledge to taper the tax relief that high earners can claim on their pension contributions. The standard annual allowance of £40,000 will be reduced by £1 for every £2 of “adjusted income” over £150,000. The allowance decreases until income reaches £210,000, when the maximum tax relievable contribution will be £10,000 each year.
To ensure that people do not simply exchange salary for employer pension contributions, “adjusted income” will be used. This adds pension contributions to income to measure whether an individual is caught by the new rules. Any new salary sacrifice arrangements made after 8 July will be affected.
Many people, such as the self-employed, do not have regular income and/or make regular pension contributions, so the concept of threshold income has been introduced. If your total income, before pension contributions are added back in, does not exceed £110,000, you will not be affected by the reduction.
The announcements made to date have been slightly ambiguous about “adjusted income” and “threshold income”, so we await further details from HM Revenue & Customs.
It is still possible to carry forward unused contributions from previous tax years. These can be used to boost pension savings, despite the reduction to the annual allowance.
Pension input periods
The Chancellor also announced that pension input periods (PIPs) would be brought into line with the tax year. PIPs are one of the little known and more complex parts of pension legislation, which are used to measure whether the annual allowance has been exceeded.
We welcome this simplification, but there is a brief additional complexity to bring these in line with the tax year resulting in the current tax year being split into two parts:
- Pre-alignment tax year runs from 6 April 2015 to 8 July 2015. The annual allowance for this mini tax year is £80,000.
- Post-alignment tax year runs from 9 July to 5 April 2016. The annual allowance for this period is nil, but up to £40,000 from the pre-alignment tax year can be carried over to this period.
What does this mean? The alignment of PIPs with the tax year creates a planning opportunity to contribute up to £80,000 plus any available carried forward contributions before 5 April 2016. Some example scenarios are detailed in the Box.
Seek advice The new rules are complex and many will need help in working out the best option. It is important to ensure individuals take professional advice before making any contributions.
Pension input periods
Jasper earns £180,000 each year. He read the party manifestos and knew that the government would make changes to pension tax relief. He tries to contribute the maximum each year, so has no unused contributions to carry forward. On 5 May, he decided to contribute £40,000 (gross) to his SIPP; his pension input period was due to close on 5 April, so under the old rules he would not have been able to make further tax relieved contributions in the 2015/16 tax year. The Chancellor’s announcement means he is able to contribute another £40,000 before 5 April 2016 and receive tax relief on the full £80,000 he has contributed in the tax year.
Maria also earns £180,000. She made a contribution of £20,000 in May. Although she has not made the maximum contribution in the pre-alignment tax year, the maximum contribution she can make is still £40,000. Her brother John made the same contributions, but he had unused pension contributions of £30,000 carried forward from the previous tax year. He is able to use this now to make a total contribution of £70,000.
Frank made a pension contribution of £20,000 to his SIPP in March 2015 and his pension input period ended on 5 April. He has not made any contributions since then. The maximum he can contribute from now until 5 April 2016 is therefore £40,000.
Legislation to change the taxation of death benefits will be included in the Finance Bill. From April 2015, lump sum death benefits are taxed at 45% if the member dies aged over 75. From April 2016, lump sum benefits will be taxed at the recipient’s marginal rate of income tax.
This is the last in a series of changes to pension death benefits. The effect of these has been to make pensions one of the most tax efficient ways of passing wealth down the generations.
One of the key changes was to allow beneficiaries other than a spouse or dependent child to draw income from the pension instead of a lump sum. Any income (and from April 2016 lump sums) is taxed at the recipient’s marginal rate.
Keep your nomination(s) up to date To profit from the changes, it is very important that individuals keep their death benefit nominations up to date. Only named beneficiaries can take income from the fund rather than a lump sum. For example, if your grandchild was not nominated, they could take a lump sum, but not income. If they are under 18, taking an income is likely to be far more tax efficient than a lump sum.
Consultation on future of pension tax relief The Chancellor also announced that the government would publish a Green Paper asking for input on the future of pension tax relief and declared himself open to “radical reform”. He mooted the idea of making pensions more like ISAs, with no tax relief on contributions but allowing income to be paid tax free.
As part of the consultation, the government is seeking answers to eight key questions and wants to base any changes on the following principles:
- It should be simple and transparent.
- It should allow individuals to take personal responsibility for ensuring they have adequate savings for retirement.
- It should build on the early success of auto-enrolment in encouraging new people to save more.
- It should be sustainable.
Take advantage now The cost of pension tax relief is approximately £34.3bn a year, so finding ways to reduce this burden is high on the government’s agenda.
The consultation may not lead to legislation in the near future, but it makes sense to take advantage of tax relief while it is still available.
This article first appeared in Pensions World on 27 July 2015.