The new lower annual allowance for pensions
George Osborne confirmed in the 2011 Budget that substantial changes to the annual tax allowances for pension contributions will come into effect over the next two years following the enactment of the 2011 Finance Bill on March 31 2011. As a result, many taxpayers will face unexpected income tax charges.
The annual allowance is the maximum amount of pension savings an individual can make in any one year. The amount of the allowance is reducing from £255,000 to £50,000 with effect from 6 April 2011. From 6 April 2012, the lifetime allowance will reduce to £1.5 million.
Payments to retirement benefit schemes in excess of these amounts are taxed on the beneficiary; the charge for exceeding the annual allowance will be levied at the individual taxpayer’s highest rate whilst the charge for exceeding the lifetime limit can be as high as 55%.
Some individuals may not be aware how this will affect them. This may be particularly true of members of defined benefit schemes who may well not appreciate that a tax charge could fall on them if they maintain their current rate of pension accrual. Scheme trustees and/ or employers should consider making their members aware of this danger. They should also be getting ready to issue the certificates of entitlement that the new rules will require.
The changes will affect not just high earners but also long-service members of defined benefit schemes and those whose income fluctuates from year to year, for example because of irregular commission payments.
Under the current tax legislation there are two circumstances in which an individual could contribute more than the annual allowance without a tax charge: in the year the contributor dies or in the year the pension is first drawn. After 5 April 2011, the exemption for retirement is to be restricted to cases of retirement on ill-health grounds.
In applying the annual limit, an individual can use up any unused portion of the allowance from the previous two years so the absolute maximum contribution in a future year will be £150,000 (if they had made no contributions at all in the previous two years).
To assess whether an individual will exceed their allowances, they will need to add together amounts paid or credited to all of their pension schemes for the year. Members of defined benefit schemes will need the assistance of their scheme administrator.
Implementation of these changes will largely be undertaken by pension scheme administrators, and it is envisaged that scheme administrators will issue certificates to all members notifying them of the relevant numbers to report. However, it will be the responsibility of the individual scheme member to report any amounts failing to be taxed as a result of the lowered Annual Allowance on their tax return.
Individuals facing tax charges in excess of £2,000 in consequence of the changes to the annual allowance will be able to elect for their liability to be met out of their pension funds, rather than by direct collection from the member.
Note: this is based on draft legislation and our understanding of the effect of announcements made by government. It is subject to change.