Defined Contribution Schemes and money purchase

Taxpayers with personal pension arrangements will know how much they are contributing and therefore whether their contribution levels exceed the new limits. Similarly, taxpayers in defined contribution schemes will know how much they and their employers pay over to the pension scheme administrator on their behalf.

In both cases, individuals will know whether their contributions exceed the new annual allowance and they may be able to adjust their saving profile accordingly.

The effect of these rules could be to bear down particularly hard on certain members of defined contribution schemes. Rather than seeking an immediate cash payment from the individual member though the PAYE system, individuals facing a tax charge of more than £2,000 will be able to arrange for the liability to be met out of the member’s share of the pension fund itself.

Defined Benefit Schemes

There has been less publicity about the effect of the changes on employees who belong to schemes operated by their employers. For these individuals, an additional tax charge may come as an unwelcome surprise.

Employees in defined benefit schemes are treated as having received a pension contribution equal to the increase in their benefits that has accrued during the pension input period.

Pension benefits are evaluated according to the scheme rules relating to pensionable salary and accrual period (so 10 years’ service with an employer whose scheme accrues benefits at the rate of 1/60th of final salary for each year of service would represent a benefit of 1/6th of current salary). Any lump sums that are payable other than from a commuted pension are added. The total of benefits is then multiplied by a government-set constant of 16 (10 for 2010/11).

This calculation, which will need to be performed for scheme members by the scheme administrator, is undertaken both at the beginning and end of the pension input period.

The figure at the beginning of the period is “uprated” by the increase in the Consumer Price Index and then subtracted from the figure for the end of the period; the difference is the “contribution” made on behalf of the scheme member.

The key effects of the changes on contributors to defined benefit schemes are:

• the annual allowance is set very low so that many executives will be affected;
• a majority of relatively modest earners will also be affected, particularly if their earnings fluctuate from year to year; and
• the sheer complexity that follows when taxpayers are members of more than one pension scheme. Where an individual is a member of more than one scheme, the same calculations need to be performed for each scheme and the results aggregated to determine whether the £50,000 limit is breached.

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