Government's July 2015 budget: reform of pensions tax relief
The Chancellor announced yet more tax changes which will impact on the amount of tax relievable pensions savings for "high earners". These proposals are summarised below.
Reduction of Annual Allowance for High Earners
From 6 April 2016 the Annual Allowance (AA), currently £40,000, will be reduced for people with incomes of more than £150,000.
The AA is the maximum amount of pension savings that a person can make each year in a UK pension scheme which qualifies for tax relief. The AA was first introduced (with the reform of the UK pensions tax system) from 6 April 2006 and the amount of it then was £215,000. After an initial increase, the value of the AA has fallen, to £50,000 from 6 April 2011 and then to £40,000 from 6 April 2014.
The Government has now announced that from 6 April 2016 the AA of £40,000 will be reduced for people with what is termed "adjusted annual income" (which includes all pension contributions) in excess of £150,000. People with income (excluding pension contributions) of £110,000 or less will not be subject to this reduction. Salary sacrifice arrangements entered into after July 2015 will be included in the £110,000 figure.
How the reduction in AA is applied
There will be a rate of reduction of £1 for every £2 that the person's "adjusted annual income" exceeds £150,000, subject to a minimum AA of £10,000. People on an adjusted income over £210,000 will have an AA of £10,000.
A person affected by this reduction in AA will be allowed to carry forward the amount of his unused AA in any tax year.
The process of calculating the value of a person's pension saving against the AA limit in each tax year is complicated. It broadly reflects the annual increase in the value of the person's accrued pension benefits.
The period over which the pension accrual is measured is called the "Pension Input Period" (PIP). The period of the PIP to date has not always been aligned to the tax year which has caused difficulties with the calculations.
This will all change from 6 April 2016, when the PIP for all schemes will be aligned to the tax year. The motivation for this change is to streamline the application of the reduced tax relief for high earners under these proposed changes. There are transitional measures for the change in PIP's which are required to protect the value member's accrued pensions.
Reduction in Lifetime Allowance
The Chancellor also confirmed that the reduction in the Lifetime Allowance (LA) to £1 m will start from 6 April 2016. Transitional protection will be introduced to ensure there is no retrospective element to these changes. From 6 April 2018 the LA will be indexed in line with the Consumer Prices Index.
These proposals will raise money for the Treasury but will have a negative impact on high earners.
The Government's proposals with these changes are to make sure "the right incentives are in place to encourage saving into pensions for the longer term". For high earners caught by the reductions in available tax relief the message by these reforms is that tax efficient pension savings will be more limited.
Some high earners may have limited pension savings and faced with these changes, may find it difficult to build up adequate pensions pots through traditional pensions saving. If their confidence in UK pensions is knocked, this may impact on their commitment or willingness to provide good pension benefits for staff.