Financial Wellbeing: Pension Tax

The pension tax allowances are changing (again!) – don’t get caught out with unwanted tax charges and fines.

The Annual Allowance (AA) and Lifetime Allowance (LTA) were introduced to limit tax relief on pension savings, although these have been significantly reduced over the last few years, and in the July 2015 Summer Budget the Government announced more changes.

  • The changes are complex, and the impact will depend on personal circumstances.
  • Advice should be sought to avoid unwanted, unexpected and unnecessary tax charges and fines as these could be significant.
  • Individuals who are likely to be affected may wish to consider maximising their tax-efficient pension contributions in advance of the changes.

£10,000 Annual Allowance for high earners

The AA initially increased from £215,000 to £255,000, although it has subsequently reduced to £40,000. Any pension funding in excess of the AA, including employer contributions, incurs a tax charge for the member at their highest rate of income tax.

From April 2016, the AA will be reduced by £1 for every £2 of income over £150,000, with a £10,000 AA for individuals with earnings in excess of £210,000. The definition of ‘earnings’ includes the value of employer and employee pension contributions, and could therefore reduce the AA for individuals with earnings in excess of £110,000.

It’s not just about high earners

From April 2015, members of defined contribution pension schemes have greater freedom when taking their benefits.  However, if they use the new freedoms and withdraw more than the maximum tax-free lump sum, their AA is automatically reduced to £10,000. The member is required to notify all other pension schemes to which contributions are still being paid of their reduced AA, and if they fail to do this within 91 days, HMRC will impose a fine of £300 increasing by £60 a day until this is rectified.

Reduction in the Lifetime Allowance

The LTA increased from £1.5M to £1.8M by 2010, although it has subsequently reduced to £1.25M and will reduce again to £1M from April 2016. A tax charge of up to 55% is incurred by the member on any pension savings in excess of the LTA.

Those with pension savings in excess of £1M, or those likely to exceed this in the future, will have the option to apply to HMRC to retain the £1.25M LTA. However, depending on the type of protection applied for, this may require the individual to cease all future pension funding.

How can we help?

We can highlight which employees may be affected and what the implications are for them.

We can help you decide on the appropriate level of assistance that should be made available. This would include targeted communications to the affected individuals to help maximise their available pension tax relief in advance of the changes, plan for the changes, and put the appropriate arrangements in place.

The LTA also has an impact on the design of death in service schemes. HMRC classes most schemes that provide death benefits only as ‘registered pension schemes’. Therefore, any lump sum death benefits paid from a ‘registered’ life assurance scheme would count towards the member’s LTA, in addition to any lump sum death benefits from the member’s pension schemes. However, lump sum death benefits paid from an ‘excepted’ life assurance scheme do not count towards the member’s LTA.

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