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The Budget 2010 commentaries - pensions & investment

"The commentaries below are written in general terms. Details can also be found in our downloadable Budget Report brochure. You are strongly recommended to seek specific advice before taking any action based on the information given, both in the commentaries and in the publication."

Changes to pension taxation

A few changes to ‘tidy up’ some loose ends in the Pensions Act 2008 were announced in the 2010 Budget:

  • the National Employment Savings Trust (NEST), which will be introduced in 2012, will fall within the tax legislation relating to tax-registered pension schemes;
  • regulations will be introduced which will enable tax anomalies arising from the introduction of NEST to be ironed out – the changes could be retrospective but only insofar as they relieve rather than increase any person’s tax liability;
  • interest charged by a qualifying pension scheme on contributions made late by an employer will no longer be subject to tax; and
  • removal of the tax charge on borrowing linked to establishing and running a registered pension scheme.

Comment

Bringing NEST within the tax regime applying to tax-registered pension schemes should make NEST more attractive to both employers and employees and potentially help ease administration.  The other changes will also be welcome by pension schemes and employers.

Implementing the restriction of pensions tax relief

The 2009 Budget trailed the restriction of pensions tax relief as of 6 April 2011.  Consultation was published in December 2009 for which the consultation period has now ended. 

Legislation will be introduced in Finance Bill 2010 to recover tax relief above the basic rate on pension contributions made by or on behalf of individuals with high income.  For people with annual income of £150,000 or over, but below £180,000, tax relief on pension contributions (including the value of employer contributions for those in employment) will reduce gradually from the individual’s marginal rate to basic rate as income increases.  Where income is £180,000 or over the measure restricts tax relief on pension contributions to basic rate.  These changes will be effective from 6 April 2011.

The new rules are complex, however, they can be broadly summarised and applied as follows:

  • firstly establish whether or not pre-tax income from all sources, including personal pension contributions and charitable donations, is greater than £130,000;
  • if so, add employer’s pension contributions and, if the resulting total is £150,000 or more, the new provisions will apply;
  • if affected by the provisions, establish the restriction of tax relief to be applied to those pension contributions paid personally and by the employer;
  • if income, including all pension contributions, is £180,000 or more, effectively only basic rate tax relief for pension contributions will be given;
  • if income falls between £150,000 and £180,000, a taper rate is applied to determine how much tax relief is lost;
  • this taper rate starts at 49% for those with income equal to or greater than £151,000, falling by 1% per £1,000 until it reaches 20% for those with income of £180,000 or more;
  • if the taper rate is more than 40% it is only applied to contributions otherwise receiving tax relief at 50% with the restriction to tax relief calculated by deducting the taper rate from 50% and then multiplying the pension contribution which has received tax relief at 50% by the difference, and the resulting figure is the tax relief which is clawed back;
  • if the taper rate is less than 40% it is applied to contributions which received tax relief at both 40% and 50% in the same manner as described above.  The total is the amount of the restriction.

Individuals in final salary pension schemes will have their pension contributions calculated on an actuarial basis.

Following the consultation, HMRC has decided to use age related factors (ARFs) as opposed to the multiplier of 10 (applied in determining the annual contribution for cap purposes) to calculate the deemed contribution for applying the restriction for tax relief. 

Comment

Clearly the spirit of pensions simplification was forgotten when the legislators considered these rules.  Not only are there now complex calculations for those in defined benefit schemes to determine the actual level of pension contributions, a second set of complex calculations will then have to be applied to establish how pension tax relief should be restricted. 

These complex calculations are required by all individuals, including those in final salary pension schemes who satisfy the income criteria referred to above.

This also adds another layer of complexity for pension scheme trustees who will have to ensure that their actuaries can provide relevant information for affected members of the scheme.

This clearly presents the potential for much confusion and mistakes which may or may not be in the taxpayer’s favour.  It is strongly advised that an individual seeks advice if they believe they will be affected by the changes.

Whilst it looks as though the rules are here to stay a much more simplified approach would have been welcomed.

Individuals likely to be caught by these new rules should consider making maximum use of higher rate tax relief on their pension contributions whilst there is scope to do so.  However, the anti-forstalling rules, applying to the 2009/10 and 2010/11 tax years, restricting the effective tax relief obtained for increased pension contributions, should not be forgotten.

Pension schemes – annual allowance and lifetime allowance

It has been confirmed that as of 6 April 2010 and for a further five tax years up to and including the tax year 2015/2016 that the lifetime allowance will be held constant at £1.8 million and the annual allowance at £255,000. 

Comment

The thrust of this change is that individual who vest their pension benefits within the next six years and whose value exceeds £1.8 million will suffer a tax charge of 55% on the excess, unless they have applied for protection. 

The freezing of lifetime allowance will, potentially, bring a lot more people into charge to tax than perhaps originally anticipated.

If you believe that you might be affected you should take advice to see whether either your investment strategy should be changed or whether benefits should be crystallised before you breach the limits.

The freezing of the annual allowance will, however, have less of an impact because from April 2011 individuals with gross income over £180,000 are to be limited to basic rate tax relief of 20% on their pension contributions.  Whilst this should not deter everyone from making pension contributions it is likely to persuade many high earners that the upfront tax relief and tax-free growth is no longer as attractive as it was when full higher rate tax relief was available.

Individual savings account (ISA) limits

From 6 April 2011 and over the course of the next Parliament, the ISA limits will be increased in line with the Retail Prices Index (RPI) on an annual basis.  Should RPI be negative, the ISA limits would remain unchanged.

As announced in the 2009 Budget, the ISA annual limits are being increased for all savers from 6 April 2010 to £10,200, of which £5,100 can be saved in cash.

Comment

A regular inflationary increase in ISA allowances is welcome news for savers, although given the current low interest rates the increase is unlikely to have an immediate significant monetary impact.