For these high earners, pension tax relief will be tapered down until it becomes only 20% when relevant income reaches £180,000 per annum. These changes mean that high earners will need to ask whether it is sensible for them to make additional pension contributions.

High earners who accrue benefits in defined benefit (final salary) pension schemes or where their employers make contributions on their behalf will not escape the new rules. The government has announced that equivalent tax charges will be in place and it will consult on how these will be applied.

To prevent effective tax planning ahead of the 2011 start date, the government has introduced new rules which may restrict tax relief on some pension contributions made from April 22, 2009.

These new preventative measures will not apply if:

- Relevant income is less than £150,000 in the 2009/10 tax year and each of the previous two tax years, or

- Normal ongoing pension saving arrangements (protected pension input) are in place before April 22, 2009 and continue unaltered, even if relevant income is £150,000 or more in any tax year from 2007/08 to 2010/11. These must involve regular contributions paid quarterly or more frequently, or

- Overall annual pension savings in 2009/10 and 2010/11 are less than the special annual allowance. This allowance is £20,000 and is inclusive of existing normal ongoing pension saving arrangements.

An amendment to these rules was introduced on July 3, 2009 for those making less regular pension contributions, often business owners or the self-employed. This may allow them to invest in excess of the £20,000 allowance. They are able to invest the average of their last three years contributions or £30,000, whichever is smaller, without a reduction in tax relief.

Next steps

The new rules are complex and it may not be immediately clear whether an individual is affected by the changes. This will depend on their relevant income in the current and two preceding tax years and on their existing pension arrangements and previous contributions.

The first step is to establish whether the new rules apply to them and if existing pension contributions qualify as normal pension savings arrangements. The impact of this is likely to dictate their next steps.

Those with income above £150,000

For those with relevant income above £150,000, it is important to assess the impact of the changes on their eligibility for higher rate tax relief. They will continue to benefit from higher rate relief on normal ongoing pension savings or up to £20,000 if greater in 2009/10 and 2010/11.

Those making less regular payments may be able to contribute up to £30,000 if their previous pension contributions are sufficient. In fact, in 2010/11 the highest rate of income tax will be at 50% and so there may be even more reason to ensure this allowance is utilised.

Where high earners currently have no normal ongoing pension savings, they should look to utilise their £20,000 contribution limit in 2009/10 and 2010/11 as they will receive higher rate tax relief.

However, it will no longer be appropriate for them to make additional pension contributions in excess of the £20,000 limit. These high earners will therefore need to carefully investigate their overall financial plan and consider alternative means of long-term retirement planning.

Those with income under £150,000

Those with relevant income under £150,000 will not be affected by the reduction of tax relief on pension contributions. However, the Chancellor also announced changes to income tax whereby an individual’s basic personal income tax allowance is reduced by £1 for every £2 of ‘adjusted net income’ above £100,000.

For those with income above £100,000 they may be able to make a pension contribution to reduce their adjusted net income to below the £100,000 threshold. They may then benefit both with higher rate tax relief on their pension contribution and from preserving their income tax personal allowance. This could provide an effective tax relief rate of up to 60% on pension contributions.

Many employees may also benefit from a review of salary exchange opportunities to reduce National Insurance Contributions and income tax liabilities. Salary exchange is where an employee gives up the right to part of their cash remuneration due under their contract of employment and in return the employer agrees to provide some other form of benefit, such as pension contributions. This also reduces the employer’s National Insurance Contributions.

Putting salary exchange in place now could preserve pension benefits in the future if changes similar to those announced without warning in the Budget for high earners are introduced on a wider scale.

The new pension rules are complex and high earners need to understand how they are affected. They need to ensure that they know whether the new rules apply to them, if existing pension arrangements are protected, and what their next steps should be.

The most appropriate course of action will depend on an individual’s circumstances and so it is important that they have access to the right professional advice to react to these changes in the short-term and if necessary adapt their longer-term financial plans.

John Richardson is head of technical planning at Towry Law

Printer friendly version

Email this article to a friend