Defined benefit pension scheme members will be hit by the Conservative government’s plan to reduce the annual allowance for tax-relieved pension saving by half for every pound earned over £150,000, Old Mutual said.
Speaking to FTAdviser, retirement planning manager Adrian Walker said proposals to taper tax relief announced during the election campaign are expected to be confirmed at next month’s summer Budget, reducing relief to a maximum of £10,000 for those earning more than £210,000.
The plans will reduce the annual contribution allowance by 50 pence for every pound earned over £150,000 up to this upper cap. A saver earning £160,000 will have a reduced allowance of £35,000 on which relief is paid, or where no liability is created for employer contributions.
At the time the Conservatives said the move would raise £1bn and be used to help fund a new allowance to exempt £1m properties from inheritance tax.
Mr Walker said that while it has been well-established the proposals will hurt those in money-purchase pensions, with a saver in the highest income bracket losing anywhere up to £30,000 in tax relief, those in DB schemes will also be hit.
He explained annual allowance is calculated for defined benefit savers by taking the increase in eventual pension income for that year minus an allowance for CPI inflation and multiplying by the standard factor of 16.
This which could leave savers “owing the Revenue” under the new regime, Mr Walker said.
He gave an example of a client in a DB scheme with accrual of 1/60th of annual salary for each year of service and, as above, a pensionable salary of £160,000. Under the assumed new system, the annual allowance would be £35,000.
If the year before the changes the person had accumulated 10 years’ service, the pension accrued at the start of the year would be £26,667. By the end of the following year, the 11th of service, this would have risen to £29,333.
This means the pension income will have risen by £2,667. The 1.2 per cent CPI inflation allowed on the opening figure is £320, leaving £2,347. Multiplied by the factor of 16 this gives an annual equivalent for the purposes of the annual allowance of £37,547.
The individual would therefore be liable for potential tax charge on £2,547 above the £35,000 annual allowance, which at 45 per cent would give rise to a bill of £1,146.
“For advisers, the threat of a reduction in government pension funding available to higher earners could mean there is an opportunity to connect with clients that wish to contributions to a money purchase scheme now in order to take advantage of existing rules.”
Vince Smith-Hughes, head of business development at Prudential, explained that the reduction in annual allowance for higher rate tax payers is likely to come up in the summer Budget, but the question is when will it start.
“If I had people in that camp I would be urging them to put contributions in now as who knows when it will start. It could be immediately or from the next tax year.”
donia.o’loughlin@ft.com
