Rumours are circulating that the Chancellor’s Budget next week will contain dramatic changes to the existing structure of tax relief on pension contributions.
It is likely, according to speculation, that we may see tax relief on pension contributions being reduced or completely overhauled. The full implications of such a change can be considered another time, but there are changes coming that we do know about which will take effect from 6 April 2016.
These will include reductions to the Lifetime Allowance (LTA) and the tapering of the Annual Allowance. There will also be another set of protection options individuals will be able to apply for.
Reductions to the LTA
The LTA will be reduced from £1.25m to £1m and will increase in line with the Consumer Prices Index (CPI) from April 2018. In addition, two new protections are being introduced, namely Fixed and Individual Protection 2016.
How will these work?
Fixed Protection 2016 (FP16):
• Protects pension benefits up to £1.25m
• No further contributions can be made after 5 April 2016
Individual Protection 2016 (IP16):
• Must have benefits of at least £1m as at 5 April 2016 to apply.
• Protects pension benefits up to the individual’s protected amount (up to £1.25m).
• Can continue to contribute to the plan.
So what are the planning issues and opportunities?
A decision will need to be made as to whether protection should be applied for and if so which, or both.
Where the decision is to apply for FP16:
• What is the current size of existing pension savings?
• What is the investment strategy and can any assumptions be made on projected growth?
• Where benefits are at or near the LTA limit, will they grow more than the CPI-linked increases to the LTA from April 2018?
• How many years has the member got before they plan to retire?
• Should additional contributions be made before 6 April 2016?
Where the decision is to apply for IP16:
• Are pension savings already at or above £1m or do additional contributions need to be made before 6 April 2016?
• Should additional contributions be made before 6 April 2016 to take the individual protection limit as close to £1.25m as possible?
• Once the protection is in place, is the intention for future contributions to be employer-based, individual or both?
• If employer-based contributions only, is this more tax-efficient than taking additional remuneration in the form of salary, bonuses or dividends in lieu of pension contributions?
• Are the employer contributions excessive, compared to remuneration, and has consideration been given to the wholly and exclusively rules?
Many individuals will be members of Defined Benefit (DB) schemes.
Deferred members
For deferred members there may be the risk that any revaluation is too high and deemed a contribution, therefore losing fixed protection. If benefits will be above £1m at 5 April 2016 it may be worth applying for both FP16 and IP16.
Active members
A decision will need to be made around whether to cease being an active member of a scheme and apply for fixed protection, or apply for individual protection and continue to accrue benefits within the scheme.
This brings up a number of issues:
• Any benefit accrual in excess of their protected LTA will face an LTA charge.
• The tapered annual allowance may also affect certain individuals who are still active members within the scheme, as large pay rises can affect the annual allowance calculation used, resulting in the member possibly facing an annual allowance charge at their marginal rate of income tax.
• If the member chooses to no longer be an active member, the employer may not be willing to compensate the member for the loss of any future benefit accrual (in other words, with additional remuneration, bonuses or dividends).
Taking additional remuneration
Where the employer is willing to compensate the member, it may be more tax advantageous to take increased remuneration in the form of salary, bonuses or as dividend income. Any pros and cons would need looking at, including the tax implications of both.
Taking benefits early
The member could retire early, at say age 55, and possibly get an actuarial reduction, which would result in a lower valuation for LTA purposes. DB schemes value the pension payable at retirement by multiplying it by a factor of 20 and then adding in any tax-free cash. The lower valuation therefore might mitigate some or all of the LTA charge.
Tapering of the annual allowance
As well as reductions to LTA there will also be a tapering of the annual allowance.
How will it work?
Put simply, it will reduce the annual allowance by £1 for every £2 of adjusted income over £150,000, where the maximum reduction in the annual allowance will be £30,000.
So in practice it will mean that where adjusted income is between £150,000 and £210,000, the annual allowance will decrease from £40,000 to £10,000. For incomes over £210,000 their annual allowance will be £10,000.
So what are the planning issues and opportunities?
What can be done up to 5 April 2016?
• Is there scope to maximise pension contributions before 6 April 2016?
• Is there scope to take full advantage of the transitional pension input period year and pay up to £80,000 into a pension for this tax year?
• Is there any unused allowance from the previous three tax years that can be carried forward into this tax year?
What can be done after 5 April 2016?
• Carry forward of unused allowance from the previous three tax years will still be available for those affected by the tapered annual allowance
• Look at alternative non-pension products, for example, international investment bonds to fund for additional retirement provision.
In summary, many clients will be affected by the reduction in the LTA and will need to make a difficult decision as to what type of protection to apply for. This decision may be complicated further if the individual is a member of a DB scheme.
The tapered annual allowance will also restrict those with high incomes from making sizeable pension contributions going forward, although taking advantage of carry forward of unused allowance and looking towards other forms of non-pension retirement provision may provide a possible solution.
As the Budget date looms, we may see further changes to tax relief on pensions and so fully utilising this year’s annual allowance and taking advantage of any existing unused allowance may prove a prudent move.
Sam Newton is a technical project manager at Canada Life
Key points
The Lifetime Allowance will be reduced down from £1.25m to £1m and will increase in line with the Consumer Prices Index (CPI) from April 2018
For deferred members there may be the risk that any revaluation is too high and deemed a contribution, therefore losing fixed protection
The tapered Annual Allowance may also affect certain individuals who are still active members within the scheme
