This year is no different – even considering the fact that very few legislative developments have occurred in the past tax year with regards to pensions.
Lifetime allowance changes
When pension simplification came into effect on April 6 2006 (A-day), it introduced the concept of the lifetime allowance. The LTA was originally set at £1.5m, less than the benefits already accrued by some at either A-day or their planned retirement date.
In order not to disadvantage these people, the government introduced transitional protections that gave a higher or unlimited entitlement to the LTA.
We now have many variations on the LTA, ranging from £1.055m – the current standard – to the £1.8m applicable to those with fixed protection (from 2012). All of these different allowances will impact on the amount of benefits the member can take.
The LTA is scheduled to rise each year in line with the consumer prices index, although the actual amount is confirmed by the government on each occasion.
It will be 2025-26 or thereabouts before we see the LTA getting back close to £1.25m, and into the 2030s before we get near £1.5m. This is all dependent on the government not changing the rules, as well as CPI remaining around the 2.5 to 3 per cent level we are currently seeing. See Chart 1.
Although the LTA has only increased by £25,000, it will have an impact on the amount of charges payable. Assuming the excess over the allowance is taken as a lump sum, it could save a pension scheme member an immediate tax charge of £13,750 – or £6,250 if taken as taxed income. This isn’t an insignificant amount, and all tax savings should be welcomed.
Tax-free cash payments
The amount of tax-free cash (pension commencement lump sum) payable is dependent on the LTA that a pension scheme member has available to them. So the £25,000 increase means that most people will be entitled to an extra £6,250 tax-free cash.
For those that are higher or additional-rate taxpayers, this amount, while small, is still significant. However, it should be remembered that the maximum payable figure is still 25 per cent of the amount crystallised, so it will only be a benefit to those that are already at or near the standard LTA.
Protected tax-free cash
One of the big issues we often see in relation to the allowance change is the difference it can make to scheme-specific, tax-free cash. That relates to situations where an individual was in an occupational pension scheme before A-day, a position that entitled them to more than 25 per cent of the fund as tax-free cash.
This entitlement was because the way in which the cash was calculated in occupational schemes wasn’t related to the fund value. Instead, it was calculated based on salary earned and the time they worked for the relevant employer. That meant they could accrue a large proportion of cash in a scheme in comparison to their actual fund value. This cash was protected within the scheme at A-day.
Revalued to today, any additional growth in the scheme could pay out a further 25 per cent. However, April’s LTA increase means that some will get a lower protected tax-free cash sum than they would have done before the rise. This is also an issue for those with protected LTAs of £1.5m or less, because they would be entitled to a lower amount of additional growth than those without. See Box 1.
It should be remembered that for those with a standalone lump sum, where the entitlement to tax-free cash exceeded the fund value at A-day and no further payments have been made, the LTA has no impact on this entitlement. This means that whatever the allowance is at the point they access these benefits, the cash remains entirely tax-free – provided they have available LTA to pay it.
Carry forward and the TAA
We can’t talk about the change in the tax year without commenting on the availability of carry forward. This is especially important to those that are impacted by the tapered annual allowance.
We are entering the fourth year of the TAA and it is becoming an increasing burden on pension scheme members, their financial advisers and accountants – so ensure that the calculations are accurate. This is also the first year where someone could have been subject to the TAA for all the years from which they could possibly use carry forward from.
We have also just lost access to the special split tax year, wherein pension input periods were aligned to tax years. For many, this increased the amount of carry forward available, an advantage that will now not be available.
The TAA is impacted by non-pension-related taxation changes, because the test looks at the net income of a pension scheme member as defined by income tax and not pension legislation.
This tax year has brought another incremental change, relating to the way that interest on mortgages is dealt with for buy-to-let properties. Historically, this interest was a deductible expense when calculating rental profit, but since 2016-17 it has moved from an expense to a tax relief. This means that the amount of profit applicable to the threshold and adjusted income tests has increased for those impacted. There isn’t anything that can be done about this, but it is something to be aware of.
Personal allowance
The personal allowance has risen to £12,500, which will have an impact on both low and high earners contributing to a pension scheme.
Low earners will have the scope, if in a relief-at-source pension scheme, to claim more tax relief even if they aren’t actually paying any tax. This is because the scheme will reclaim 20 per cent tax on contributions, provided they are less than 100 per cent of their earnings.
If the scheme is a ‘net pay’ pension scheme this situation doesn’t apply because the 20 per cent tax relief can’t be claimed in the same way. This just shows that the division between the two types of pension schemes will become even greater as time goes on, and should be addressed sooner rather than later.
For high earners we have the issue of the lost personal allowance for those with adjusted net incomes between £100,000 and £125,000. If a pension scheme member were to pay a pension contribution of £25,000 gross (£20,000 net) then not only would they be able to claim back 20 per cent higher-rate tax relief on the amount, but they would also be able to reclaim their personal allowance of £12,500.
This means they wouldn’t be paying 40 per cent tax on that £12,500, and would result in the £25,000 pension contribution costing them only £10,000, a 60 per cent tax saving.
The other benefit of this pension contribution is that it would take the pension scheme member out of the TAA because it would most likely reduce their threshold income to below the £110,000 cut-off. This would then restore their annual allowance to £40,000 for the 2019-20 tax year.
Even in years where there are only minor changes, pensions need to be reviewed afresh because of external factors that may have an impact. This dictum relates to both the LTA and the annual allowance, and is why a full review of pension funding on a regular basis is essential to ensuring good client outcomes.
Claire Trott is head of pensions technical at St James’s Place Group
