Managing Your Money 

Pensions tax relief to change

Pensions tax relief to change

Higher earners who planned to make for Switzerland following the last government's plans to reduce pensions tax relief for higher earners can start unpacking. Last week, our new Con-Lib coalition government announced that it is planning to scrap Labour's plans to restrict pensions tax relief for those earning over £130,000, subject to a consultation which will run until 27 August. Although this move has been warmly received by the pensions industry, there is a caveat: the government plans to plug the shortfall created by doing this by drastically reducing the annual amount you can put into a pension tax-free and by reducing the lifetime allowance.

The net result of these changes could be that more pension savers end up with their tax relief curtailed than under the previous proposals - possibly double the number, according to one actuary.

However, it should be good news for those earning over £130,000, provided they remain within the yearly and lifetime limits. "This approach would make the restriction in tax relief easier to understand and would not cause sectors of the population to effectively have to abandon pensions," says Paul Kennedy, director of tax planning at Fidelity International.

If these new proposals are adopted, they will come into effect from 6 April 2011, following legislation introduced in the Finance Bill 2011 this autumn.

Annual allowance slashed

At present you can put up to £255,000 every year into a pension tax-free, but the government says following provisional analysis it would need to drop this to between £30,000 and £45,000 to compensate for restoring pensions tax relief for higher earners.

This will be particularly detrimental to savers in final salary schemes as they could more easily hit or exceed the lower limit given proposals to change the way they are calculated. The government suggests using a higher conversion rate than at present when converting the annual pension accrual into a capital value to count towards the annual allowance. Final salary scheme members build up extra entitlement each year so, for example, if a long-serving employee on a middle income gets a pay rise substantially increasing the value of their benefits, it could take them over the proposed new limit - even if they are not a higher earner.

Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), said: "It's a simpler approach that will encourage higher earners to stay in their workplace pensions, so helping protect pensions saving for all staff. But it is disappointing that the government seems to be pressing ahead with including past service in the valuation of defined benefit pension rights. At a stroke this will drag many people on modest earnings with final salary pensions into the net."

Those currently contributing in excess of the proposed new limit should look to make other arrangements to save for their retirement as putting funds into a pension is unlikely to be attractive if you're not receiving tax relief on the contributions, says John Richardson, head of advice policy at wealth manager Towry. This could include working with employers to consider how you can amend remuneration packages to take account of the changes.

Options include revising your pension arrangements so that you have a cap on pensionable salary, with anything above this going into a defined contribution scheme. But this could be a fairly complicated arrangement and Laith Khalaf, pensions analyst at Hargreaves Lansdown, says: "If you have got a final salary scheme with guaranteed benefits, it is so valuable it is not a good idea to opt out. It may be that some higher-earning employees may want to move into a defined contribution scheme or self-invested personal pension (Sipp) - however, get advice before you do this because you could be giving up a lot of benefits."

If you are earning below £130,000, Mr Khalaf suggests making a large lump sum contribution during this tax year before the lower annual limit is introduced. He adds: "£30,000 to £40,000 a year will still build up a good pension pot. Going forward you will need to make regular contributions, within your yearly limit. You will not be able to, for example, contribute nothing for a period and then put in a large lump sum to compensate. But as most employer schemes involve monthly contributions, for people enrolled in these it should be less of a problem."

Other restrictions

It has also been proposed that the maximum amount you can contribute to a pension during your lifetime will be reduced from £1.8m to £1.5m. If you are in danger of breaching this you will need to consider other tax-efficient savings vehicles such as individual savings accounts (Isas), or if you have a higher risk appetite, venture capital trusts (VCTs) and enterprise investment schemes (EIS). Onshore and offshore bonds may also be options for some investors.

Another suggestion put forward by the government is to limit tax relief to a maximum of 40 per cent, rather than your marginal rate. While this will not affect most people, it will mean that those earning over £150,000 who pay the 50 per cent tax rate will not get tax relief at their marginal rate.

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