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Pensions: Good news for high earners

Shared from Tax Insider: Pensions: Good news for high earners
By Kevin Read, June 2020

Kevin Read discusses the recent changes to the tapering of the pension annual allowance and reminds readers of the importance of ‘scheme pays’ elections. 

Had George Osborne got to complete his reform of pensions, there would probably no longer be any higher rate tax relief on pension contributions. However, the restrictions he introduced on top rate tax relief (i.e. via a tapering of the normal £40,000 annual allowance) are still with us and, in the context of defined benefit schemes for doctors, they received a lot of bad publicity in the months before the Budget. 

Forthcoming attraction 

Finance Bill 2020 contains provisions to relieve some of these concerns, by making sure that the restrictions will apply to far fewer taxpayers.  

This is achieved via a £90,000 increase, from 6 April 2020, in each of the two thresholds contained in the legislation. ‘Threshold income’ (broadly, net income before tax, excluding employer pension inputs) rises from £110,000 to £200,000 and ‘adjusted income’ (i.e. threshold income plus employer pension inputs) rises from £150,000 to £240,000. 

Only where both threshold income and adjusted income are exceeded is there is a restriction in the annual allowance (AA), now being 50% of the excess of adjusted income over £240,000. However, this tapering cannot reduce the AA below £4,000 (i.e. lower than the previous minimum of £10,000). 

Thus, those with adjusted income between £150,000 and £240,000 no longer suffer any restriction on the AA, and only those with adjusted income above £300,000 (i.e. when the AA is tapered below £10,000) are worse off from the changes. 

Example: Billie gets her pension topped up 

Billie has a total income of £230,000 in 2020/21. In addition, her company made a pension contribution of £55,000 on her behalf into her self-invested personal pension (SIPP). 

This means her AA is tapered, as she has both  

  • threshold income above £200,000 [£230,000], and  
  • adjusted income above £240,000 [£285,000] 

Her final AA will be: £40,000 – [50% (£285,000 - £240,000)] = £17,500. 

In the absence of any unused allowance brought forward from the preceding three years, Billie will be liable to an AA charge in 2020/21 of £37,500 (£55,000 - £17,500). This will be taxable at her marginal rate (i.e. 45%), giving a tax liability of £16,875. 

For defined contribution (‘money purchase’) schemes, such as Billie’s SIPP, pension inputs are the cash contributions into the scheme (by the individual or an employer) during the tax year.  

In the case of defined benefit (for example, final salary) schemes, annual pension inputs are more complicated to calculate, as they are based on the increase in the member’s pension benefits for the year, multiplied by a factor of 16. With final benefits linked to salary, a relatively small increase in salary can thus lead to a large pension input. This, in turn, can lead to a high AA charge and tax liability, which perhaps the taxpayer does not have the cash to meet. 

‘Scheme pays’ elections 

Those who may be subject to an AA charge from a defined benefits scheme should request an annual benefits statement, which will show pension inputs. Unlike a defined contribution scheme, these statements are not automatically sent out annually. 

If the tax liability on an AA charge is greater than £2,000, an election is available to ask the pension scheme to pay this tax. Depending on circumstances, this ‘scheme pays’ election may be either ‘mandatory’ or ‘voluntary’. In the latter case, the pension scheme does not have to agree to settle the tax charge on behalf of the member (and often will not). Unfortunately, any such election resulting from a tapered AA can only be ‘voluntary’. 

Where the scheme does pay the tax charge, the amount (increased by the CPI) will be recovered by the scheme:

  • when benefits are paid at retirement (impacting both pension and lump sum, but not death or dependents’ benefits), or  
  • if you transfer out of your pension scheme. 

The deadline for making an election for 2018/19 is 31 July 2020, so it is rapidly approaching. 

Practical tip 

Consider ‘scheme pays’ elections where clients have a tax liability resulting from an annual allowance charge. 

 

Kevin Read discusses the recent changes to the tapering of the pension annual allowance and reminds readers of the importance of ‘scheme pays’ elections. 

Had George Osborne got to complete his reform of pensions, there would probably no longer be any higher rate tax relief on pension contributions. However, the restrictions he introduced on top rate tax relief (i.e. via a tapering of the normal £40,000 annual allowance) are still with us and, in the context of defined benefit schemes for doctors, they received a lot of bad publicity in the months before the Budget. 

Forthcoming attraction 

Finance Bill 2020 contains provisions to relieve some of these concerns, by making sure that the restrictions will apply to far fewer taxpayers.  

This is achieved via a £90,000 increase, from 6 April 2020, in each of the two thresholds contained in the

... Shared from Tax Insider: Pensions: Good news for high earners