Restricting Tax Relief on Pension Contributions

New rules for restricting tax relief on pension contributions and reducing the Lifetime Allowance (LTA) limit for total tax privileged pension savings, were announced by HM Treasury on the 14th October.

Whilst the rules will undoubtedly have a significant impact on the pension savings decisions of many GP’s and consultants, the new rules do at least have the advantage of being significantly less complex than those that had been put in place by the previous labour government.

Annual Allowance (AA)

The new rules have greatly reduced the AA that can be paid into tax advantaged pension schemes from £255,000 to £50,000, with effect from the 6th April 2011. The good news is that pension contributions up to £50,000 will continue to receive income tax relief based an individual’s marginal rate of tax (including the new 50% rate). The bad news is that any contributions over this amount will be subject to tax at the individual’s marginal rate (including the 50% rate).

This means that an individual paying tax at a rate of 50%, who contributes (or is deemed to contribute) £60,000 into a pension scheme, or combination of pension schemes, will from the 6th April 2011, be subject to an income tax charge of 50% on the £10,000 that is in excess of the new £50,000 limit.

In order to provide some protection for those individuals whose pension contributions rise significantly due to a significant pay increase (as a result of a promotion or other event), there will be the opportunity to carry forward from the previous three years, any part of the £50,000 allowance that has not already been utilised.

This means that an individual who for the 2008/09, 2009/10 and 2010/11 tax years has only contributed (or deemed to have contributed) a sum of £25,000 in each of those tax years, will be able to carry forward £75,000 (£150,000 minus £75,000) into the 2011/12 tax year, if their contribution in that year had exceeded the normal £50,000 allowance.

The £50,000 contribution applies to all pension contributions paid in a tax year, and will include contributions to occupational schemes such as the NHS Pension Scheme.

Deemed Contributions

It is easy to identify the level of contribution paid into a “Defined Contribution” (DC) scheme (such as a Personal Pension Plan (PPP) or a Self Invested Pension Plan (SIPP)), as in these cases the contribution is the actual amount invested. However, it is more difficult to assess the value of the contribution in a “Deferred Benefit” (DB) scheme such as the NHS Pension Scheme or indeed any other occupational pension scheme, where members receive an increased amount of pension income for each year of service.

The government has decided to value the deemed level of contribution, based on the increase in the individual’s pension benefits over the year, multiplied by a factor of 16. This is a flat rate factor which has been calculated by the Government Actuary Department (GAD).

Where a scheme pays a separate lump sum, (such as the NHS Pensions 1995 Section), the amount of the additional lump sum is added to the deemed pension contribution.

Whilst the deemed contribution should be relatively straightforward to work out for officers (employees) pension contributions, it will be much more complicated for GP’s whose actual contributions fluctuate significantly and are not known until some significant time after the tax year is over. The scheme will have to provide this information to members where their benefits exceed the £50,000 limit.

Again it is likely that the new rules will have been drafted without giving consideration to the unique nature of GP’s pensions. However, we will endeavour to seek clarification of the position before the new tax year.

Individuals who exceed the maximum £50,000 AA limit will need to make decisions about whether or not any action should be taken.

Reduced Lifetime Allowance (LTA)

The Government has also decided to reduce the maximum tax privileged LTA from the current level of £1.8m to a significantly reduced level of £1.5m from the 6th April 2012.

There are to be some transitional protection mechanisms available to enable those who have either already accrued pension pots in excess of the newly proposed £1.5m limit, or have arranged their affairs so that they will have exceeded the £1.5m by 5th April 2012.

However, the final rules for protection have yet to be announced. A proposal in the HM Treasury release suggests that individuals would be able to retain benefits in excess of the £1.5m and within the £1.8m limit, provided they did not contribute any further payments into a DC Pension Scheme (such as a PPP or SIPP), and also do not accrue any further benefits within a DB Pension Scheme.

If this were to be the case, members of the NHS Pension Scheme, who have benefits in excess of the £1.5m as at the 14th October 2010, would have to opt out of the NHS Pension Scheme if they wish to avoid an LTA excess charge, which is currently 55% if the excess was taken as a lump sum, and 25% if the excess was taken as a taxable pension income.

The introduction of the reduced LTA is being deferred until the 2012/13 tax year, to allow further consultation before the exact rules regarding transitional protection are put in place.

Summary

A reduced AA of £50,000 p.a. will take effect from 6th April 2011.

Full tax relief (up to 50%) will be available on contributions up to the AA.

Contributions above the AA subject to income tax at marginal rates.

LTA reduced to £1.5m from 6th April 2012.

Further consultation of transitional protection for those who exceed the LTA limit at 14 October 2010 (or will do by 6th April 2012).

Whilst the new rules are likely to have an impact on a number of GPs and other medical professional’s pension decisions, and whilst there is still likely to be a degree of complexity around the decisions that will need to be made, at least some of the more complex rules surrounding levels of earnings, tapering of tax rates and two-way age related factors for calculating deemed contributions, have been scrapped.

In addition, many individuals will still be able to make significant pension contributions and receive full tax relief of up to 50% for contributions (or deemed contributions) up to £50,000.

Stephen Caps – Ramsay Brown Financial Services