As a part of the 2009 Budget the Chancellor announced some radical changes to the taxation of higher earners. Not only will those with taxable income in excess of £150,000 be subject to new higher rates of Income Tax, those with income close to or above this threshold will also find that the tax reliefs that they have previously enjoyed in respect of contributions to their pension plans will be dramatically restricted. If your current or expected future earnings are at this level you should be familiar with these changes and should factor in their effect when deciding how to provide for your retirement.

How things used to be

Prior to 22nd April 2009 the extent to which you could obtain tax relief for your pension contributions was typically limited by two factors:

1.  a requirement that your annual contributions did not exceed the lower of your relevant earnings for the year and a prescribed      annual allowance, and
2.  a restriction on the size of your overall pension pot, known as the lifetime allowance.

Subject to this, any taxpayer could obtain full relief for their contributions at their marginal rate of tax. For someone whose income was well into the 40% tax band, a cash contribution of £100 would attract a basic rate tax credit of £25 that would be added to the pension, and on top of this the gross contribution of £125 would receive further tax relief via their tax computation. The net result was that an addition of £125 to the pension would cost just £75 – ie. tax relief at 40%.

The 50% tax rate

In his 2009 Budget the Chancellor brought forward and amended earlier proposals such that, with effect from 6th April 2010, taxable income above £150,000 per year will be subject to tax at two new rates – 42.5% for dividend income and 50% for everything else. At the same time, the personal allowance (the amount that any individual can earn before paying tax) is to be subject to a tapered reduction for those earning more than £100,000 such that it disappears totally for those earning more than about £113,000.

These measures were accompanied by a freezing of the annual and lifetime allowances mentioned above plus, crucially, an announcement that tax relief on pension contributions for those earning more than £150,000 per year will be restricted from 6th April 2011.

Where are we now?

It is no surprise that the Treasury moved to prevent higher earners adding significantly to their pension pots before 6th April 2011 by announcing anti-forestalling measures. Affected individuals have a special annual allowance of between £20,000 and £30,000 depending on their contribution history. Quarterly or more frequent contributions to pensions are protected up to 5th April 2011 and continue to attract full tax relief, as do other contributions that do not exceed the special allowance. Unprotected contributions in excess of the allowance, however, are subject to a special tax charge that restricts the relief to the basic rate of 20%. The anti-forestalling provisions are worded such that they catch pension contributions made by an employer as well as those made by the individual.

What happens on 6th April 2011?

From 6th April 2011 there will be no protected contributions and no special allowance. If you have a gross income (earnings plus pension contributions made on your behalf) in excess of £150,000 and income before employer contributions in excess of £130,000, you will be subject to a tapering of the tax relief on your pension contributions. This will mean that for those earning £180,000 or more, tax relief will be reduced to the basic rate figure of 20%. Returning to the example given above, for these individuals the £125 addition to the pension pot will now cost £100 instead of £75 – an increase of one-third.

Is this still going to be an issue after the General Election?

While there is a possibility that this legislation will be reversed if there is a change of government, such a change is likely to be low on the list of priorities given the need to re-balance the public finances. At the time of writing the Conservative Party website reads as follows with regard to the 50% tax rate: “We do not regard the new 50p tax rate as a permanent feature of the tax system, but we could not even think of abolishing the 50p rate on the rich while at the same time asking many of our public sector workers to accept a pay freeze”. There is no mention at all of the restrictions on pension contributions for those earning over £150,000.

What should I do?

While pensions still have tax benefits even with relief restricted to 20% it is clear that higher-rate relief is a key factor for many in deciding how much to contribute.

The big questions are therefore:

1.  Does it still make sense for me to put money into my pension?
2.  If not, what are the alternatives?

The answers will vary from individual to individual. If you are affected you should take advice as to your tax position before exploring other options. Those other options will depend upon your circumstances – in particular, whether you have control or influence over an employer – but might include:

• alternative provision on the part of a company such as an Employer Funded Retirement Benefit Scheme – an EFRBS
• other tax efficient investments such as EIS and VCT schemes 
• for those intending to leave the UK at or before retirement, the transfer of an existing pension pot to a Qualifying Recognised Overseas Pension Scheme (QROPS)

The new rules – particularly the anti-forestalling measures – are very complex and they have necessarily been expressed in simplified terms for the purpose of this Taxflash. If you think you may be affected, you should take appropriate professional advice. At UHY Hacker Young we can evaluate and explain your tax position, talk you through the effects of the changes, advise you on the alternatives and help you or your employer take advantage of these. We are not able to recommend specific investments but our associated IFA business, UHY Financial Planning, can help with this.

If you are concerned about your future pension planning please contact Mark Giddens of our London private client services department or your usual UHY Hacker Young partner.