Pensions Relief restricted despite the era of auto-enrolment

7 April 2017

Some may find the government’s policy on forcing all employers to provide pension schemes to their eligible employees rather contradictory in comparison with the severe restriction imposed, typically on the self-employed, on how much contribution they can make.  Should Hammond follow his U-turn on Class 4 NICs by being more consistent with relief for pension contributions?

We now have to take into account not one, but from 6 April 2017, potentially three annual caps on making pensions contributions.

For most the annual cap will be £40,000, and they can also use up any excess cap from the previous three years.

However for those fortunate enough to enjoy income above £150k they will find this limit is reduced by £1 for every further £2 of income above that limit, until they reach £210k, thus restricting them to relief on an annual allowance of £10,000 once the upper cap is reached.  Fortunately, in this transitional phase when the annual limits were higher, unused relief brought forward from the three previous years can also be claimed. Accordingly, such individuals should make sure they take the benefit of the brought forward balances before they are measured on the lower annual limit.

This all pre-supposes the individual has not accessed their existing money purchase scheme flexibly.  For individuals who have, (and for more of what that entails see below) the Money Purchase Annual Allowance (MPAA) is £10,000 for 2016/17 (ie the same as above) but significantly reduces to £4,000 for 2017/18.

Money purchase schemes need to be contrasted with direct benefit (DB) schemes particularly because even if individuals access their DB entitlements they are not subject to the MPAA. Whilst it may be possible to phase the drawing of DB rights, any DB rights will only deliver a lump sum and income for life, which is not flexible access.

So how does the MPAA impact upon auto-enrolment? Some individuals enrolled into more generous employer schemes may face an MPAA charge, even if they are only on modest income.  Whilst the average private sector employee/employer contribution rate is around 4%, by 2019 the required contribution will have risen to 8%, so individuals with pensionable earnings above £50k will be impacted.  Nevertheless the government has been keen to encourage higher contributions than the statutory minimum and some schemes have been set up to meet the Pensions Quality mark (PQM) with contributions of 10%, whilst others achieve the PQM Plus standard with 15% contributions.  With the 2017/18 auto-enrolment upper earnings limit set at £45,000, many beneficiaries will find themselves subject to the tax charge.

Whilst the government’s aim of preventing re-cycling is perhaps laudable, this policy will severely affect those with volatile earnings and their ability to catch up on foregone contributions.  What should also be emphasised is that the individual subject to the MPAA will not have the flexibility of using surplus balances brought forward, so is treated far more stringently.  This is all in the name of preventing re-cycling, but the individual may have had little choice than to access his funds flexibly at the time.

Another perceived mischief is employers allowing employees to salary sacrifice for an employer pension contribution and such persons having greater scope to salary sacrifice when they have accessed their pension funds flexibly.  This is regarded as indirect re-cycling and thus in their view justifies applying the MPAA not only to personal schemes, but also those organised by employers.

If you wish to discuss any of the issues brought up in this blog, please contact me or your local UHY tax expert for further guidance and advice. Alternatively, to read more of our tax blogs click here.