How to prepare for next April's pensions tax changes

The end of the tax year might seem a while away, but for those with large pension pots or high earners there is little time to think about how to maximise pension contributions.

In July this year George Osbourne announced his fourth change in six years to the amount spent on pension relief. To be clear it has been cut; showing just how irresistible pensions have become to the Chancellor. And there could be even more substantial upheaval to come…

In a nutshell, the following changes were announced:

A reduction in the Annual Allowance for those earning over ￡150,000 from 6 April 2016.

Pension Input Periods (the time period over which pension savings are measured for comparison with the Annual Allowance) will be aligned with the tax year for all pension schemes from 6 April 2016.

There are transitional arrangements to ensure that there’s no retrospective taxation when Pension Input Periods are brought into line with the tax year.

And we mustn’t forget the reduction in the Lifetime Allowance to ￡1m from April 2016 that was announced in the March 2015 Budget. There will be new Individual and Fixed Protections for those impacted.

In summary of the above changes, if you don’t do something about this before next April, your employees could end up paying more tax.

What does all this mean for individuals?

To state the obvious, from 2016 high earners will be able to save less within pension arrangements.

Although ￡1m is well out of reach for the vast majority of people, there are some who wouldn’t consider themselves fat cats being drawn into the Lifetime Allowance net. For example, someone retiring from a generous defined benefit scheme on two thirds of final salary would only need to be earning ￡75,000 to hit the ￡1m Lifetime Allowance. There may be difficult decisions for some people to make about opting out of their pension scheme at this stage in order to avail themselves of the new Fixed Protection.

The reach of the Annual Allowance reduction is a bit narrower, only affecting those with earnings above ￡150,000, but for those caught the impact could be dramatic – a 75% reduction in the Annual Allowance for those earning above ￡210,000. This will mean a complete rethink of retirement savings plans for some, and employers will need to reassess what pension benefits they provide for their most senior employees.

A problem with the new rules is that the Annual Allowance for high earners can only be determined at the end of the tax year in which the savings are being made. This makes planning difficult. Where taxable earnings are clearly above ￡210,000, an individual will know their Annual Allowance is going to be ￡10,000. But for others, due to the tapering arrangement, it will be impossible to know in advance how much can be contributed.

The silver lining for those wanting to maximise their pension contributions is that most people will have extra scope to make contributions in the 2015/16 tax year. As an example, if the Pension Input Period was already tax years, someone planning to contribute ￡40,000 over the year might already have paid in ￡10,000 at the Budget date. This will be measured against the ￡80,000 transitional Annual Allowance, with the maximum amount of ￡40,000 being carried forward to use in the 9 July 2015 to 5 April 2016 period. So contributions can be increased, with ￡50,000 contributed within the Annual Allowance.

What should companies be doing in response?

If you’ve not yet started to think about this, it’s important that you consider the following:

Ensure employees are sufficiently well informed to take advantage of any potential tax advantaged pension saving created by the higher transitional Annual Allowance during the 2015/16 tax year.

Conduct an impact assessment to determine how many employees could be impacted by the reduced Annual Allowance and/or reduced Lifetime Allowance.

Explore the possible options for mitigating the adverse tax impact for those affected. For example, many companies are offering alternative remuneration to those senior employees for whom pension contributions no longer make sense.

Communicate with affected employees about the changes and the choices they need to make. As a minimum, companies are typically providing written communications and decision trees, but some are also providing webinars, individual support and online modelling tools.

What next for pensions?

Arguably the biggest Budget bombshell (as yet unexploded) from a pensions perspective was the announcement of a consultation on the future of pensions tax, with the Chancellor indicating that he was open to a complete overhaul of pensions taxation (perhaps with no upfront tax relief). Overturning principles of pensions taxation that have been in place for generations could have a profound impact on costs for employers, on how individuals save and spend, and on investment markets … Watch this space.

Comment

Senior Management and high earners will do well to discuss their affairs with an Independent Financial Adviser as well as discussing options with their employers.

The possible elimination of tax relief on pension contributions will leave us all asking the question. How will our income be treated in retirement? Will this mean we will have more disposable income in our retirement? Cynically, I very much doubt it.