Pension planning - pensions changes introduced by the UK's coalition government
The UK coalition government has announced a raft of changes relating to the State pension, workplace pensions and personal pensions. But what does it all mean for you and your clients?
The background to all of this is very straightforward. We have too many people who are not saving enough for their retirements and then living too long afterwards, meaning they become a financial burden on the State.
It would be very easy for the government to ignore this problem. After all, governments have done that in the past, not wanting to force through legislation which, while beneficial in the long term, may not be popular from a political perspective in the short term. However, all that appears to be changing. The current government is using the challenge of tackling the national debt to also instigate long-term pension reform.
State Pension Age increases
The government has announced that the State Pension Age will rise to 66 for men and women from 2020, rather than the previously scheduled date of 2026. This change will be gradually introduced from 2015.
However, while this is a positive step to help the UK’s financial problems, there are concerns that the government is still greatly underestimating increased longevity. It has been suggested that the announced increase doesn’t reflect the real picture of life expectancy, that while the State Pension Age for men will increase by one year in the next decade life expectancy is increasing by at least double that. This may be addressed soon though, as we can expect a further acceleration in the State Pension Age to 67, 68 and possibly beyond in the not-too-distant future.
It is important that clients understand that just because the State Pension Age is increasing it doesn’t necessarily mean they have to retire later. What it does mean is that they may need to give more focus to their retirement planning and to take account of when their State Pension is likely to kick in. For some clients this will necessitate increasing pension and other long-term savings contributions now.
Pension Annual Allowance
The previous Labour government planned to introduce new rules from April 2011, which would have meant reduced initial tax relief for higher earners when they invested into pensions, with those earning over GBP180,000 being restricted to basic rate tax relief on both the contributions they make personally and employer contributions on their behalf.
For a higher earner this could have meant getting 20 per cent initial tax relief on contributions and then, after enduring the restrictions and lack of flexibility of a pension, potentially paying tax at 40 per cent or 50 per cent on the majority of their pension benefits. The best advice for many high earners would have been to stop pension contributions altogether.
Thankfully the coalition government has simplified Labour’s proposals while still aiming to reduce the total amount of pension tax relief by the same GBP4 billion amount each year.
From April 2011, the pension Annual Allowance will reduce from GBP255,000 to GBP50,000; this is the amount that somebody can pay into pensions and still benefit from initial tax relief. Reassuringly, for contributions up to GBP50,000 each year, individuals will still receive tax relief at their marginal rate, so potentially up to 50 per cent.
Financial planning considerations
The new GBP50,000 pension Annual Allowance will be adequate for the vast majority of people. Importantly as initial tax relief will be given at an individual’s marginal rate it will still make sense for nearly everybody to contribute into a pension scheme. With the recent raft of changes, the government had the opportunity to reduce tax relief for higher earners and the fact they haven’t may suggest that existing levels of relief may be retained in the coming years. However, there are no guarantees and high earners should, where they are able, maximise pension contributions now.
There is a particular opportunity for those who are not currently restricted by the complicated set of anti-forestalling rules that the Labour government introduced in the run-up to April 2011. It could be that these people have a long-established regular pattern of pension contributions, for example, and so may be able to invest significantly more than the forthcoming GBP50,000 limit if contributions are made in this tax year. Because of the complex nature of the current pension rules, however, it is sensible for high earners to take professional financial advice before making any significant pension contributions. Getting it wrong could see them facing a major tax bill.
High earners in final salary pension schemes need to be especially careful when the new Annual Allowance comes into force, as the multiplier used to value their benefits has increased. This means that some scheme members could face a potential tax charge following only a fairly modest rise in their salary.
What is clear is that high earners will need to review the impact of the new rules and determine whether their current level of pension contributions is the most appropriate. For some it may mean that they need to consider alternative savings vehicles to replace some of their pension savings.
Carry forward relief
New ‘carry forward’ rules stipulate that if an individual has invested less than an assumed Annual Allowance of GBP50,000 into pensions in the tax years 2008/09, 2009/10 and 2010/11 then any unused amounts can be carried forward and used in addition to the GBP50,000 allowance in 2011/12. In future, unused allowances will automatically be carried forward for up to three years.
The carry forward rules will be particularly useful for individuals whose earnings or payment patterns fluctuate or those where earnings have increased significantly or where ad-hoc bonuses are possible. They will also be advantageous for high earners whose contributions have been restricted to GBP20,000 each year by the current anti-forestalling rules. Again, we would encourage people to maximise pension contributions that will benefit from higher rate tax relief while they can.
The Lifetime Allowance is the overall cap on the size of pension fund savings that individuals are allowed without incurring a pension tax charge.
From April 2012, the Lifetime Allowance will be reduced from GBP1.8 million to GBP1.5 million. This means that higher earners will need to be more vigilant with the scale of their pension accumulation, especially when allowing for investment growth, which could push them above the limit.
Those who have already applied for transitional enhanced or primary protection from 6 April 2006 will continue to benefit from this. Also there is an intention to provide protection to those who may be affected immediately by this reduction.
It is possible that even those who are outside the current protections, but are likely to breach the GBP1.5 million limit in the future, may be able to benefit from new transitional arrangements, but the framework for this is subject to further consultation. To qualify it is likely that no further pension contributions or accrual will be permitted.
The current Lifetime Allowance tax charges of 55 per cent for lump sums and 25 per cent for pension payments will continue to apply.
Pension input period
The pension input period is the period of time that is used to measure the value of contributions paid and to calculate if an Annual Allowance charge is due. This doesn’t have to be the same as a tax year and it is possible to change the dates. Individuals may have several different pension arrangements over one or more registered pension schemes and it is possible that these may all have different input periods because they commenced at different times.
Some investors have pension input periods ending in the 2011/12 tax year, which will be subject to the reduced Annual Allowance. To cater for this transitional protection has been put in place for contributions made, or deemed to have been made, prior to 14 October 2010 and for these cases the Annual Allowance of GBP255,000 will apply. However, contributions made after this date may be subject to the reduced GBP50,000 Annual Allowance.
Anyone who makes regular pension contributions in excess of GBP50,000 each year should check with their pension provider when their pension input period ends to ensure that their contributions will not exceed the new limit.
The previous government had over-complicated the pension regulations and I am pleased that the new proposals are easier to understand and much easier to administer.
For the vast majority of people an Annual Allowance of GBP50,000 and a Lifetime Allowance of GBP1.5 million will be sufficient scope to save for retirement. The option to carry forward unused tax relief from the previous three years is a generous concession.
However, there are still a number of complexities, particularly concerning transitional rules for higher earners. It is therefore important that individuals review their pension and other retirement planning arrangements. This will allow them to consider the role that pensions should play going forwards and to understand the most tax efficient way to hold their investments. Getting it wrong could prove expensive and as a result many people should take independent financial advice.
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