UK: Taxation Of Pensions – Changes In Limits

Last Updated: 18 December 2013
Article by Smith & Williamson

In the Autumn Statement 2012 the Chancellor announced measures related to the taxation of value in and out of registered pension schemes:

  • a reduction to the annual allowance for pension savings from £50,000 to £40,000;
  • a reduction to the lifetime allowance for pension benefits from £1.5m to £1.25m.

Reduction to the annual allowance for 2014/15

The amount of an individual's pension savings which benefits from tax relief is limited to an annual allowance (AA). For 2014/15 the AA is to be reduced from the current £50,000 to £40,000, but it might already have an impact.

Although an individual's tax relief for pension contributions is given in the tax year in which it is paid, for the AA one has to consider the combined value of all pension savings and benefits accruing in respect of each policy's pension input period (PIP) ended in the tax year. This includes employer's contributions and an amount based on the accrual of benefits in defined benefit (final salary) schemes.

A PIP usually covers 12 months but it does not have to match the tax year. It is also likely that the PIP for different schemes will be different.

The reduced AA will apply to pension savings counting towards the AA for 2014/15 onwards, That is, it will first apply to the total of savings made in PIPs that end in the tax year 2014/15.

The value of any pension funding and benefits accruing over the AA is subject to an annual allowance charge, calculated as if the top slice of taxable income.

For a pension scheme with a PIP of 1 May to 30 April a contribution in May 2013 will fall in the PIP ending 30 April 2014 and hence be taken into account in considering the position against the reduced 2014/15 AA figure. It is therefore important to recognise and understand the importance of PIPs.

There is the ability to carry forward and utilise any unused allowance from the previous three tax years. This will continue and the amount of any unused allowances arising from the tax years 2011/12 to 2013/14 carried forward to 2014/15, and subsequent years if applicable, will still be based on the £50,000 limit.

There are a number of planning points to consider in relation to the pension savings:

  • those with income in and just over the high marginal rate bands of £100,000 to £118,880 for 2013/4 (who lose their personal allowance) and £50,000 to £60,000 (where the high income child benefit is in point) making additional pension contributions to reduce their taxable income will result in greater effective tax relief than the headline tax rates suggest;
  • maximise the use of the current £50,000 AA for 2013/4 limit; and
  • utilise any unused AA available for 2013/14 from 2010/11 onwards in 2013/4. Reduction to the lifetime allowance from 6 April 2014

From 2014/15 the lifetime allowance (LTA) for pension savings is to be reduced from £1.5m to £1.25m.

The LTA is the overall maximum value of pension benefits that someone can accumulate in registered pension schemes over their life, with any excess taxed at 55% if taken as a lump sum and 25% in other cases. This concept of a LTA was part of the 'A' Day changes introduced in April 2006. The initial LTA was £1.5m, but this had increased over the years to £1.8m. The LTA was reduced in April 2012 to £1.5m as part of the Coalition Government's restriction to pension benefit tax reliefs.

When the LTA was introduced in 2006, two types of protection were available to be applied for by those with large pension pots.

  • Primary protection – Where the value of pension rights exceeded £1.5m an election could be made for a greater personal LTA based on the value relative to the standard LTA.
  • Enhanced protection – The value of funds within pension schemes would be able to grow and be taken without limit, but with the proviso that active membership ceased in all registered pension schemes and no additional funding was made.

With the reduction to the LTA in April 2012, if someone ceased to accrue benefits in, or fund, any registered pension scheme, and did not have either of the protections mentioned above, an application could be made for 'fixed protection' from the reduction in LTA from that date. Where this applies the individual's pension benefits received continue to be measured against a £1.8m limit until such time as the actual LTA exceeds that amount.

In connection with the proposed reduction in the LTA from 6 April 2014, there is provision for a protection regime to individuals to prevent retrospective taxation. This protection regime will work in a similar manner to that for the reduction in the LTA from £1.8m to £1.5 in April 2012.

Individuals who apply for 'fixed protection 2014', before 6 April 2014, will have a LTA of the greater of £1.5m and the standard LTA (£1.25m from April 2014). Pension contributions would have to cease and scheme accruals capped from 6 April 2014 with any pension savings above £1.5m subject to a LTA charge when benefits are taken.

The Government is also looking to offer an individual protection regime in addition to transitional protection. The suggestion is for a protection to give individuals a LTA of the greater of the value of their pension rights on 5 April 2014 (up to an overall maximum of £1.5m) and the standard lifetime allowance (£1.25m from April 2014). However unlike fixed protection, individuals with this individual protection would be able to carry on saving in their pension scheme, without loss of protection, so as to make up any underperformance in growth.

It is likely that individual protection will only be available to those with pension pots over £1.25m on 5 April 2014 and will probably be dealt with in a similar manner as for Primary Protection on the 'A' Day transition in 2006.

We have taken care to ensure the accuracy of this publication, which is based on material in the public domain at the time of issue. However, the publication is written in general terms for information purposes only and in no way constitutes specific advice. You are strongly recommended to seek specific advice before taking any action in relation to the matters referred to in this publication. No responsibility can be taken for any errors contained in the publication or for any loss arising from action taken or refrained from on the basis of this publication or its contents. © Smith & Williamson Holdings Limited 2013

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