Paul Leatherbarrow, Liverpool
Background
The Chancellor announced in last year’s Budget on 22 April 2009, that too much of the tax relief given on pensions was going to a relatively small number of high earners. He outlined the Government’s plans to remove this ‘unfairness’ by restricting the higher rate tax relief available to high earners with effect from 6 April 2011.
If he had left it at that there would have been a mad rush by high earners to pay large amounts into pensions whilst they could take advantage of the pre-2011 rules. This is why on the same day as the announcement the Chancellor introduced rules to avoid a mad rush. He did this by introducing the ‘anti-forestalling’ rules with immediate effect.
The rules originally caught individuals with ‘relevant income’ of £150,000 or more. These rules were made more complicated in December 2009 with a reduction in the relevant income threshold to £130,000. Since then we have had further legislation introduced piecemeal to amend certain anomalies. Legislation like this is complicated enough but when it is layered two or three times it becomes even more complicated. So it is not surprising that Advisers are finding it difficult to advise clients in this area. In this article we try to clarify the issues and take you through an easier to understand process which should enable you to advise the vast majority of your clients without having to refer to pension specialists.
The process
• You need to find out if you are caught under the ‘anti-forestalling’ rules
• Next To see if anything can be done to get them out of it
• If you are still caught ,the next action is to see what contribution history you have, with a view of establishing a ‘protected
pension input amount’. This is the amount you can pay without being liable for a special annual allowance tax charge
• If you are caught and have no contribution history, you will have a higher rate tax relief restricted. And you will get higher rate tax relief on the first £20,000 personal contribution but only effectively basic rate relief on any in excess of that.
Find out if you are affected by anti-forestalling
Only individuals who have ‘relevant income’ of £130,000 or more in the current tax year or in any of the previous two tax years will be affected. So if you are affected you will need to calculate your ‘relevant income’ as detailed below for the current tax year and then repeat the process for the previous two tax years. Add income from the following sources:
• Earnings from employment
• Earnings from self-employment / partnership
• Pensions in payment
• Dividends received
• Interest on savings
• Rental income
• Income from trusts.
Deduct
• Up to £20,000 of relievable pension contributions paid by the client
• Any charitable donations including gift aid.
Add
• Any salary sacrifice set up after 21 April 2009 if caught under the rules because of the £150,000 ‘relevant income’ threshold and
• Any salary sacrifice set up after 8 December 2009 if caught under the rules because of the £130,000 ‘relevant income’ threshold.
This is all you need to do to calculate ‘relevant income’ for the vast majority.
If you have more complex financial affairs then you will also need to see what other reliefs are available . For example
You may have complicated business interests and be able to claim one or more of a variety of loss reliefs. These are listed under section 24 of the Income Tax Act 2007.
After having followed this process for the current and previous two tax years you will fall into one of two categories:-
1. If ‘relevant income’ calculated is under £130,000 for each of the three tax years you will not be affected by the ‘anti-forestalling’ rules. This means you can continue pension planning under the ‘normal’ pension rules.
2. If ‘relevant income’ calculated is £130,000 or more for any of the three tax years you are caught under the ‘anti-forestalling’ rules. This means that you will be restricted on the amount of pension contribution you can make and still benefit from higher rate tax relief.
Pension planning you can carry out if you fall into the second category
Even clients caught under anti-forestalling will get tax relief at their marginal rates on a personal contribution of up to 100% of their relevant UK earnings under the ‘normal’ pension rules.However, if your pension input amount exceeds the greater of:-
1. the special annual allowance (SAA)
2. enhanced SAA or
3. Your protected pension input amount,
You will be liable for a SAA tax charge on the excess. This will mean that you will receive effectively basic rate tax relief on the excess.
The next stage is for you to calculate what these elements are:-
1. The SAA is set at £20,000
2. The enhanced SAA is the average of the irregular contributions paid by, or in respect of, the client in the previous three tax years and is capped at £30,000. For this you need to add all irregular contributions paid by the client and/or his employer in the previous three tax years and divide by three. You must divide by three even if irregular contributions were paid in only one or two years.
3. The protected pension input amount is the regular contribution (defined as paid quarterly or more frequently) that was in place when the member was first caught under the ‘anti-forestalling’ rules. This means regulars in place on 21 April 2009 if caught under the £150,000 threshold or in place on 8 December 2009 if caught under the £130,000 threshold. For this element you need to include benefits accrued in Defined Benefit (Final salary) schemes for the tax year. This highlights an important point which is sometimes misunderstood. Even if the excess contribution is paid by an employer it is
always the member who is liable for the SAA tax charge. Higher rate tax relief will be claimed in one part of the self-assessment form and the SAA tax charge is paid in another part of the same self-assessment form. The self-assessment forms for 2009/2010 and 2010/2011 will have the new sections added for the SAA tax charge.
For Defined Benefit schemes you can calculate the pension input amount as follows:
• Calculate the pension benefit accrued at the beginning of the tax year
• Calculate the pension benefit accrued at the end of the tax year
• Multiply the difference by 10
• If tax-free cash is paid separately you would just add the tax-free cash accrued for the tax year – no need to multiply the tax-free cash amount by 10. The highest of these three elements will represent the amount your client and/or third party and/or their employer can pay, without the client being liable to the SAA tax charge.
Pension planning points
1. Check to see if your relevant income is under £130,000 for the current year and previous two tax years.
2. If it is not, then see if it can be reduced by deducting the relievable pension contributions or charitable donations including gift aid. Often clients give their prepared figures, especially for previous years, without being aware of these possible deductions.
3. If you are not caught for the previous two tax years but looks like getting caught in the current tax year then plan to keep your relevant income to below £130,000 by using the above deductions.
4. If you have been caught by ‘anti-forestalling’ and there is no way around it, then plan on maximising your personal contributions with higher rate tax relief. i.e. use the SAA.
5. If you are are assuming that only contributions with higher rate tax relief are worthwhile. Then consider the advantages of contributions with just effectively basic rate tax relief. They will still get basic rate tax relief, a quarter of the fund back tax-free on vesting benefits, improved death benefits for dependants and increased income benefits in retirement for yourself and your dependants.
6. If you are caught by ‘anti-forestalling’ and are interested in paying further contributions with just effectively basic rate tax relief, find out if your employer is prepared to offer salary exchange with the benefit of employer’s national insurance saving being passed to the client’s pension plan. This is still more tax-effective than the client paying a personal contribution from net income.
The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.
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