Penalties and perks of pensions limit cut

WHEN Alistair Darling last year announced curbs on the tax relief available on high earner pension contributions, a measure affecting a tiny minority of savers sparked outrage in the pensions industry.

Fears over the impact on savings incentives and over the administration costs were, rightly or wrongly, at the heart of the backlash. After more than a year of lobbying the industry got its wish this week when the government announced that instead of cutting tax relief, it would reduce the annual allowance.

But while the move has been welcomed as a simple and effective solution, it will still have implications for some high earners, especially long-serving public sector workers.

Under the new measures, the amount that can be saved into a pension - including tax relief and all individual and employer contributions - will be slashed to 50,000 a year from next April. It is also trimming the lifetime pension savings allowance from 1.8 million to 1.5m from April 2012.

The Treasury claimed the move would affect around 100,000 high earners, although experts believe the real figure could be twice as high.

Chris Massey, head of pensions at PricewaterhouseCoopers Scotland, said: "Many people in Scotland will be relieved that the annual allowance on pensions tax relief has only been reduced to 50,000 as they will be able to continue saving without tax consequences."

Savers who don't use all of their annual allowance will be able to carry it forward to the following three years.

Neil Whyte, tax partner at PKF, said the vast majority of pension savers would be unaffected. "However high earners, middle income earners nearing retirement and those lucky enough to be members of final salary schemes could face additional tax charges or be severely restricted in their options."

Kate Smith, pensions development manager at Aegon in Edinburgh, called on the government to ensure the allowance increases in line with inflation to prevent more people from being caught in the net when their salaries rise. "Without indexation, the value of the annual allowance will gradually be eroded, increasing the risk of more people facing a tax charge. This in turn erodes the value of pension saving."

WINNERS

It's good news for high earners who were set to lose the entitlement to tax relief on pension contributions at their highest marginal rate next year. Under the changes 50 per cent taxpayers will continue to get 50 per cent relief, 40 per cent taxpayers will get 40 per cent relief and so on.Consequently high earners will be able to claim up to 25,000 a year in tax relief on pension contributions.

Tony Baily, at pension consultants Aon Hewitt, said: "The higher than previously proposed annual allowance and a relatively low valuation factor mean that the winners are long-serving, middle-income earners in defined benefit plans, many of whom will now not be affected by the annual allowance.

Andrew Tully, senior pensions policy manager at Standard Life, agreed that the measures were an improvement on the previous plans. "The allowance of 50,000 allows the vast majority of people to save as much as they want, when they want. This change means pensions will continue to be an attractive home for long-term savings."

LOSERS

A pocket of high earners will lose tax allowances as a result of the reduced limit and those caught out could face hefty tax charges. The lifetime allowance will be the biggest concern for many, depending on how the government deals with pensions already above the 1.5m limit. George Bull, head of tax at Baker Tilly, urged the government to protect those with large savings who could be affected by retrospective legislation. Investors who have made contributions based on the current 1.8m limit potentially face a tax rate of 55 per cent if their funds exceed 1.5m.

"The reference in the Treasury statement to a further consultation on using pension funds to pay tax suggests that people with pension arrangements worth more than 1.5m at 6 April 2012 will suffer an unwelcome and potentially heavy tax charge," said Bull.

But the biggest losers will be high earners in final salary schemes. The multiplier by which their benefits are increased is going up from a factor of ten to 16, which effectively means a 1,000 increase in annual final salary benefits would equate to a value of 16,000 in the context of the annual allowance.

Massey at PwC said some final salary scheme members could be hit with up to 185 per cent of tax penalty on pay rises under the new rules.

"For example, an executive earning 150,000 a year with 20 years' service in a final salary pension scheme will face tax of 12,200 on a pay rise of 9,000 - a marginal rate of tax of 135 per cent on the pension increase plus 50 per cent income tax," he explained.