Millions of high earners face big cuts to their pension tax breaks: what should they do now?
If you are a higher or additional rate taxpayer, then your pension saving is probably about to take a hit. The generous tax breaks on offer look set to be slashed in the next Budget due to be delivered on Wednesday 16 March.
So what's going to change? And what should you do now to make the most of the breaks on offer before they disappear?
Tax relief
One of the suggested changes to pensions tax relief is to bring in a flat rate, rather than the current system where tax relief is determined by your Income Tax band.
Under the current system, your contributions are topped up the Government, with the size of that top up down to your tax bracket. So normal rate taxpayers, who pay 20% Income Tax, will see their contributions increased by 20%. However higher and additional rate taxpayers enjoy top ups of 40% and 45% respectively.
That looks likely to change in March's Budget though, with talk of a flat rate, irrespective of your Income Tax band. The table below shows what top-up higher and additional rate taxpayers are currently eligible for and what relief they would receive under alternative flat-rate schemes:
|
|
40% taxpayer |
45% taxpayer |
||
|
Contribution |
£10,000 |
£40,000 |
£10,000 |
£40,000 |
|
Current tax relief system |
£4,000 |
£16,000 |
£4,500 |
£18,000 |
|
25% flat rate |
£2,500 |
£10,000 |
£2,500 |
£10,000 |
|
Potential loss |
£1,500 |
£6,000 |
£2,000 |
£8,000 |
|
30% flat rate |
£3,000 |
£12,000 |
£3,000 |
£12,000 |
|
Potential loss |
£1,000 |
£4,000 |
£1,500 |
£6,000 |
|
35% flat rate |
£3,500 |
£14,000 |
£3,500 |
£14,000 |
|
Potential loss |
£500 |
£2,000 |
£1,000 |
£4,000 |
Source: Hargreaves Lansdown
The Lifetime Allowance (LTA)
The Lifetime Allowance is how much you can save into your pension pot over your lifetime without paying tax. It is to be reduced from £1.25 million to £1 million from 6 April 2016. What's more, the Government is believed to be considering cutting this still further, down to £750,000.
Obviously, this means that more pension investors will exceed this limit, exposing their excess pension savings to a punitive 55% tax charge. Potentially, this reduction could affect any pension investor, but is a particular worry for high earners and long-serving workers who have already built up substantial pension pots during decades of service.
Workers whose pension savings are already over the £1 million limit on 6 April 2016, or who are worried that they might exceed this limit in future, can apply for their pots to be protected from this tax whammy. For investors who already are close to or over the £1 million threshold, it may make sense to boost pension funding this year, knowing that it may become necessary to suspend further pension funding later.
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The Annual Allowance Taper (AAT)
You can save up to £40,000 into your pension in a year without paying tax. This is the Annual Allowance. However, from April 2016, workers earning over £110,000 will be subject to a taper on their Annual Allowance.
This taper starts when total income exceeds £150,000 and progressively reduces the maximum pension contribution with tax relief to £10,000 for those earning over £210,000. Also, the income test for the taper takes account of unearned income and not just workplace earnings.
So for workers earning over £210,000, a cut in the Annual Allowance from £40,000 to £10,000 means a loss of 45% tax relief on a £30,000 contribution; they lose out on £13,500 of tax relief.
Carry forward
Normally, investors are restricted to an Annual Allowance of £40,000. However, to boost their pension funding in the current year, they can also bring forward unused allowances from previous years. Investors get tax relief on this whole contribution, provided it doesn’t exceed their earnings in the current tax year. This means that the theoretical maximum contribution with full tax relief which could be made this tax year is a whopping £180,000.
If you can afford to do, it makes sense to make the most of this boosted allowance.
Two bites of the Annual Allowance cherry
Even if you have already made sizeable contributions this tax year, you may now have an opportunity to invest more.
As part of a tidying-up of some technical pension rules known as Pension Input Periods (PIPs) in the Budget, the Government announced it was effectively 'resetting' the Annual Allowance for the rest of the tax year. The £40,000 Annual Allowance usually covers a whole tax year, but 2015/16 is a special exception, as you can see from the table below which outlines how much you can contribute:
|
Contributions registered from 6 April to 8 July 2015 |
Current allowance (9 July 2015 to 5 April 2016) |
|
£0 |
£40,000 |
|
£15,000 |
£40,000 |
|
£40,000 |
£40,000 |
|
£60,000* |
£20,000 |
|
£80,000* |
£0 |
Source: Hargreaves Lansdown
* Contributions over £40,000 registered in this period reduce the 'new' £40,000 allowance
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This article has been updated
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