Significant changes to pension rules take effect from 6 April 2016, such as a reduction to the Lifetime Allowance and new Annual Allowance rules, and further announcements are expected in the March Budget.
This article is a summary of the changes and aims to serve as a useful reference point that you can relate to your own situation.
What are the changes to the pension rules?
i) Lifetime allowance reduction
The Budget on 18 March 2015 announced that there will be a further reduction (with effect from 6 April 2016) in the lifetime allowance from GBP1.25 million to GBP1 million.
Pension rights are tested against the lifetime allowance when a benefit crystallisation event occurs. Any excess above the lifetime allowance is subject to a lifetime allowance charge of 55 per cent, if the excess is to be taken as capital or 25 per cent if the excess is to be taken as income (plus PAYE income tax on the resultant income).
Individuals will have the opportunity to apply for fixed and individual protection (not available to those with primary or enhanced protection).
Fixed Protection (2016)
- Provides a protected lifetime allowance of GBP1.25 million
- Pension contributions/accrual must cease by 5 April 2016 (limited types of accrual within Defined Benefit pensions is permitted; ie CPI (Consumer Price Index) or as defined in the scheme rules as at 9 December 2015)
Individual Protection (2016)
- Available to those with pension rights valued at GBP1 million or more as at 5 April 2016
- Provides a Personal Lifetime Allowance which will be the value of pension savings as at 5 April 2016 up to a maximum of GBP1.25 million
- Pension contributions/accrual may continue
When can you apply for fixed or individual protection?
HM Revenue and Customs have confirmed that the online forms to apply for both Fixed and Individual Protection 2016 will not be available until July 2016. The value of pension rights to be noted on the forms will be as at 5 April 2016.
Pension funds below GBP1 million
For those with less than GBP1 million in accrued pension benefits, there is a choice to be made:
- No protection; or
- Fixed protection 2016. For those who do not benefit from employer pension contributions, the points to consider are the time to retirement and the likely increase in value of the pension fund
The following table shows the growth rate and number of years required for the current value of a pension pot that will grow to GBP1 million over various terms to retirement, given different growth rates (and assuming no contributions):
For individuals with pension rights of between GBP1 million and GBP1.25 million (as at 5 April 2016) they have the option of applying for both Fixed Protection and Individual Protection – Fixed Protection being lost if any contributions are made after 5 April 2016. The proximity to retirement (vesting of the pension funds) will make the consequences easier to understand.
For those who receive employer contributions into their pension schemes, the choice will be between stopping contributions (and possibly receiving alternative benefits), or continuing with contributions having considered the tax costs of doing so given the new annual allowance rules from 6 April 2016 (see below).
Individual circumstances will differ and advice should be sought from your pension adviser regarding your specific situation.
ii) New annual allowance rules from 6 April 2016
From 6 April 2016 the annual allowance (GBP40,000) is to be reduced for those with total income (including pension employer and employee/individual contributions) in excess of GBP150,000 per annum. For every GBP2 of income above GBP150,000, GBP1 of annual allowance is withdrawn down to a minimum annual allowance of GBP10,000. So, for those with income of GBP210,000 or over (including personal and employer pension contributions), their annual allowance will be GBP10,000.
Contributions made in excess of an individual’s adjusted annual allowance will be subject to the annual allowance charge. This is the amount of the pension contribution that is in excess of the adjusted annual allowance, added to the individuals other income for the tax year in question and charged to income tax at the individual’s marginal rate.
For example; if you are a 45 per cent taxpayer and the excess (as defined above) is, say GBP100,000, the annual allowance charge will be GBP45,000.
Affected individuals may wish to consider maximum funding their pensions before 6 April 2016. This could include using the carry forward of unused annual allowance from previous tax years. Please note that this assumes that there is both sufficient headroom against the lifetime allowance and sufficient relevant earnings. The fixed protection option will then need to be considered.
Carry forward of unused annual allowance
As a result of the new annual allowance rules, there is a last remaining opportunity to use the Carry Forward Rules potentially allowing a large pension contribution before 6 April 2016. Going forward, the ability to use the carry forward rules will remain but only using the reduced annual allowance.
Once an individual has fully funded the current year's annual allowance, they may carry forward any unused allowance from up to the previous three years as long as they were a member of a UK registered pension scheme in those years. Employer contributions also use up previously unused annual allowances.
The maximum possible contribution that could be made before 5 April 2016 would be GBP180,000 gross, calculated as GBP50,000 for tax years 2012/13 and 2013/14, with a further GBP40,000 allowance for tax years 2014/15 and 2015/16 (this does not include any possible extra contributions also possible as a result of the alignment of (Pension Input Periods - see below).
Personal contributions paid in any one year, including any relating to carried forward allowance, may still not exceed 100 per cent UK relevant earnings in the year of payment for tax relief purposes.
Traditional rules regarding the alignment of Pension Input Periods (PIPs)
8 July 2015 (Summer budget): announced that from 6 April 2016, all PIPs would be aligned to the tax year. Some complex transitional rules for the remainder of the 2015/16 tax year were required in order to achieve this alignment.
8 July 2015: all PIPs were closed
9 July 2015 - 5 April 2016 (the post alignment PIP): For pension input purposes, the tax year has essentially been split into 2 mini tax years, as follows:
6 April 2015 to 8 July 2015:
Annual Allowance: increased to GBP80,000
9 July 2015 to 5 April 2016::
Pension savings: initially have a nil Annual Allowance, but a maximum of GBP40,000 from the GBP80,000 Annual Allowance that remained unused at 9th July 2015 can be added on to this, giving a total possible pension input amount of GBP40,000 for the post-alignment PIP
So, in addition to using the carry forward rules there is another one-off opportunity for clients to fund more than GBP40,000 in the Tax Year 2015/16 depending upon whether they have made any pension contributions in PIPs ending between 6 April 2015 and 8 July 2015. However, individuals should still remember that their contributions in any given year (including any ‘carried forward’) cannot exceed their ‘relevant UK earnings’ for that period.
There are many issues to consider given the most recent changes to the pension rules – as noted earlier further changes are expected in the March Budget. Therefore it is vital that you speak to your usual pension advisers as soon as possible in order to ensure that you make the right election.
Our Strategic Financial Planning Team can work with you on a range of planning areas from Investment Structuring and Business Exits to Estate Planning and Family Governance.
Why not contact your Relationship Manager to arrange a meeting with one of the team?