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Impending pension tax changes: what should investors do?

Anyone fortunate enough to be a higher rate or top rate taxpayer is facing the prospect of cuts to their pension tax breaks.

For the one percent of the working population who earn over £150,000, the difference between making a pension contribution this year rather than next could be thousands of pounds of extra government money paid into their pension. Even for the 4.5 million higher rate taxpayers, there are good reasons to act now rather than next year. We have set out below our top tips for retirement saving.

Top tips for pension investors

Check how close you are to the current £1.25 million Lifetime Allowance, look at making extra contributions to beat the impending cut to £1 million. Check your annual allowance for this year; the ‘reset’ on 9 July may give an extra funding opportunity. Get a pension forecast (of all your pensions) so you can see what kind of retirement income you’re currently on track for. Pay as much as you can into your pension this tax year, ideally do it before 25 November. Use Carry Forward if possible to boost this year’s contribution above the £40,000 Annual Allowance. Use Salary or bonus Sacrifice if possible to save National Insurance costs. Check whether you have capital available which could be used to boost pension funding this year.

Talk to your employer, particularly if you might be affected by the Annual Allowance Taper

Consider drawing on other investments this year to fund your pension, then diverting pension contributions to replace those investments next year. If in doubt, pay for advice, depending on your circumstances these can be complicated issues and there’s a lot to take into account. Tom McPhail, Head of Retirement Policy: “The price of pension freedom is fewer tax breaks; some cuts we already know about, others are still being consulted on. For higher earners in particular, it is a case of hoovering up as much tax relief as you can, while you still can and if you’re in any doubt, talk to a financial adviser.”

The Lifetime Allowance (LTA)

The LTA is being reduced from £1.25 million to £1 million from 6 April 2016. This increases the danger that pension investors will exceed the limit; any pension savings over the limit will be subject to a 55 percent tax charge. This potentially affects any pension investor but is likely to be of particular relevance to workers who are closer to retirement and who have already built up substantial pension pots. Any investor whose pension savings are already over the £1 million limit on 6 April, or who is worried that they might exceed this limit in the future can apply for them to be protected from tax. For investors who are close to or already over the £1 million threshold it may make sense to boost pension funding this year. Note that it may subsequently be necessary to suspend any further pension funding thereafter, so it makes sense to look ahead and see how your savings are likely to grow in the years to come. Some investors may also choose to continue membership of a pension even if they exceed the Lifetime Allowance and so will be taxed at 55 percent on the surplus, in order to benefit from continued employer contributions.

Annual Allowance Taper (AAT)

The AAT is specifically targeted at those earning over £150,000. From April 2016 those earning over £110,000 will potentially be subject to a taper on their annual allowance. The taper actually starts when total income exceeds £150,000 and progressively reduces the maximum tax relieved pension contribution to £10,000 for those earning over £210,000. The income test for the taper takes account of investment income, not just workplace earnings.

For someone earning over £210,000, a cut in the Annual Allowance from £40,000 to £10,000 means a loss of 45 percent tax relief on a £30,000 contribution, costing them £13,500 in lost tax relief.

Changes to Pension Tax Relief

The government has been conducting a thorough review of pension taxation and has now announced it will give a full response to this consultation in next year’s Budget. Whilst no one knows for sure, there is widespread expectation of cuts to pension tax breaks, probably focused on reducing the tax relief on contributions (though the tax breaks on investment growth and the retirement lump sum haven’t been ruled out either). Likely changes include a move away from tax relief to a flat rate incentive on contributions of somewhere more than 20 percent but less than 40 percent. There could also be a more general cut to the Annual Allowance from its current level of £40,000.

Carry Forward

Investors are normally restricted to an Annual Allowance of £40,000, however they can also bring forward unused allowances from previous years to boost their pension funding in the current year. They’ll get tax relief on the whole contribution provided it doesn’t exceed their earnings in the current tax year. This means the theoretical maximum contribution which could be made in the current tax year is £180,000.

Synchronising the PIPs: 2 bites at the cherry

If you have already made a contribution this tax year, you may have an opportunity to invest more. As part of a tidying up of some technical pension rules known as Pension Input Periods (or PIPs), in this year’s 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 a new £40,000 allowance effectively runs from 9 July 2015 to 5 April 2016. If you made contributions from 6 April to 8 July 2015, even if you used the full £40,000 allowance, you might be able to invest more now – see the examples below and contact us if you have any questions.

Examples – how much more can you contribute? 

*Anything over £40,000 registered in this period reduces the new £40,000 allowance

Potential impact of a cut in tax relief

The table below illustrates the potential impact on investors, showing what top-up they are currently eligible for and what they would receive under alternative flat rate schemes.

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