First Briefing – Resticting Pension Tax Relief


In the “Restricting Pensions Tax Relief, Oct 2010” Briefing we covered the Government’s proposals for changes to the pension tax regime insofar as they were known at that stage. Legislation has now been enacted to effect those changes and this Briefing provides an update on the position and focuses on some of the finer detail.

Restrictions apply on the amount of pension savings made to a registered pension scheme that benefit from tax relief. There are limits on both the annual amount of savings that can be made (the “Annual Allowance”) and the total value of benefits that can be taken over an individual’s lifetime (the “Lifetime Allowance”). For the tax year commencing 6 April 2010, these amounts were £255,000 and £1.8m respectively.

What has changed?

With effect from 6 April 2011, the Government has reduced the Annual Allowance (the “AA”) from £255,000 to £50,000. Individuals whose pension savings are below this limit will continue to benefit from tax relief at their marginal rate on all the pension contributions they make. Individuals whose pension savings breach this limit will be subject to a tax charge, which effectively claws back tax relief granted on the pension savings in excess of the AA.

The Lifetime Allowance (the “LTA”) is also being reduced from £1.8m to £1.5m, although this change isn’t taking place until April 2012. This has given the Government time to design a protection regime for those who already had pension benefits in excess of £1.5m when the changes were announced or who were hoping to build up pension benefits in excess of that level.

Will the allowances be increased each year?

There is provision in the legislation to enable the Government to change both the AA and the LTA in future. However, the Government has not committed to doing so. Even if they do, in the case of the AA, there is no guarantee that it will be increased.

Are there any other changes to the way in which the Allowances will operate?

With the exception of the reduction in the level, the Government has kept the operation of the LTA largely unchanged. From April 2012, however, the trivial commutation limit is being de-linked from the LTA, so that it will no longer be set as 1% of the LTA. It will instead be a flat amount of £18,000. Again, there is provision in the legislation for the Government to change this amount in the future should they wish to do so.

There have however, been a number of changes made to the way in which the AA operates, explored below.

Over what period does the Annual Allowance apply?

The AA applies over the tax year. However, the period over which schemes measure the increase in pension benefits is known as the Pension Input Period (“PIP”). This may be different to the tax year. For an individual, the total pension savings made over all PIPs ending in a tax year are assessed against the AA applying in that year.

What is the Pension Input Period?

The rules surrounding PIPs are complicated and different schemes can (and will) have different PIPs. Indeed, different members within the same scheme may have different PIPs. The PIP that applies for each individual will depend on when the individual started accruing benefits under the arrangement and whether or not a nomination has been made to change the PIP from the default.

How is the amount of pension savings calculated?

Defined Contribution arrangements

For Defined Contribution (“DC”) arrangements, the amount of pension savings is the total pension contributions made by the individual and their employer to the DC arrangement during the PIP. If an individual has more than one DC arrangement, the total contributions made to all those arrangements with a PIP ending in the tax year need to be combined and compared against the AA. This is no different to how DC pension savings were valued before 6 April 2011.

Defined Benefit arrangements

For Defined Benefit (“DB”) schemes, it is less straightforward. The contributions paid into the scheme are not relevant for the purpose of carrying out the test against the AA; it is the increase in the value of the benefit over the PIP that is important.

Previously, for active members, the increase in the value of the benefit for the purpose of the AA test was calculated by determining the difference between the benefit the member would have received had they become entitled to payment of it at the end of the PIP and the benefit the member would have received had they become entitled to payment of it at the start of the PIP. This difference was then multiplied by a factor of 10. For deferred members, the benefit at the start of the PIP was adjusted for revaluation before the calculation was undertaken.

With effect from 6 April 2011, the increase over the PIP in the benefit the member would have received makes allowance for the benefit at the start of the PIP to be revalued to the end of the PIP in line with the increase in the Consumer Prices Index (“CPI”). In addition, the factor has changed from 10 to 16.

Where the change in the value of the accrued benefits is negative, this is set to zero. In other words, the member is deemed to have not made any further pension savings over that PIP.

Can unused AA be carried forward?

Whether an individual will incur a tax charge for breaching the AA in a particular year will depend on whether they have any unused AA from previous years. Unused AA from up to three previous tax years may be “carried forward” and offset against excess pension savings made in a particular year. For the purpose of the carry forward calculations, the AA is assumed to be £50,000 in each of the previous tax years.

What about those individuals whose PIP for 2011/12 started before the changes were announced?

Transitional protection applies for anyone whose PIP(s) started before 14 October 2010 (the date on which the Government first announced that changes to the pensions’ tax regime would be taking place), where the PIP ends (or has ended) in the 2011/12 tax year, and where the pension savings made exceed £50,000.

What are the charges that will be incurred for breaching the AA?

Where a member does incur a tax charge, the amount will depend upon the rate of tax relief that the member received on the pension savings. The charge will be tailored in order to recoup the full marginal rate of relief that the individual initially benefitted from when the pension savings were made.

What will happen if an individual cannot afford to pay the tax charge?

An individual can only pay the tax charge from their pension savings, rather than income, where the charge exceeds £2,000. Schemes will only have to offer members the option of paying their tax charge from their pension savings where the member has breached the AA limit outright in that scheme.

Next steps

Now that the main legislation has been finalised, the Government has issued draft regulations to ensure that vehicles like Employee Benefit Trusts and Funded Employer-Financed Retirement Benefit Schemes can not be used to make excess pension savings and avoid incurring tax charges.

HMRC issued draft guidance when the changes were first announced back in October 2010 and have stated that they hope to have updated the guidance to reflect the final legislation by late September, although at the time of writing, this is still outstanding.

Further information

For further information on pension tax relief and the AA test, including:

  • The LTA protection regime
  • Which members are exempt
  • How increases in accrued pensions are determined upon early and late retirement
  • How AVCs are valued
  • Transitional protection

please see our full First Briefing:

“Restricting Pension Tax Relief, October 2011”

This can be found along with past briefings on our website. Alternatively for further information please contact us.


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