Mailings

Thursday 1 April 2010

Budget 2010 Tax relief on pension contributions for high earners

The Chancellor's Budget on the 24th March confirmed the Treasury's proposals to amend tax relief on pension contributions for "high earners" again from the 6th April 2011.

This is a simplified explanation of the new regime which will be known as the High Income Excess Relief Charge. It will replace the current system and there will be no £20,000 Special Annual Allowance Tax Charge, protected pension inputs or Increased Special Annual Allowance.

Where:

Total income plus gifts to charity and personal pension contributions is £30,000 or £130,000 or more

AND

Total income plus gifts to charity and personal pension contributions and employer pension contributions and salary sacrifice arrangements is £150,000 or more

THEN

Tax relief on contributions will be tapered for those with income between £150,000 and £180,000 so it is reduced to 20% for those earning £180,000 or more

Please note therefore that the calculation of income for the purposes of the regulations will change from the current regime.

The High Income Excess Relief Charge works by restricting tax relief so that for those with earnings of £180,000 or more it is reduced to 20%, and between £150,000 and £179,999 it reduces the appropriate rates by 1% for each £1,000 of gross income above £150,000.

The actual calculation involves determining how much of a contribution falls into the 50% income tax band and how much falls into the 40% higher rate band.

Examples of the way the tax relief works for those with income between £150,000 and £180,000 can be given:

Assume that an individual contribution of £40,000 is made and the income is gross income.

1. Total income £175,000

• In the absence of the restriction, they would receive 50% tax relief on £25,000 (excess over and above £150,000) and 40% tax relief on £15,000.
• As a result of the restriction, they receive 25% (50% - [25 x 1]%) tax relief on £25,000 and 25% tax relief on £15,000.

2. Total income £170,000

• In the absence of the restriction, they would receive 50% tax relief on £20,000 (excess over and above £150,000) and 40% tax relief on £20,000.
• As a result of the restriction, they receive 30% (50% - [20 x 1]%) tax relief on £20,000 and 30% tax relief on £20,000.

3. Total income £160,000

• In the absence of the restriction, they would receive 50% tax relief on £10,000 (excess over and above £150,000) and 40% tax relief on £30,000.
• As a result of the restriction, they receive 40% (50% - [10 x 1]%) tax relief on £10,000 and 40% tax relief on £30,000.

4. Total income £155,000

• In the absence of the restriction, they would receive 50% tax relief on £5,000 (excess over and above £150,000) and 40% tax relief on £35,000.
• As a result of the restriction, they receive 45% (50% - [5 x 1]%) tax relief on £5,000 and 40% tax relief on £35,000.

Where total income is £180,000 tax relief is restricted to 20% on the full £40,000.

From a calculation viewpoint, for earnings between £150,000 and £179,999 any element of the contribution in the above examples which falls into the 40% income tax band has its tax relief calculated as follows:

40 - (earnings over £150,000 - 10) = percentage tax relief.

So, in example 2 above, the 40% tax relief is reduced to:

40 - (20 - 10) = 30%

Other features of the new regulations need to be mentioned:

• All assessments are on a tax year basis and not based on pension input periods.
• Earnings used for assessment are for the tax year only and not the previous two years as with the current regime.
• For employer contributions, the reduced tax relief is collected by applying a tax charge equal to the reduction in tax relief that would have been granted in the absence of the restriction. For example, in example one above, the individual will pay a tax charge of £8,500. This is achieved through self-assessment.
• For personal contributions, tax relief is simply restricted through self-assessment.
• Final salary accrual will be based on an age related factor rather than the 10:1 factor used for the annual allowance test. Details are not yet available.
• Where someone draws a serious ill health lump sum or dies before drawing their pension, the restriction on tax relief will not apply in that tax year.
• If a tax charge of £15,000 or more is payable based on a company pension contribution, it can either be paid over three years or can be paid from the pension fund.

If you have any queries on these issues, please speak to your usual contact:

The IPS Partnership