The Treasury has today announced its formal proposals for restricting pensions tax relief from next April.  As expected, it has dropped the previous Government's arrangements which targeted those earning more than £150,000 and has instead announced a significant restruction in the Annual Allowance for pensions tax relief.  However, while we now know all the "core" elements of the new regime, we do not yet have the complete picture.

Annual allowance changes

The annual allowance will be reduced from £255,000 to £50,000 from 6 April 2011.  This applies to everyone, not just high earners.

The method of valuing defined contributions will remain the same: the total of employer and employee contributions to an arrangement, excluding any investment growth.

The method of valuing defined benefits for annual allowance purposes will be a fixed rate multiplier of 16 - as opposed to the current multiplier of 10 - meaning that a £1,000 increase in annual pension benefit is now treated as being worth £16,000, instead of £10,000.  Broadly speaking, annual increases in pension benefits are measured by comparing the value of the pension which would have been payable at the start, and end, of the year.  Deferred members will be exempt, and the government also says that it will include an allowance for revaluation of accrued rights for active members.

In addition, the carve-out from the annual allowance which currently applies in the year in which benefits are taken is to be abolished, although there will be exemptions for serious (terminal) ill-health and death.  There will be further consideration of an exemption for other cases of "major" ill-health.  However the government has rejected calls for further exemptions for redundancy or for members claiming enhanced protection.

There will be a new facility so that where a member does exceed the annual allowance in any given year, unused allowance from up to three previous years will be available to offset against excess pension savings.  It is hoped that this will mitigate the risk of members on lower to moderate incomes being caught by one-off "spikes" in accrual.  Carry-forward will be available against an assumed annual allowance of £50,000 for the tax years 2008/09, 2009/10 and 2010/11.

Any benefits above the annual allowance would not be taxed at a fixed rate, but a rate tailored in order to recoup the full marginal rate income tax relief that a member has benefited from.

Lifetime allowance changes

The new annual allowance is actually slightly higher than had been expected, due in part to a proposal to reduce the lifetime allowance.  The lifetime allowance is the maximum level of benefits that a member can draw from all registered pension schemes without incurring penal tax charges, currently set at £1.8 million.  This is to be reduced to £1.5million.  However, the Government is minded to do this only from 6 April 2012, recognising that before then it needs to consider ways of protecting individuals who have already made saving decisions based on the higher existing level.

Helpfully, the "trivial commutation lump sum" will be de-linked from the lifetime allowance so that the maximum will remain £18,000, rather than fall to £15,000.

What we don't know

The government says that a number of issues apparently merit "further engagement". In practice, this means that we still do not know:

  • whether the exemption for serious (terminal) ill-health might be extended to other ill-health cases;
  • precisely how and when changes to the lifetime allowance will be implemented;
  • in what circumstances members might be allowed to have tax charges deducted from pension, rather than met from their own resources;
  • detail of anti-avoidance measures (the government says it will legislate so that "exceptional increases in the value of a pension in payment designed to avoid the annual allowance should be caught by the pensions tax regime");
  • the detail of promised legislation to ensure that employee benefit trusts and EFRBSs (employer-financed retirement benefit schemes) "are no more attractive than other forms of remuneration";
  • whether rules override provisions will be introduced if needed to let schemes re-design benefits as a result of the changes (for example, in order to "smooth" pensions accrual under the scheme in order to avoid the incidence of one-off spikes in accrual).

As the industry has repeatedly warned, employers, trustees and administrators face something of a race against time to implement the new regime: particularly as the full extent of it will not be known until the end of the year.   For employers who wish to change benefits in light of these changes, rule amendments and employee consultation might be required.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 14/10/2010.