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The power of pension saving

Following previous 'simplification' of pension legislation, the 2009 budget revealed the government’s intention to restrict tax relief on pension contributions for high earners. The key changes and opportunities are discussed in this article, as we consider what’s left in pensions to enjoy.

For the majority of people, pensions play an important role in their overall financial plans and can deliver significant benefits:

• 25% of the pension fund can be taken as a tax-free cash sum at retirement
• virtually tax-free growth of pension investment
• the majority of pension plans during the accumulated period are established in trust, so they do not form part of the estate for IHT purposes
• income tax relief on contributions
• Spouses and (grand) children can take advantage of ‘non-earner’ pensions, investing up to £3,600 per annum with basic rate tax relief at source providing an immediate 25% investment uplift
• there is no longer a requirement to buy an annuity with the pension fund, as there is now the flexibility of drawing an immediate income from it.

For high earners, the benefits of funding a pension plan have generally been more attractive. They typically benefited from the tax relief at their highest marginal rate and, depending on their circumstances; it could be that the pension is taxed at a lesser rate on receipt. This position is changing under the new legislation.

The 2009 Budget – new pension provisions

Following previous 'simplification' of pension legislation, the 2009 budget revealed the government’s intention to restrict tax relief on pension contributions for individuals with relevant income in excess of £150,000 from 6 April 2011. Pension tax relief will be tapered down until it becomes 20% when income reaches £180,000.

For some high earners, this may raise the question whether it is sensible to make additional pension contributions. If they are already paying 40% income tax, which for some will increase to 50% from April 2010, the prospect of only getting tax relief at 20% on contributions, and then paying tax at 40% on their pensions during retirement, may not be compelling.

Following the Budget, there was a period of consultation/lobbying by the pensions industry and on 21 July The Finance Act received Royal Assent. This has provided further clarification and allows us to clearly set out the changes and opportunities.

The key changes

• Tax relief will be tapered between £150,000 and £180,000, and for ‘relevant’ income over £180,000 the relief will be worth 20%, the same as for a basic taxpayer. Relevant income generally refers to total income chargeable to tax, not just salary.
• Interim anti-forestalling rules will apply between 22 April 2009 and 5 April 2011 to restrict higher rate relief on pension contributions for individuals with relevant income of £150,000 or higher.
• The lifetime allowance for members of registered pension schemes is to be set at £1.8m for 2011-12 to 2015-16. In addition, the annual contributions limit has been set at £255,000 for these years, freezing the amounts at the level previously set for 2010-11. This may affect those with significant pension scheme values, and opportunities exist for individual vesting strategies.

Opportunities

• For the higher earners, the anti-forestalling rules prevent a contribution frenzy of large pension payments prior to the changes taking effect, but contributions of up to £20,000 per annum should continue to attract higher rate tax relief. Most exceeding £20,000 will receive tax relief at the basic rate of 20%.
• For certain irregular saving the annual allowance rises to £30,000.
• From 6 April 2010 anyone earning just over £100,000 per annum will suffer the loss of their basic personal tax allowance on a tapered basis. Pension contributions can offset this loss as 'Adjusted Net Income' is calculated as income less gross pension contributions. This will represent an opportunity for those falling between £100,000 to £149,999 per annum to reduce their 'Adjusted Net Income' to £100,000 by making a pension contribution, gaining higher rate tax relief on the contribution and regaining their full basic personal tax allowance.
• Those nearing or at retirement may wish to consider the method and timing of taking benefits as their pension income may be subject to a higher rate of tax after 6 April 2010.

Review existing arrangements

The new rules are complex and a high net worth individual should review existing pension arrangements taking professional advice, as necessary.

For example, as it may no longer be appropriate to make additional contributions in excess of the £20,000 limit, high earners will need to review their overall financial plan and consider alternative means to fund long term retirement planning.

Taking the right specialist advice, tax led structures such as the Enterprise Investment Scheme (EIS) or Venture Capital Trusts (VCT) might be an alternative option to consider, noting the higher degree of risk and suitability to the individual.

In addition, the new ISA limit of £10,200 per annum provides further scope to shelter savings and investment from tax.

At Coutts, we look at the wider planning opportunities. Whilst pensions continue to offer attractive benefits, we know that some clients choose other options as part of their longer term financial plans with wealth accumulated in investment portfolios, businesses or property. We have a number of financial planning and pension experts dedicated to providing impartial advice.

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