Pensions – some nasty traps!

Birmingham chartered accountants and business advisers Friend Partnership give important advice on pensions.

Urgent advice may be needed so read on…

With all the recent changes to the tax treatment of pension contributions, planning in this area has become much more of a minefield than ever it was.

Individuals are understandably concerned about what might happen in the Budget on 16 March. A good number are considering what actions they may need to take prior to the Budget or the tax year end in light of some of the ‘scare’ stories in the press.

Whilst looking forward is to be commended some taxpayers are finding that there are some inherent problems with the pension planning they may have in place already. So it pays to be sure you understand your present pension position.

The existing rules are well known:

• An annual allowance of £40,000 per pension input period – a year typically. Note that PIPs are aligned with the tax year for 6th April 2016 onwards; and
• A lifetime allowance of £1 million from 6 April 2016.

The potential pitfalls and planning opportunities are perhaps not as well known.

If the annual allowance is exceeded in any particular year a tax charge will arise. Remember that for those taxpayers with long established pension arrangements any unused capacity in the previous three years can be taken into account in a later year with any excess over the £40,000 taken from the earliest of the previous three years.

There is also a ‘bonus’ in the current tax year in that if a taxpayer has already used up the £40,000 at the start of the year – i.e. before 8th July 2015 – they can still make a contribution of £40,000 before 6th April 2016. This is as a result of the alignment of the PIPs with the tax year.

Remember also that the £40,000 annual allowance will be reduced for high earners with a £1 reduction for every £2 of ‘adjusted income’ above £150,000 until the lower contribution limit of £10,000 is reached when the adjusted income level is £210,000. Note here that ‘adjusted income’ is total gross income from all sources with the addition of employer’s pension contributions.

The above rules can give considerable contribution potential in the current tax year. However, note that there may be a further restriction depending on whether the contributions are personal or company. Personal contributions are limited to the taxpayer’s ‘net relevant earnings’ in the particular year. Company contributions are not restricted by reference to earnings. However, company contributions must meet the ‘wholly and exclusively’ test to be deductible for corporation tax purposes.

For those individuals in final salary schemes great care is needed and immediate advice should be sought if none has been taken already! The calculations which determine whether or not the annual and lifetime allowances have been exceeded for final salary scheme members are complicated and can potentially lead to some very material tax liabilities which may have to be funded out of post tax income rather than being set against the pension fund itself. This latter course of action will obviously reduce the pension fund and thus future pension entitlements.

This final salary issue is particularly relevant for those taxpayers with NHS pensions. A modest increase in salary can have a dramatic effect on the calculation of excess charges.

If you have a finally salary pension scheme and have not already taken advice then you should do so urgently.

There is no doubt that we will see further changes to the pensions regime in the forthcoming Budget.

The change which seems to be the favourite within the industry is a restriction of tax relief on pension contributions to a flat rate with that flat rate yet to be determined. It seems unlikely that the Chancellor will change the 25% tax free lump sum rules for existing funds but he may do so for future contributions. The suggestion of a ‘pension ISA’ would be a fundamental change to the pension framework which would take a number of years to implement and bed-in.

The pensions regime is now tremendously complicated and there are plenty of examples of instances of individual taxpayers being faced with unexpected tax liabilities which in some cases have been very difficult to settle.

I have no doubt that securing appropriate advice is advisable if only to ensure that any tax liabilities are not totally unexpected.

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