Here’s something you might have missed: If you have an income over £150K a year, the amount you can put into a pension will be cut from 2016/2017. In some cases, it will be dramatically cut. While the news that the rules are changing is old (it was announced in 2015’s July Budget), the need to act is becoming more pressing as the days tick by. Why? Because until the new rules come in to play you still have the chance to utilise this year’s more generous allowance.
Where did this come from?
In the July 2015 Budget, the Conservative Government announced an increase in Inheritance Tax Allowance, from £325,000 per person to £500,000. That means married couples and civil partners will be able to leave their beneficiaries assets worth up to £1m, including a family home, without there being any Inheritance Tax to pay. The move was likely designed to address the increasing mismatch between unchanged inheritance tax levels and rising house values, but it also suggests that the Government is now thinking that tax relief is being directed at the wrong people. After all, with a pension, the more you earn, the more tax relief you get, which puts low earners at a big disadvantage.
What is pension tax relief?
Good question. You know us so well! In short, if you pay into a pension, you automatically get 20% tax relief from the Government. So, if you put £80 in yourself, then £100 actually goes in. If you’re a higher rate tax payer, you can claim an additional 20%, meaning you would only need to add £60 to get £100 in total, while a top-rate taxpayer only needs to put in £55 to see their pension balance increase by £100.
In addition to that, there are annual and lifetime limits on how much tax relief your contributions are eligible for. In this tax year (2015/2016) you can get tax relief on contributions up to £40,000 or up to 100% of your earnings, whichever is the lower number. The lifetime allowance is also £1.25m, meaning that if you pay more into your pension than that, it will be subject to income tax at the highest rate you pay.
And this is where we have the crucial changes.
First, the lifetime allowance is reducing to £1m from April 2016, meaning that income tax will start having an impact at a much lower level than before. Second, for every £2 of income you receive over £150,000, your annual allowance (which is currently £40,000) will be reduced by £1. Confused? Let’s look at a few examples.
If you earn £150,000, your annual allowance will remain at £40,000. If you earn more than that, your annual allowance will gradually decrease. Earn £180,000? Your new allowance will be £25,000. Earn £210,000? Your new allowance is just £10,000. If you earn more than £210,000, the £10,000 remains – it doesn’t get any lower than that.
It gets a little more complicated here as factors such as the value of any employer contributions affect how your income is classified. This is one of those areas where it’s useful to get advice based on your individual circumstances.
It’s time to act
So, if you’re a high earner, you’ve got two things to consider. First, there is still time to make the most of the existing limits, meaning that you could still pay in the full £40,000 allowance this year. You may even be able to use any unused annual allowance from the previous three years. There’s a few conditions on taking this route though – you must have earned the amount of money you wish to contribute in that same tax year, and you must have been a member of a UK registered pension scheme in the tax year that you wish to use the allowance of, even if you didn’t pay anything into the fund.
Speaking of conditions, keep in mind that one of the quirks of this new ruling is that it doesn’t take into consideration the current size of your pension pot. If you’ve only got a few thousand stashed away, despite earning over £210,000 a year, then your allowance will be exactly the same as the person who earns the same but already has £250,000 in their pension fund. If you’ve got a small amount in your pension at the moment, this creates even more urgency.
Second, this change may mean that now is the time to start looking at other options to improve your tax efficiency away from pensions, as you may decide they have a smaller role to play in your retirement planning.
Well, what we’ve seen here is clearly a levelling of the playing field when it comes to tax. That field, however, still seems to be tilted in the favour of the people who earn the most, and all the signs point to the Government continuing the levelling off with the three rates of tax relief being combined into one – most likely 33% – meaning that everyone has the same incentive to save for their future. Put £67 in and the Government will boost that to £100, no matter how much you earn or how big your current pot is.
It’s something we’re expecting to see in the Autumn statement on 25th November, so if you’re considering changing your retirement planning, it’s another thing to have on your radar.
As always, if you’d like to talk about any of these changes, we’re just a phone call away.
This article is for general use only and is not intended to address your particular requirements. It should not be relied upon in its entirety and shall not be deemed to be or constitute advice.
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