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 Tax relief on pensions is reduced
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Rank; Hector Tax Inspector

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Posted - 14/10/2010 :  12:24:41  Show Profile Send Jo_B a Private Message
The amount of tax-free income that savers can put into pensions has been sharply restricted by the government.

The annual limit will be reduced from 255,000 to 50,000 in April.

Experts have warned that some people with long service in final-salary pension schemes might face unexpected tax bills.

The Treasury hopes the changes will eventually save it more than 4bn a year - which could be used to reduce the budget deficit.

The lifetime allowance on money that can be built up in a pension fund and receive tax relief has also fallen from 1.8m to 1.5m, but from April 2012.

High earners will continue to be paid tax relief on pension savings at the highest rate at which they pay income tax.

The coalition government began a consultation after the Labour government announced plans to gradually reduce the tax relief available on pension contributions for people earning more than 150,000 to just 20%, despite the fact that these people pay income tax of 50%.

The government said that changing the allowance to 50,000 would affect 100,000 pension savers a year, and 80% of those had incomes of more than 100,000 a year.

The formula for calculating the increase in someone's pension if they are in a defined benefit scheme will also become more aggressive.

The increase in accrued pension will be multiplied by a factor of 16, not 10 as at present.

So someone whose pension entitlement increases by more than 3,125 in any one year may be faced with a 40% tax bill.

However they will be able to offset that year's increase in their underlying pension pot against any unused tax-free allowance from the previous three years.

This will help people avoid a tax bill if they put more money into their pension scheme as a result of being given a one-off payment, such as a redundancy payment.

Mark Hoban, financial secretary to the Treasury, said the government had taken a "tough but fair" decision.

"We have abandoned the previous government's complex proposals and developed a solution that will help to tackle the deficit but not hit those on low and moderate incomes," he said.
'Vast improvement'

Experts immediately pointed out some important wrinkles in the government's plan.

Tony Baily, at pension consultants Aon Hewitt, said: "The higher than previously proposed annual allowance and a relatively low valuation factor mean that the winners are long-serving, middle-income earners in defined benefit plans, many of whom will now not be affected by the annual allowance.

"The losers are high pension savers who get caught by the reduced and frozen lifetime allowance," he added.

Marc Hommel, pensions partner at PwC, said: "As there is no current intention to increase the tax limits, many more people could be caught in future years particularly if inflation takes off."

Ronnie Ludwig, a partner at Saffery Champness, said the new policy would discriminate against entrepreneurs.

"Because it is based on the model of regular income and regular pension contributions, it effectively discriminates against the self-employed or small business owners whose income patterns are more uneven," he said.

Tom McPhail at investment advisers Hargreaves Lansdown said the limits would still allow most people to build up a decent pension without incurring extra tax bills.

"This is a vast improvement on the tortuous system for restricting tax relief proposed by the previous government," he said.

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