Restricting pensions tax relief: The Coalition’s alternative approach

Introduction

In the Coalition Government’s emergency Budget on 23 June 20101, the
Chancellor, George Osborne, announced a review of the former Labour
administration’s plans2 to restrict tax relief on pension savings for high earners.
Having already initiated an informal consultation, the Treasury has now published a discussion paper3 on a possible alternative approach which would
see the AA reduced to a level between £30,000 – £45,000.

In this Alert:

• Key points
• Redesigning the Annual Allowance
• Valuing DB accrual
• Possible exemptions from the Annual Allowance
• Additional changes
• Implementation in April 2011

Key points

• The chief suggestion is the reduction in the AA from its current level of
  £255,000 to an amount in the region of £30,000 – £45,000.
• Any reduction in the AA will give rise to changes in other areas of the pensions tax relief system, such as a reduction in the level of the LTA.
• The Government’s proposals raise a number of practical and administrative issues for schemes, with the possible introduction of new information and reporting requirements.
• The consultation closes on 27 August 2010, giving interested parties little over four weeks to respond.

Redesigning the Annual Allowance

With Labour’s planned pensions tax relief restrictions shelved for being unduly
complicated, the Government intends to replace these with the simpler concept
of a lower AA. Its provisional analysis suggests that an AA of between £30,000 £45,000 would raise at least the same revenue for the Treasury – one of the
Government’s main aims in its quest for an alternative approach.

The AA limits the amount of tax relief available on pension savings paid by or in
respect of an individual to a registered pension scheme. Where pension savings exceed the AA, an AA charge applies. For the tax year 2010-11 the AA is £255,000.

To enable a reduced AA to operate effectively, other changes contemplated
include:

• a tailored charge on contributions above the AA, in place of the current 40% flat rate tax charge; and
• the possibility of aligning the “pension input period” (PIP) to the tax year.4

Valuing DB accrual

Central to the reduced AA is the need to value pension scheme contributions over the PIP. While straightforward for DC, DB benefits require a method for measuring “deemed” contributions.

DB accrual is currently measured using a flat factor of 10, with every £1 a year
of new pension payable representing a deemed contribution of £10.Alternatives include using age-related factors (ARFs) or cash equivalent transfer values. While ARFs found favour under Labour’s plans, the present Government prefers the simplicity of flat factors over the need for a precise valuation method.

Other issues to be ironed out in the DB context include:

• whether deferred members should be exempt from testing against the AA; and
• the “appropriate treatment” of potential negative accruals.

Possible exemptions from the Annual Allowance

The Government intends to disapply the AA test when individuals die or are diagnosed with serious ill-health. However, as cases of ill-health early retirement and redundancy are perceived as carrying more risk of avoidance, it
is not minded to provide exemptions in these circumstances.

Crucially, the Government is looking to remove the current exemption from the
AA test in the year in which benefits come into payment.

Additional changes

Any reduction in the AA will have a knock-on effect on the wider pensions tax
relief system. Suggested consequential amendments include:

• capping tax relief on pension savings below the reduced AA at 40% (reducing the amount of tax relief available to additional rate (50%) tax payers);
• a simultaneous reduction in the LTA to ensure “more coherence” between the LTA and the reduced AA;
• transitional protection for those with savings above a reduced LTA; and
• a possible freeze in the value of rights covered by primary and enhanced protection.

Implementation in April 2011?

In what will be a very quick turnaround, the Government plans to confirm its
intended approach on pensions tax relief by the end of September 2010, with a
view to implementing the new measures in April 2011. Whilst the proposed
approach is potentially simpler than its predecessor, it remains to be seen how
many more earners it will capture.

1 For more information, see our Alert: “Coalition Budget 2010: Final economic remedies from Gladstone’s Bag” dated 23 June 2010
2 For more information, see our Alert: “Scant relief for pensions in Darling’s pre-election Budget” dated 25 March 2010
3 http://www.hm-treasury.gov.uk/consult_pensionsrelief.htm 
4 This is the period over which pension savings are assessed for the purposes of testing against the AA. At present, trustees can nominate a PIP to tie in with the scheme year or, in DC schemes, members may even be able to nominate their own PIP