Since the new Government’s emergency budget on June 22, the industry has seen a series of consultation documents introduced that could result in significant reform of private pensions.
One of the key parts of potential reform focuses on changes to the annual allowance rules. The consultation document proposes a tax-relievable allowance of between £30,000 and £45,000. The proposals suggest that no tax relief will be available on the value of benefit accrual that exceeds that annual allowance.
If the Government delivers these changes from April 6, 2011, there are planning issues that advisers need to focus on now for clients who are funding into registered pension schemes.
They will need to ensure that maximum scope is available for funding pension schemes in the next tax year should the proposed cap on the annual allowance be implemented.
In the consultation document, the Government sought views on whether pension input period rules should remain unaltered or whether the annual allowance should be tested against the tax year in which a client pays or receives a contribution.
If the latter is chosen, it would change the basis of tax relief back to the pre-A-Day legislative regime.
If pension input periods remain, it is important that funding in the current tax year should be set against the current year’s annual allowance. Without careful planning, clients may not achieve that objective.
For money-purchase schemes, pension input periods start when the first contribution was paid into a scheme after A-Day.
A pension input period normally ends 12 months after it started. The contributions paid in a pension input period are tested against the annual allowance applying in the tax year in which the pension input period ends.
Many clients contributing to registered money-purchase schemes will contribute and receive relief in the current tax year but the contributions will be set against the next tax year’s annual allowance.
If the Government implements the new annual allowance proposed in its consultation document, the contribution paid now will exceed the proposed maximum relievable contribution. This could create an unforeseen tax charge on the individual concerned.
The Government is likely to provide transitional legislation to protect the tax position for such situations. However, it would also mean that a client in this situation would have fully funded their annual allowance for 2011/12 by virtue of the contribution paid now and could not contribute with tax relief until the 2012/13 tax year.
It is simple to avoid this problem. A client can ask their pension provider for early closure of the current pension input period so it ends in the current tax year.
This will ensure that contributions paid in that pension input period will be allocated against the annual allowance for the current tax year.
This not only avoids any potential tax liability on contributions that exceed the proposed new annual allowance but, if the Government proposals come into force, will also ensure that a full annual allowance is available for the 2011/12 tax year.
Advisers can act now to help clients facing these issues. It is critical to identify in good time the clients who may be affected if legislation changes and then to ensure that they take the necessary action to avoid these pitfalls. This action by advisers will add value to clients’ longer-term retirement planning.
Colin Jelley is head of proposition marketing at Skandia