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Forward march

Carry forward is back in favour as savers get to grips with pension tax relief

The Treasury has published its proposals regarding the operation of tax relief on pension contributions which will replace the previous high income excess relief charge announced by the previous Government.

The proposals could have a fundamental affect on the way that many people save and are able to save for their retirement and advisers’ clients – particularly higher earners – are likely to have many questions about the changes.

Annual allowance
From April 2011, this will be reduced from £255,000 to £50,000 until 2015/16, when the Government will consider options for indexation beyond that.

Despite what appears to be a massive reduction in the annual allowance, the Government will allow people to carry forward three years of unused contributions. This is useful to know, particularly if one of your clients acquires a large sum of money over £50,000 through the sale of property or an inheritance, for example, that they may wish to pay into their pension.

It is also worth knowing that the £50,000 limit applies to employer and employee contributions combined.

Tax relief will continue to be available at the individual’s highest marginal rate of tax. In other words, a higher-rate taxpayer can claim up to 40 per cent tax relief and an additional (50 per cent) taxpayer will be able to claim up to 50 per cent tax relief, which could be good news for higher earners.

The annual allowance tax charge will be tailored to recoup the full marginal rate relief the individual has received.

A flat factor of 16:1 will be used to value defined-benefit pension accrual. Currently, a factor of 10:1 is used so the proposed change to 16:1 means it will be easier for people paying into a DB pension to exceed the new lower annual allowance.

Carrying forward unused contributions
Making a comeback of which Rocky Balboa would be proud, carry forward, after a few years of being consigned to pension folklore, has returned. This means any unused annual allowance for up to three years may be carried forward where pension contributions or savings for the current year exceed the annual allowance. This will include being able to carry forward from the tax years 2008/09, 2009/10 and 2010/11 using an assumed annual allowance of £50,000 for each of those years. This could potentially open up contributions for higher earners.

’Carry forward has returned and any unused annual allowance for up to three years may be carried forward where contributions or savings for the current year exceed the annual allowance’

For calculating defined-benefit pension increases, the flat factor of 16:1 and new re-valuation method for previous year’s benefits will be used.

Pension input periods
The existing rules regarding setting pension input periods will not change. This means that pension schemes will generally continue to determine the period and it does not need to be aligned with the tax year. For money-purchase arrangements, members will still continue to be able to determine their pension input periods.

Transitional rules will be put in place for those schemes where the period started before October 14, 2010 and will end in the 2011/12 tax year to reflect the reduced annual allowance for the period from October 14, 2010.

Lifetime allowance
This is to be reduced from £1.8m to £1.5m, intended to be effective from April 2012, which means clients have about 18 months to make the most of that £300,000 difference before the new rules come into force.

For defined-benefit crystallisation, the valuation factor that converts accrued benefits into a cash equivalent value for the purposes of the lifetime allowance will remain at 20:1 (or 25:1 for pre-A-Day benefits in payment).

The link between the lifetime allowance and trivial commutation will be removed from April 2012, so instead of the limit being 1 per cent of the lifetime allowance, it will instead remain at £18,000.

Protection will be given to those who have “already made pension savings decisions based on the current level of the lifetime allowance”.

Vince Smith-Hughes
Head of pensions development, Prudential

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