Over the past two weeks I have looked at the fundamental misconception that pension death benefits are tax-free. Of course, we all know that is only true if the member or, in the case of payments to successors, the beneficiary/nominee dies under age 75.
There is also a whole lot of detail to take on board in relation to how to nominate who should receive what benefits. Unjustifiable detail (and complexity) it could be argued but detail that has to be dealt with nonetheless. Advice is essential.
This week, I would like to turn to another reasonably well-publicised change that also has the capacity, by virtue of the relative simplicity of the headline, to mislead clients. The change is that focused on “reducing pensions tax relief for high earners” – introduced, believe it or not, to fund the cost of the new residence nil rate band for inheritance tax that is to be phased in gradually (a feature of many changes delivering taxpayer benefit).
To start, it is important to understand that the “cutback” in tax relief for “high earner” pension contributions takes the form of a £1 reduction in the annual allowance for every £2 that “adjusted income” exceeds £150,000. The annual allowance reduction continues until it reaches £10,000. And that is as low as it goes – for now, anyway.
Many see this reduction as an indication of what the future holds. With the cost of pensions tax relief exceeding the level of the defence budget, and 75 per cent of the benefit of relief going to higher rate taxpayers, some – probably fundamental – change seems inevitable.
The Government consultation, entitled ‘Strengthening The Incentive To Save’, and the latest Centre for Policy Studies report promoting Isa-centric savings would both indicate as much. Most think the writing is on the wall: they are just not sure whether the “writing” will amount to a sentence, a paragraph or a whole story. The Centre for Policy Studies definitely favours the story.
For now, though, let’s return to the annual allowance reduction we do know about. Those that think the cutback only applies if “earnings” are £150,000 or more are labouring under a massive misunderstanding. As I have already referenced, it is “adjusted income” that counts. That includes:
- All taxable income less any reliefs available under section 24 ITA 2007 except those in respect of pension contributions
- All employer pension contributions
- All employee pension contributions made under the net pay system.
This includes many more people than would be the case if the £150,000 threshold were linked solely to the earnings of the member. But it would be wrong to stop there. Even if adjusted income exceeds £150,000, an individual can be excluded from the reduction in the annual allowance if their “threshold income” is less than £110,000.
But what is threshold income? It is all taxable income less any reliefs available under section 24 ITA 2007 (this means that relief in respect of pension contributions made personally is deducted) with employer contributions being ignored except under an anti-avoidance provision, which adds back any pension salary sacrifice made on or after 9 July 2015. This threshold income provision may help some to avoid the annual allowance tapering.
So while this additional complexity could mean fewer people are caught it is also likely to make informed advice even more important to those who might be in the ballpark.
The annual allowance tapering provisions have caused further necessary change in order to align all pension input periods with the tax year: 2015/6 has become a “transitional year” in which this (much written about and discussed) alignment takes place.
As many will already be aware this could give rise to some worthwhile opportunities in the so-called “post-alignment” (mini) tax year, to make extra relievable contributions of up to £40,000.
Hopefully, I have got somewhere close to reminding you how the seemingly highly focused annual allowance tapering provisions result in a strong responsibility to engage with and inform all clients who might be affected. From this responsibility will spring the opportunity to deliver important advice and planning on complex and important subjects – the essence of mutually beneficial financial planning.
Tony Wickenden is joint managing director at Technical Connection