Speculation surrounding the reduction of the annual pension allowance is high as members of the Government seem determined to find a way to fund an increase in the personal allowance to £10,000.
Reducing the pension annual allowance will mainly affect those that are more affluent. Also at risk is whether higher and additional-rate tax relief on pension contributions will continue to be available without restriction.
If clients are worried that the Government will announce a reduction in the maximum annual allowance or a reduction to the level of tax relief that will apply to future personal contributions, they need to act before Budget day to be certain of benefiting from the current allowances.
Clients can maximise their contributions in this tax year by fully investing their allowance for this year, utilising unused allowances from the three previous years and using up next year’s allowance through clever use of pension input periods.
The maximum annual allowance is currently £50,000, which means someone who has previously built up pension savings but has not funded into pension arrangements in recent years could personally contribute up to £250,000 by utilising all allowances in one go.
Clients cannot make relievable contributions personally that exceed their relevant earnings in this tax year.
Companies can make significant employer pension contributions on an employee’s behalf that are not linked directly to their earnings from the employment.
For higher earners, there is the potential of receiving significant higher and additional rate personal relief on contributions they make.
We predict that significant numbers of higher and additional-rate taxpayers will use the coming weeks as an opportunity to maximise their contributions and will then opt out of the pension system by applying for fixed protection.
“Significant numbers of higher and additional-rate taxpayers will maximise their contributions and opt out of the system by applying for fixed protection”
Fixed protection will essentially protect the future value of a person’s pension savings from a lifetime allowance tax charge based on the current £1.8m lifetime allowance rather than the reduced limit of £1.5m that will apply from April 6, 2012. Once a person applies for fixed protection, they can make no further contributions to their pension from the beginning of the 2012/13 tax year.
However, in opting out of future pension savings, clients will need to take into account the possible loss of ancillary benefits, such as death-in-service rights that they may lose if they cease to be an active member of their registered pension scheme.
A high number of investors have already taken the opportunity to apply for fixed protection. HMRC has reportedly already received an inflow of over 70,000 fixed protection applications, with a spike expected in March and the beginning of April as people rush to get their applications in before the deadline.
Clients with significant pension savings who do not want to opt out of the pension system, but are of an age where they are thinking of drawing down some or all of their pension savings, could benefit from doing so now rather than waiting until the new tax year.
Money drawn down in this tax year will be tested against an LTA of £1.8m. This will use up less of the client’s available LTA than by waiting until April 6, 2012.
As an example, if a client draws down £900,000 of pension savings in the current tax year, the client would use up 50 per cent of the available LTA. This would leave a further £750,000 available for future drawdown from the next tax year that would not be subject to additional tax charges.
If they delay taking those benefits until the 2012/13 tax year, they will use up 60 per cent of their available LTA, leaving only a further £600,000 available to draw down before additional tax charges apply.
Whatever action the client takes, it is important to act fast.
Budget day is the first priority and clients should maximise pension allowances prior to that date. To protect pension fund growth, if clients apply for fixed protection, they should send the form to HMRC by recorded delivery to ensure it is received by the April 5 deadline.
If clients decide to draw down some pension savings to release more LTA, forms need to be completed and received by the providers concerned well ahead of the tax year end deadline to ensure they can be processed in time.