Help your members avoid pension tax pitfalls!
Have you noticed that nothing stays still for long in the pensions world?
Every new tax year seems to bring with it a number of new things to look out for, or at least consider. In 2015 we witnessed a mini ‘pension evolution’ with the introduction of pensions freedom. This rather overshadowed other important changes which took immediate effect and others from 6 April this year. This note explains some key changes for pensions.
Let’s start by looking at two of the immediate changes to pensions in the Summer 2015 Budget…
- Alignment of Pension Input Periods to tax years
On Budget day (8 July 2015) all existing Pension Input Periods (PIPs) were closed.
To appreciate the importance of this perhaps we should explain what PIP is, and how it may have been used in the past.
A PIP is the period over which pension contributions (DC Schemes) and pension accrual (DB schemes) are assessed for tax purposes. In the past it was possible for the employer or trustee to set up the PIP. This was stopped on 8 July when all PIPs were closed, and a new PIP began running from 6 July 2015 to 5 April 2016 - the end of the 2015/2016 tax year.
Of course no one was prepared for this change, so the Government introduced some ‘transitional arrangements’ for 2015/16 only, which allowed for contributions in respect of two PIPs to be assessed in the 2015/2016 tax year. Importantly, since 6 April 2016, all PIPs are aligned to tax years. If you did have a PIP specific to your scheme, you will need to ensure that all your members are aware of this change.
This doesn’t mean, however, that unused allowances cannot be recovered - far from it! Members of a registered pension scheme (such as your own) for the past three tax years, will still be able to ‘mop up’ unused allowances from the previous three years if they have used up the current year’s Annual Allowance.
You can find out more about the transitional arrangements for the 2015/2016 tax year by visiting our website at www.pru.co.uk/tax.
- The Money Purchase Annual Allowance
The Taxation of Pensions Act 2014 modified the Annual Allowance for pensions for those who have drawn pension benefits flexibly by introducing the Money Purchase Annual Allowance (MPAA). There are several ‘triggers’; the most common of these triggers are taking all pension savings as cash or drawing pension as income (known as Flexi-Access Drawdown). Importantly, once triggered, the MPAA (which is £10,000 for the 2016/2017 tax year) will always apply to a member’s money purchase contributions from that point onwards. Once again transitional arrangements were introduced for the 2015/2016 tax year.
This seems straight forward, but it’s worth digging a little deeper, as there are other implications…
The MPAA includes any money purchase contributions and increases in the value of any defined benefit (either final salary/career average) pensions. However, once triggered, the MPAA will apply to any money purchase contributions. As long as money purchase contributions remain below the threshold, any defined benefit growth will remain unaffected as long as the total increase in money purchase contributions and defined benefit accrual is less than the total standard Annual Allowance of £40,000.
However, exceeding the MPAA will not only result in a tax charge in respect of the money purchase contributions in excess of £10,000, but will also reduce the remaining allowances for any defined benefit pensions to £30,000. Unlike the Annual Allowance there is no scope to carry forward any unused MPAA from the past three tax years.
Well, again, in pension terms this is fairly straight forward. But what was introduced from 6 April 2016 adds an additional layer of complexity…
Since 6 April 2016…
- The Tapered Annual Allowance
Since 6 April 2016, a new concept has been introduced of assessing tax on pensions based on an individual’s income rather than their earnings. This takes into account all sources of income, including earnings from all employment and self-employment, interest on savings from banks/building societies, property rents, dividends, and may include contributions paid into a pension scheme (both employee and employer).
Individuals with very high incomes may be affected by the Tapered Annual Allowance which reduces their available Annual Allowance. If their total annual income exceeds £110,000 (and also exceeds £150,000 when adding back in pension contributions paid by them, or on their behalf), their Annual Allowance gradually reduces at a rate of £1 for every £2 of income, to an eventual ‘floor’ of £10,000. This means that members with income of £210,000 or more will see their available Annual Allowance reduce by the maximum reduction of £30,000 to £10,000.
So what? Like many things, pension rules should not be considered in isolation.
Let’s consider the outcome for a higher earner, who has taken benefits flexibly since April 2015:
- If their total income (from all sources) exceeds £110,000 their Annual Allowance may be further reduced by the taper.
- Their maximum Annual Allowance for money purchase contributions is £10,000 as they will be subject to the MPAA.
- If they exceed the MPAA they will incur a tax charge on the excess.
- If they are subject to both the MPAA and the Tapered Annual Allowance, their MPAA will remain at £10,000. However, in any year when they exceed the MPAA, their Annual Allowance for other types of tax-relieved pension savings, such as defined benefits (currently £30,000) will be gradually reduced – removing this completely for an individual with income over £210,000.
Reduction in the Lifetime Allowance
The Lifetime Allowance is an overall lifetime limit on the amount of tax-privileged savings that any individual can draw.
The Lifetime Allowance for the 2016/2017 tax year has been reduced from £1.25m to £1m. This applies to the total of all pensions including any existing entitlement to a defined benefit scheme, but excluding State Pension. If the benefits taken exceed the available Lifetime Allowance, a tax charge will be due on the excess.
As a result of the latest reduction in the Lifetime Allowance, the Government has introduced additional forms of pension protection (Individual Protection 2016 and Fixed Protection 2016), whilst any existing protection for individuals who exceeded earlier higher Lifetime Allowances may still remain valid.
More information about past pension protections, may be found at https://www.gov.uk/guidance/pension-schemes-protect-your-lifetime-allowance
What should you do?
So, as you can see there are a number of changes, individually or combined, and certain members are at greater risk of tax charges than others – even if contributions are not planned to be increased this year!
There’s no better option than recommending that affected members seek professional financial advice. We would also advocate a short communication to staff who you feel are most at risk:
- Members who you know are earning close to, or exceed, the income thresholds for the Tapered Annual Allowance.
- Members who are paying close to the MPAA, although you will need to explain that the MPAA will only apply when taking benefits flexibly.
- Members who may have accumulated significant pension funds (including money purchase and defined benefits)
How can we help?
Hopefully this article explains the changes clearly. However, there’s information on our website at www.pru.co.uk/tax and we’ve produced a simple questions and answers document which we hope you/your members will find helpful.
The above is based on our current understanding, as at May 2016, of current tax legislation and HM Revenue & Customs practice, all of which may change without notice. The impact of taxation (and any tax relief) depends on individual circumstances.