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Pension problems Osborne has given high earners
Lorna Bourke explains how the Autumn Statement's reduction in pension allowances leaves high earners in an awkward spot.
by Lorna Bourke on Dec 06, 2012 at 16:19
Hundreds of thousands of high earning public sector workers and others in private sector final salary linked pension schemes have a very difficult decision to make following the reduction announced by the chancellor in his Autumn Statement in the annual limit on pension fund contributions to £40,000 and the restriction in the lifetime allowance to £1.25 million.
Those in defined contribution schemes will be affected too but for them the decision is relatively easier.
This is because the annual contribution limit of £40,000 for those in a final salary linked scheme is not related to actual contribution levels but to the deemed increase in the value of their pension pot. Given that most people still contributing to final salary schemes are those working in the public sector these are the individuals it will affect most adversely.
For all high earners saving in any pension scheme there is an important decision to be made and if they get it wrong it could cost them up to £62,500 in extra tax – the tax payable on the difference between a £1.5 million and £1.25 million pension fund – an expensive mistake. Many will need advice from their employer’s pension administrator and/or a pension consultant to determine whether they will benefit from the ‘transitional relief’ offered under the new limits.
‘This is one of the most difficult pension decisions that anyone has to make,’ warns Chris Noon of pension consultants Hymans Robertson. Not everyone will be aware whether they are near the existing £1.5 million lifetime limit or the new £1.25 million limit. ‘It is up to them to find out from their pension administrators,’ says Noon.
But he points out that the administrator will only be able to tell them whether they are approaching the lifetime limit in their current scheme. Individuals will have to work out themselves whether the current scheme, combined with benefits from all the other schemes – both occupational and personal pensions – to which they have contributed, will bring them up against the lifetime limits.
The statement from the Treasury says, ‘a transitional "fixed protection" regime will be introduced for those who may be affected by the reduction in the lifetime allowance.’ The new £1.25 million limit is effective from April 2014 and people have until then to decide whether they want to go on contributing to their pension scheme – in which case they will opt for the new £1.25 million lifetime limit.
Clearly those on lower salaries who are unlikely to be anywhere near the lifetime limit have nothing to worry about and should go on making contributions.
The alternative is to go for ‘fixed protection’ in which case the lifetime limit remains at £1.5 million – but no more contributions to the scheme can be made. This will affect older employees with long service and high earners who have already built up substantial pension pots.
Noon points out that huge assumptions have to be made about which to choose. ‘You have to decide when you want to retire, how the lifetime limit might increase in future and what your employer might offer as an alternative to being a member of the pension scheme.’
And for those with savings in a defined contribution scheme, personal pension or Sipp (self-invested personal pension), an assumption also has to be made about future investment returns which could, for example, push a current pension fund of £1 million over the £1.25 new limit if the individual is still contributing and has some years to go until retirement. Any excess over the lifetime limit is taxed at 55% so this could be an expensive mistake.
‘Some people near the limit last time round [in 2006] when they had to make this decision on protection simply decided to retire. But to do that you must be at least 55,’ Noon points out. Of course, this could be a clever ploy by the government to encourage high earning civil servants to leave without the costs of making them redundant or offering extra incentives. If they are unable to earn any extra pension, why carry on working?
There is an added complication which affects anyone thinking of taking advantage of the higher £50,000 limit for the current tax year – and 2013-14. Many who make additional voluntary contributions to a defined contribution or personal pension may find that contributions made as early as next spring could count towards their annual contributions in the following tax year. This is because the pension ‘measurement period’ does not necessarily coincide with the tax year so they could inadvertently exceed the annual limit.
It can affect members of final salary schemes and some people contributing to defined contribution schemes whether they are employed or self-employed. Noon explains that in 2006 when this complication previously arose around two-thirds of pension schemes changed their measurement year to align with the tax year. But if they didn’t, contributions are calculated from the tax year in which the ‘measurement period’ ends. For some this could be as soon as April 2013 so they will effectively lose the ability to make up to £50,000 of contributions a year early. This could catch out those who boost their contributions in an attempt to beat the cut in the annual limit.
It will also affect some self-employed people and others who make their own pension provision through Sipps or personal pensions. Individuals may have their own ‘pension input period’ which, again, doesn’t necessarily align with the tax year. It may run from the anniversary of when contributions were first made to a Sipp or pension plan, it could be fixed by the pension scheme or it could be agreed by the saver with the scheme administrator.
Noon cites the example of a person with an input or measurement period starting in May. This means contributions in the year starting in May 2013 will count towards the lower £40,000 allowance in the 2014/15 tax year.
Given these ghastly complications it will clearly be necessary for high earners and those making pension contributions up to the maximum to take professional advice. Those most at risk are members of final salary schemes earning around £80,000 a year or more with 15 to 20 years’ service or accumulated pension contributions from former employers or personal pensions.
Noon reckons the cost of advice could be around £1,000 to £2,000 but it could be more. But it’s a problem most of us would like to have – and it’s good business for pension consultants.
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