Page last updated at 23:04 GMT, Thursday, 30 April 2009 00:04 UK

Wrinkles in the pension tax plans

Money Talk
By Tom McPhail
Head of Pensions Research, Hargreaves Lansdown

Chancellor Darling reads his Budget
The changes will be especially complicated for the next two years

The government's plans to limit the tax relief granted on pension contributions for high earners - as announced by the chancellor in his April Budget - are very complicated.

We do not yet have all the details - a consultation paper will be published shortly - but it does appear that there will be opportunities for some higher earners to exploit anomalies in the rules.

The basic point is that tax relief for the pension contributions of people earning more than £150,000 a year will be reduced from 2011.

But to stop these people stuffing huge sums into their pension funds before then, and gaining full advantage of the current rates of tax relief, some new rules have come into effect immediately.

These are known in the jargon as anti-forestalling regulations.

For example they state that with immediate effect, investors earning over £150,000 will have their higher rate tax relief limited to annual pension contributions of up to £20,000, for this tax year and the next.

The exception is if their pension contributions, both from themselves and their employer, were running at a rate of more than £20,000 a year anyway.

Any contributions in excess of this ceiling, that cannot be deemed to be part of a normal pattern of pension investing, will be subject to a tax charge which will limit the tax relief to the basic rate of 20%.

First wrinkle

The £150,000 threshold is hugely significant.

Tom McPhail
A bizarre anomaly has emerged
Tom McPhail, Hargreaves Lansdown

As soon as your income goes over it, your scope for claiming higher rate relief drops to just the £20,000 that now applies under the anti-forestalling rules.

Because of this, you might actually choose to give up a small amount of income if it brought you down below the threshold; certainly if your income is £150,000 you might want to give up £1.

A bizarre anomaly has emerged though.

The calculation of an investor's income, used to determine whether they breach the £150,000 threshold, allows for the deduction of certain expenses, including up to £20,000 of pension contributions.

This means that investors earning up to £169,999 can make a £20,000 pension contribution under the new rules.

This would also bring their assessable income down below £150,000.

At that point the rules would no longer apply to them, so they would be free to invest another £100,000 (for example) in their pension and receive full tax relief.

Another way of doing this would be to make charitable donations using the gift aid system to reduce your headline income.

Someone earning £160,000 might take the view that a £10,001 charitable donation would be a price worth paying.

They could then make a pension contribution of up to £149,999 and claim full tax relief on all of their contribution.

Remember, these rules only pertain to this tax year and the next, after which higher earners' scope for pension planning will probably be curtailed.

Personal allowance

There is another wrinkle in the rules that will be of use to those earning just over £100,000.

Filling in a self-assessment form
Pension contributions may help restore the personal allowance for some

The chancellor announced in his 2009 Budget that from April 2010, once your income breaches this threshold, you will start to lose your personal tax allowance.

And by the time your income reaches £112,950 (based on this tax year's allowance), the personal allowance will have been completely withdrawn and you will pay tax on all your income.

You can reduce your income though, by making pension contributions, to bring your assessable income back down below £100,000.

At this point you will get your personal allowance back again, and reverse an effective 60% tax charge.

This is because every £2 in income above £100,000 not only suffers 40% income tax (80p altogether), it also triggers the withdrawal of £1 of personal allowance.

This then means you have to pay 40p tax on that extra £1 of income that previously fell under the tax-free personal allowance.

This results in a cumulative tax charge, triggered by the extra £2 of income, of £1.20 - or 60p per pound.

The oddities in the rules have been confirmed in the technical documents supporting the budget, however they have not yet been enshrined in legislation, so it is important to remember that they may change.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.



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