Pension Annual Allowance Reduction

Budget Dec 2012 - Pension Annual Allowance Reduction

The current maximum that can be paid, or deemed to paid, into a pension will be reduced from £50,000pa to £40,000 pa with effect from April 2014.

Investment Linked Money Purchase Pensions (Personal and Company Pensions).

• This is relatively straightforward for most, you will not be allowed to pay in as much as you do today.  In the long term, this is a dramatic fall for higher earners who want to pay more but are restricted.

• Carry Forward: Currently, if you do not pay in the maximum, you are allowed to carry forward unused pension tax relief for three years.  This means that you can pay in the maximum this year and carry forward from previous years and pay in for the previous three years, i.e.  £50,000, £50,000 and £50,000.

For Defined Benefit and Final Salary Scheme members.

Many high earners, people with long service in the pension or those that get a promotion and payrise may be hit with a tax charge if their pension entitlement increases by too much in a year.

Example Final Salary Annual Allowance Valuation: Average Worker earning £20,000.

• You earn £20,000pa.  You are a member of an 1/60th pension scheme and you have worked for 15 years.
• Your accrued pension entitlement is therefore 15 years x 1/60th x Salary = 15/60ths X £20,000 = £5,000pa Pension Accrued.

You secure a promotion next year meaning your basic salary is now £30,000pa and you have achieved 16 years service.

• Your accrued pension entitlement is therefore 16 years x 1/60th x Salary = 16/60ths X £30,000 = £8,000pa Pension Accrued.
• Your pension has increased from £5,000pa to £8,000pa – an increase of £3,000pa.
• Annual Allowance Calculation, the increased value has a valuation factor of 16 times.
• Value for Annual Allowance Calculation £3,000 X 16 = £48,000 deemed annual contribution.
• New Annual Allowance threshold £40,000 meaning you have exceeded the annual allowance by £8,000.
• You will be taxed at your highest rate of income tax (in this case 20%) on £8,000.
• Meaning an additional tax bill to pay of £8,000 X 20% = £1,600.
• (this is an extreme example assuming no inflationary increase on pay allowed).

This position is even worse for high earners.

Example Final Salary Annual Allowance Valuation: High Earner earning £100,000.

• You earn £100,000pa.  You are a member of an 1/60th pension scheme and you have worked for 15 years.
• Your accrued pension entitlement is therefore 15 years x 1/60th x Salary = 15/60ths X £20,000 = £25,000pa Pension Accrued.

You secure a promotion next year meaning your basic salary is now £120,000pa and you have achieved 16 years service.

• Your accrued pension entitlement is therefore 16 years x 1/60th x Salary = 16/60ths X £120,000 = £32,000pa Pension Accrued.
• Your pension has increased from £25,000pa to £32,000pa – an increase of £7,000pa.
• Annual Allowance Calculation, the increased value has a valuation factor of 16 times.
• Value for Annual Allowance Calculation £7,000 X 16 = £112,000 deemed annual contribution.
• New Annual Allowance threshold £40,000 meaning you have exceeded the annual allowance by £72,000.
• You will be taxed at your highest rate of income tax in this case 40% and 50% as your deemed income would be £120,000 + £72,000 pension allowance = £192,000.
• £150,000 is 50% threshold.
• Therefore: £192,000 - £150,000 = £42,000 taxed at 50% and remaining £30,000 taxed at 40% (ignoring all personal allowances as you do not have one).
• £42,000 X 50% = £21,000 plus £30,000 X 40% = £12,000.
• Meaning an additional tax bill of £33,000 for a pay rise of just £20,000.
• (this is an extreme example assuming no inflationary increase on pay allowed).

Both the wealthy and the average will be hit hard by this annual allowance reduction.

Back to UK Budget December 2012 Summary