Tax relief changes may herald official move to encourage career average pension schemes

Thursday 14 October 2010

Tax relief changes may herald official move to encourage career average pension schemes

Generous annual allowance higher than expected but could land some final salary scheme members with unexpected tax bill

The Government has just announced its long-awaited proposals for changing the pensions tax relief regime. The annual allowance will be reduced from £255,000 a year maximum to £50,000 a year. This new limit is higher than the annual contribution limit suggested in the Consultation document, which talked of a range of £30,000 - £45,000, so presumably many people will be relieved that the level is not too low.

Obviously, an annual allowance of £50,000, with full tax relief, is quite generous by most people's standards. Indeed, those paying 50% tax will get 50% tax relief, which is even more generous than before. The Government says this move will affect around 100,000 people, who currently contribute more than £50,000 into their pension schemes each year. There will also be a reduction in the lifetime maximum allowance from £1.8million now, to £1.5million in 2012, but those who have already exceeded that level will have transitional protection.

Overall, the new tax relief regime is much better than the complex set of changes which were due to start in 2011, and the amounts that can be put into pensions will still be large by most people's standards.

However, there could be a problem for long-serving members of final salary schemes. The multiple of annual additional pension accrual which will be deemed to accrue will be 16 times the amount of extra pension. At the moment, that figure is 10 times and the effect of this could be that those earning, say, £50,000 a year could suddenly be landed with an unexpected tax charge as a result of a significant promotion or pay rise.

This does not affect career average pension schemes, but it would impact final salary. In a career average scheme, members accrue a 'slice' of pension each year, so changes to salary would not apply to past years' entitlements. With a final salary scheme, however, salary increases will apply to all past pension entitlements.

Is this the Government's way of craftily trying to move pension schemes away from final salary towards career average?

Lord Hutton's report last week called final salary schemes 'inherently unfair' and the BBC has just proposed moving to career average too. The writing seems to be on the wall. If top earners are penalised in final salary schemes, they may decide to close them for everyone. If they move to career average, that is not as bad but if they simply move to defined contribution, that would be a disaster for many people's pensions.

Government needs to be very careful with its pension policy changes - the law of unintended consequences could damage well-meaning policy.


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