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Plan Ahead For Pension Changes

In the run up to the Chancellor’s March 2016 Budget Statement there was wide expectation that changes would be made to the way in which pension tax relief works. Expectations of either the introduction of a flat rate of relief – widely believed to be 25-30%, or a ‘pension ISA’ haven’t been realised, but other changes still apply from 6 April 2016.

Pension access is to be made easier for those with serious ill health and for more dependants who inherit pension pots. The details are yet to be finalised and your pension administrator will be able to provide detail where appropriate.

The government is also to consult on allowing you to draw up to £500 from your pension, tax-free, to pay for pension advice. Plans were also outlined to change the role of the Money Advice Service (MAS) and PensionWise in the delivery of pension advice.

Finally, the consensus view is that the introduction of the ‘Lifetime ISA’ for under 40’s is setting a direction of travel for pensions, moving from tax relief upfront with pension income taxable, to pension contributions coming from taxed income but with pension income then tax-free. Should this be the case, it makes sense to maximise your pension contributions whilst the current arrangements exist. Read our guide to contributing to your SIPP.

Below we summarise the changes coming to pension allowances.

Please bear in mind that The Motley Fool Share Dealing service does not provide investment or tax advice. This information is based on our understanding of current and proposed legislation as at 23 January 2016, which may be subject to change. It is a summary only of the changes and does not cover every consideration or circumstance. The impact of these, or any other tax and allowance changes, will depend on your personal circumstances. If you are at all unsure you should seek advice from a tax and/or financial adviser.

Limitations on the annual allowance from 6 April 2016

The annual allowance is the maximum amount that can be contributed to your pension in any one year (including employer and any other third party contributions) and still receive tax relief. Currently it is set at £40,000, but you can also “carry forward” any unused allowance from the past three years, including the “double allowance” resulting from changes to the current (2015/16) allowance.

What is the change?

This only affects higher earners, although in this instance the definition is not directly linked to the additional rate tax band. For individuals whose income including employer (or other non-personal) pension contributions is more than £150,000, or whose income is more than £110,000 excluding pension contributions, the annual allowance of £40,000 will be reduced. The reduction is £1 for every £2 of income over £150,000, subject to a maximum deduction of £30,000, i.e. leaving you with an annual allowance of £10,000.

For example, if your income is £130,000 and your employer pays £30,000 into your pension, your total ‘adjusted income’ is £160,000. Your annual allowance is then reduced by £5,000 (£10,000/2).

“Anti-avoidance” measures will apply so that any salary sacrifice arrangement set up on or after 9 July 2015 will be included in applying this reduction. Please note, too, that contributions above your available allowance may incur a tax charge at your marginal rate.

What might you do?

If you might be affected then, once it is in place, there’s little you can do about it. But before 6 April 2016 you still have the opportunity to use the full annual allowance – and any unused allowance from the last three tax years, including the 2015/16 “double allowance”.

Double the opportunity

If you made a pension contribution from 6 April 2015 to 8 July 2015, you might also be able to contribute up to a further £40,000 under the transitional arrangements arising from the Summer Budget 2105. That could mean total contributions of up to £80,000 would be allowed in 2015/16. Please bear in mind that where you contribute more than the Annual Allowance (taking into account any “carry forward” availability) the tax relief you have received can be reclaimed by HMRC through a tax charge.

To receive tax relief, your total contributions should not exceed your earnings. Where you have no “relevant earnings” or earn less than £3,600, you can contribute £2,880 which then receives tax relief of £720 to give a total of £3,600.

Reduction in the Lifetime Allowance from 6 April 2016

What is the change?

Also announced in the 2015 Summer Budget, from 6 April 2016 the Lifetime Allowance – the total value of all your pensions, both employer and personal – will reduce from £1.25 million to £1 million. This value is measured at the point at which you start to draw on your pension (or at various other times such at age 75) and includes investment growth and income. Should you exceed the LTA, you can either take the excess as a lump sum, subject to a 55% charge OR keep it in your pension less a charge of 25%. Income from that pension is then taxable at your marginal rate. Whilst £1 million may still sound a lot, and most people will not be affected, if you are concerned that you may be, it makes sense to look at what your pension might grow to.

For example, take a pension currently worth £400,000, with contributions of £6,000 p.a. (including tax relief) and capital growth and investment income equivalent to 6% p.a. Over 15 years that pension value could grow to over £1m. And if that was the case, anything over the Lifetime Allowance becomes taxable.

What might you do?

A lifetime allowance was first introduced in 2006 (a date often referred to as “A day”.) It was then amended in 2012 and 2014, and is now being amended again. You may already have applied for protection under the 2012 or 2104 schemes. If not, you can apply for “lifetime allowance protection 2016”, effectively crystallising your allowance up to the current level. There are two types of protection available:

Fixed protection 2016 – you retain an LTA of £1.25 million but cannot make any further pension contributions after 5 April 2016. (Investment income and growth does not count as a contribution.) Making contributions would re-set your LTA to £1 million.

Individual protection 2016 – this will be equal to your pension value as at 5 April 2016, subject to a maximum of £1.25 million. Further contributions can still be made. For example, if your pension is valued at £1.2 million as at 5 April 2016 and you obtain individual protection, should your fund then grow to £1.25 million, you will incur a lifetime allowance charge on the excess of £50,000, whereas applying for Fixed protection would have given you the full £1.25 million allowance. To apply for either protection scheme you will need to write to HMRC – although a new online application process should be available from July 2016. You can learn more about the lifetime allowance changes and applying for protection at the HMRC’s website.

We hope you have found this information helpful in planning your pension contributions over the next couple of months and beyond.

For details of how to open a SIPP account with Motley Fool Share Dealing please click here.