Pensions tax changes

The Spring Budget included some changes to pensions tax. Our pensions advisers ISIO outline the detail behind this, the implications for pension scheme members, and what your housing association should consider.

The pensions talk in the lead-up to the Budget centred around the NHS.  Hospital doctors and GPs have been struggling with the annual allowance taper ever since it was introduced in 2016, but it has come to a head in this tax year with many more doctors refusing extra shifts and GPs in particular talking about early retirement. 

In addition, there had been some speculation that a cash-strapped government might be tempted to implement, or at least reopen consultation on, more drastic reform of the pensions tax system such as introducing a flat rate of tax relief.

What happened in the Budget?

Pensions tax got a bit simpler, but only in respect of the taper.

In the end there was just one headline change:

• The annual allowance tapering has been alleviated with both earnings thresholds raised by £90,000, and with the new fully tapered annual allowance reduced to £4,000 down from £10,000.

There were also a couple of other announcements:

• The lifetime allowance increased in line with CPI to £1,073,100 for tax year 2020/21.
• A call for evidence would be published in due course on the continuing issue for lower earners in net pay schemes who do not receive the 20% tax credit that their counterparts in relief at source schemes do.

The taper easement

An easement in the annual allowance taper had been widely trailed in the press prior to the Budget. For most individuals, the standard annual allowance of £40,000 applies. But higher earners – under the current rules this is those with ‘threshold income’ above £110,000 a year and ‘adjusted income’ over £150,000 a year – will have their annual allowance reduced by £1 for every £2 of excess income. 

A minimum allowance of £10,000 applies to those with adjusted income over £210,000. Threshold income is, broadly, income from all sources, but excluding the value of pensions input, and adjusted income is income including the value of pensions input.

From tax year 2020/21, both income thresholds will be increased by £90,000 (to £200,000 and £240,000 respectively), with the minimum allowance falling to £4,000 for those with adjusted income over £312,000.

This change comes with an estimated cost of £2bn over five years at a time of significant spending constraints. And it comes with no real cost mitigation either, except the reduction in the annual allowance to £4,000 for the very highest earners. It might have been expected that such a large increase in the taper would be accompanied by a modest reduction in the annual allowance for all.

What does it mean for pension scheme members?

The result of this change is an unexpected tax windfall for higher earners.  Whilst the new taper is a worsening of the position for anyone with income over £312,000, it is an improvement for everyone else who was previously affected by the taper. 

Anyone with total income below £240,000 will have the full annual allowance for pensions savings of £40,000 from next year. Those who gain the most are in the range £210,000 to £240,000, who pick up £13,500 a year. So there are two groups that benefit:

• Many members of defined benefit schemes will face a reduced annual allowance charge. This will particularly be the case for those who currently exceed their annual allowance, because a large part of their total earnings is pension accrual.
• Members of defined contribution schemes who have limited their pension contributions to a reduced annual allowance or opted out of saving altogether will now have more capacity to make new pension savings.

For both groups it is the same result – more tax-free pension savings than before – but thought needs to be given to how this is communicated to scheme members. For example, members of Defined Contribution schemes who are considering paying more need to be reminded to check their lifetime allowance position as well.

What action could you take?

If your organisation offers a cash alternative to a pension for your higher earners you may want to review this, and to consider eligibility for the cash alternative, such as the salary thresholds. The below scenarios may also be worth thinking about:

• If you offer modelling tools, or access to advice or guidance to enable your senior people to make their pensions tax decisions, you may want to review this.
• If you offer a flat £10,000 a year will you reduce this to £4,000 and at what earnings level?
• How will you communicate with employees about this? This is something that both employers and pension schemes will need to consider.
• If you have not yet passed the payroll deadline, would it help your employees to defer a bonus payment due in March so that it is received after 5 April?