Pension relief restricted for high earners

High earners are being advised to make contributions to their pensions now, before higher rate tax relief is scaled back further from 2011.

Financial advisers also said that salary-sacrifice schemes were likely to become much more popular with higher-rate taxpayers keen to maximise their retirement benefits.

Alistair Darling, the chancellor, this week announced a further restriction on pension contributions for high earners following a clampdown earlier this year – attracting criticism from advisers, who said the rules were now very complex.

People earning more than £150,000 will see their tax relief on pensions cut from April 2011, tapering from 40 per cent to just 20 per cent for those earning more than £180,000, as set out in the Budget in April.

But this week those measures were extended. The restriction will now apply to those with “gross” incomes of more than £150,000, where gross income also includes employer pension contributions – so earners below the original £150,000 level could also be caught by the new rules. Earners below £130,000 will not be affected.

The government also introduced complex “anti-forestalling” measures this year to prevent earners above £150,000 from making top-ups of more than £30,000 a year to their pensions before 2011. These rules now also apply to those earning more than £150,000 under the new “gross earnings” calculation.

People in defined contribution pensions can easily work out whether they will fall into the new gross earnings level, as their employer contributions are a fixed percentage of their salary. But for those in defined benefit schemes, it will be harder. Tom McPhail, of Hargreaves Lansdown, suggested that employees ask the trustees of their schemes for a valuation.

Financial advisers warned that further restrictions on pension tax relief could be made in the future.

“Higher-rate taxpayers should beware the creeping tide of tax withdrawal,” said McPhail. “If you’re a higher rate taxpayer, get your money in your pension now.” He said those earning more than £130,000 should try to make the full permissible annual top-up over the next 16 months to benefit from possible higher rate tax relief of 50 per cent from next April.

High earners are also expected to make greater use of salary-sacrifice schemes, which allow some of their income to be paid directly into a pension. These schemes are expected to become more attractive to employers after national insurance rises from 2011 – making it cheaper for employers to pay into an employee pension, as their contributions do not attract national insurance.