Tax relief warning for high earners

High earners are being warned that the government could impose further restrictions on pension savings in the emergency Budget on June 22.

Accountants and wealth advisers report a flurry of calls from clients earning more than £100,000 who are concerned that further changes to pension tax relief could restrict their ability to save for retirement.

Rules restricting how much high earners can pay into a pension were put in place in 2009. Anyone earning more than £130,000 can now only put a maximum of £20,000 a year into a pension, with some exceptions (see chart for details).

These so-called “anti-forestalling measures” are meant to stop the highest earners pumping their pensions full of cash before higher-rate tax relief is restricted next year. From April 2011, higher-rate relief will be tapered from 40
per cent down to 20 per cent for people earning £150,000 to £180,000.

But accountants warn that people earning less than £150,000 could see their tax relief restricted
as well. The Liberal Democrats had stated before the election that they would
cut higher-rate pension tax relief completely. Grant Thornton, the accountancy firm, thinks it is “likely” that the government will lower the threshold for higher-rate relief in June.

But Mike Warburton, tax partner at Grant Thornton, says this does not necessarily mean that high earners need to pay more into their pensions immediately.

He does not expect the government to change the anti-forestalling measures – meaning that, if any changes are made, those earning under £130,000 should have until next April to top up their
pension.

However, others say that cautious investors should take action sooner. Chris Noon, partner at Hymans Robertson, says that while he does not expect the government to lower the contribution limits, anyone who thinks this is a risk should top up their pensions as much as possible before the Budget, just in case.

Those earning above £150,000 have been advised to top up their pensions as much as possible since the beginning of the current
tax year.

As the highest rate of income tax has gone up to 50 per cent, but restrictions on tax relief do not come into effect until next year, high earners have a one-year window to pay into their pensions and get 50
per cent tax relief – albeit with the annual restriction of £20,000.

However, consultants warn that people may be caught out by restrictions without realising it. Ray Pygott, partner at KPMG, says that anyone earning more than £100,000 should review their pension arrangements, as they may have other sources of income – such as bonuses or rental income – that
will push them over the current limits.

Some consultants fear that the restrictions, and other tax charges being introduced, will ultimately turn high earners off pensions altogether.

From next April, those earning over £150,000 will have their employers’ contributions to a pension taxed as a benefit in kind at 30 per cent. Then, if they are still higher-rate tax payers when they retire, they will have to pay 40 per cent on the income payouts from their pension. In effect this adds up to a 70 per cent
tax hit.

“A lot of people will be disadvantaged by being in pensions – I think we’ll see high earners coming out of pensions altogether and looking at alternatives,” says Pygott.

Noon at Hymans Robertson says that, unless investors can be sure they will be basic-rate taxpayers in retirement, they should not pay into a pension at all from next year.

Investors are already turning to other investment schemes that offer tax breaks, such as venture capital trusts, which offer 30 per cent tax relief on an investment.

Companies are also scrambling to put alternative schemes in place for their high earners. These schemes can include corporate individual savings accounts (Isas) – where the company pays into an
Isa on behalf of its employee – share plan schemes and offshore savings schemes known as employee-funded retirement benefit schemes (Efrbs).

But the pensions industry believes that cutting high earners out of pensions will have knock-on effects for workers on lower salaries, as company directors are often active in supporting pension schemes for the whole workforce.

“We’re getting the hint that this could hasten the closure of more pension plans,” warns Pygott.