High earners face pension tax trap

Thousands of higher earners risk triggering big tax bills if they don’t take action to adjust their pension contributions ahead of a steep drop in the annual saving limit.

This warning comes from financial advisers ahead of the lowering of the annual allowance for pension contributions from £255,000 to £50,000 on April 6.

Individuals who breach the new £50,000 contribution cap face tax charges at their marginal rate – so high earners are most at risk of being caught out by the changes. Companies have already started to identify executives at risk of exceeding the annual allowance, and also those who risk breaching the new lifetime allowance, which will fall from £1.8m to £1.5m from April 2012.

“We are finding that employees may have signed up some years ago to, say, £30,000 per annum of matching pension contributions with their employer, to give a total contribution each year of £60,000,” says Mike Fosberry, director at Smith & Williamson, the accountancy and financial services group. “Now, individuals must urgently renegotiate such arrangements.”

Advisers urge anyone who thinks they could be caught by the new rules to take action before April 6.

Cash allowance

Anyone at risk of breaching the £50,000 annual allowance could negotiate with an employer for the payment of a cash allowance instead of a matching
pension contribution. This cash allowance would, in effect, be a pay rise that the employee agrees to accept instead of the pension contribution.

“Senior executives are being offered a cash allowance if saving into a final-salary scheme is no longer as tax efficient,” says Stephen Green, senior consultant at Towers Watson, a professional services firm. He warns that a decision to halt contributions into a final-salary scheme should not be taken lightly,
but says this option would
make sense for individuals whose contributions
were likely to be well above the £50,000 threshold.

Bonus deferral

Employers can help their employees stay under the new contribution limit by offering them the option to defer a bonus payment.

Currently, employees ear-ning more than £130,000 a year are restricted from boosting their pension contributions by anti-forestalling rules. But advisers say a new “carry forward” facility will make putting a deferred bonus into a pension an attractive option.

This “carry forward” rule will allow three years’ worth of unused pension contributions to be rolled forward – with the amount that can be carried forward per year set at £50,000, making a maximum of £150,000.

“Therefore, if people have not paid in £50,000 per year in the tax years 2008/09, 2009/10 and 2010/11, they can roll any unused relief forward to 2011/12 and make those extra contributions as long as they were a member of a registered pension scheme throughout the period,” says Fosberry.

Jerry McLoughlin, of Punter Southall, a firm that advises companies on pension schemes, says: “Employers are holding off so that the bonus can be paid into the pension pot in the new tax year. This is really to take advantage of the carry-over facility.”

Pension input
period warning

Individuals hoping to make the most of the current £255,000 contribution limit are being urged to check their pension input periods (PIP) before making a contribution.

Advisers say that some individuals could inadvertently expose themselves to a tax charge because some pension schemes have PIPs that do not coincide with the tax year. For example, a scheme could have a pension input period of January 1 to December 3l. A member of this scheme who tried to make a £100,000 contribution before April 6 would face a tax charge as the PIP ends in December 2011, which is in the 2011/12 tax year and subject to the new £50,000 limit.

“You need to be check your input period before making a contribution into a scheme before April 6,” says Green of Towers Watson.

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