Lightning storm

There have been some radical changes to pensions in recent years and in April 2016 further changes will be introduced by government that could leave high earners with unexpected tax bills of up to £13,500, with more employees hitting the lifetime allowance ceiling if they fail to seek advice and take action now.

From 6th April 2016, the annual allowance will be tapered from £40,000 for those with earnings of £150,000 or less to £10,000 for those with earnings of £210,000 or more. Whilst this will mostly impact high earners, there will be some people earning below £150,000 that may also be affected and people with a basic salary of more than £100,000 should also be seeking advice.

One of the big changes is that someone’s earnings will no longer be taken just as their salary, they will be ‘adjusted’ to include their pension contributions or any other income including savings, bonuses or even an individual’s buy-to-let property rental income. This change will take many more people into a higher earnings bracket. The annual allowance will reduce by £1 for each £2 of adjusted earnings above £150,000.

Employees who are earning £150,000 or more may also need to look at their pension contributions. From 6th April, they will be taxed at 45% on any excess over £10,000 and face a surprise tax liability of £13,500 when they submit their Self-Assessment tax return.

However, there are ways that people can reduce the possibility of their tax liability. They can either carry forward any leftover pension allowance from previous years (going back 3 years), or take advantage of the transitional Pension Input Period (PIP) which will provide the opportunity of making a payment of up to £80,000 into their pension pot this year.

Another major change is the reduction of the lifetime allowance from £1.25m to £1m. After April 2016, anyone who breaks through the £1m threshold will be liable to 55% tax on any amount over the limit. Again, many businesses and individuals are completely in the dark about the enormity of these changes and won’t realise how many people will actually reach the lifetime allowance cap.

Taking into account an annual growth rate of *5%, any individual with a fund currently worth £457,000 with 20 years to go until retirement is likely to hit the £1m ceiling. Similarly, someone retiring in 15 years with a pension pot today of £557,000 could also be affected.

An unintended consequence is that most ‘death in service’ benefits paid out will count toward the £1m – a factor which could leave a bereaved family with less than half of any expected pay out, once the tax is taken if death occurs whilst still in service

Employers and individuals need to understand who will be affected and consider all their options before 6th April. Individuals can apply for fixed protection, at £1.25m, but they will need to stop their pension contributions completely, at least whilst they consider their options. However, it is worth noting that the benefit of the pension contributions may outweigh the cost of the tax charge. Therefore individuals should seek financial advice before deciding whether to cease pension contributions.

However, those who switch jobs need to be aware that joining a new group death in service scheme that isn’t an ‘excepted’ scheme will cancel their fixed protection and could trigger a tax liability of 55% on the fund value between £1m and £1.25 – leaving them with a bill of £137,500. If people don’t take action before the 5th April, it will be too late. As little as £1 paid into the pension on or after 6th April, could unwittingly lead to a tax liability of £137,500.

From now until April, employers have a window of opportunity to put together a strategy for their high earners and communicate and educate their employees. These changes are going to affect a lot of high earners; however, taking advice and action now may save them the worry and expense of unexpected tax bills in the future

By Darren Laverty, Partner at Secondsight, part of Foster Denovo Limited