High earners and pensions - high income excess relief charge (tax years 2011/12 onwards)

The background

In the 2009 Budget, Mr Darling announced the restriction of tax relief on pension contributions for individuals who earn at least £150,000 from 6 April 2011. Relief is to be tapered away so that for those earning £180,000 and over, it will be worth only 20%, the same rate received by a basic-rate income taxpayer. A formal consultation on the implementation of the restrictions (along with draft legislation) was launched in December 2009 and legislation for the core aspects was enacted in the Finance Act 2010 by the former administration. Certain aspects were said to be subject to further consultation, the intention being that there would be additional legislation in the Finance Bill 2011 and/or further regulation in due course. The new administration might have different ideas, as mentioned earlier, so the following analysis is based on current legislation which may well change.

High income individuals (or "high earners" as they are sometimes called)

Only "high income" individuals need worry. That is anyone with a "gross income" of £150,000 or more, provided they also have a "relevant income" of at least £130,000. The concept of the £130,000 "income floor" was introduced in December 2009. It is calculated by reference to the individual's pre-tax income, excluding the value of any employer pension contributions. The individual has to work out whether he/she has £130,000 of pre-tax income, before any deduction for their own pension contributions and charitable donations, but without taking into account any employer pension benefit. If they do, then the charge will apply if he/she also has a gross income of £150,000 or more.

However, for the purposes of determining whether an individual also has a gross income of £150,000 and over, it is necessary to include both the individual's pre-tax income (including the value of their own pension contributions and any charitable donations as before) and the value of any pension benefit the individual receives from others, such as employers' contributions to pension schemes.

The devil is in the detail, as always

While the intention might be straightforward enough, the implementation is far from it! If the individual has a "high income" the high income excess relief charge applies at "the appropriate rate" of his/her "total pension savings amount".

The charge and the taper

The "appropriate rate" of the charge varies between 0 and 30%, depending on whether the individual's pension savings were originally relieved at the basic, higher or additional rates of tax. In addition, a "taper" (effectively an adjustment) applies where the individual's income is less than £180,000 but more than £150,000. The intention is that the rate of tax relief available to the individual is scaled down from 50 to 20% as gross income increases from £150,000 to £180,000, with the result that there will be 1% of relief for every £1,000 of gross income between these figures. Individuals on incomes of £180,000 and over will receive 20% relief only.

Valuing pension contributions

What is the high earner's "total pension savings amount"? This depends on the types of scheme in which the individual participates. In the case of defined contribution schemes, the legislation simply states that it is the total of the relievable contributions paid by the individual and the employer.

The total pension savings amount in the case of a defined benefit scheme is a "deemed contribution" i.e. the combined increase in value of the individual's pension and any lump sum over the course of a tax year. The increase in pension is the difference between "the opening pension" and "the closing pension" (as adjusted by reference to, for example, credits, debits and transfers into or out of the scheme), multiplied by two-way age-related factors (ARFs). The same principles apply to determine the increase in any lump sum over the year. The opening or closing pension is the annual rate of pension which the individual would, (on relevant assumptions), be entitled to at the start or end of the tax year, as appropriate.

The two-way ARFs were intended to reflect age and normal pensionable age (to be reviewed by HM Treasury at least every five years). Flesh for the bones of these two-way ARFs is awaited but the previous administration had indicated that differences between public and private sector schemes would be ignored, along with gender differences and the risk of an employer insolvency. Mr Darling also indicated in March this year that where the figure turned out to be negative, this should be fairly recognised by future legislation, which would also provide details on how the retail prices index would be taken into account.

Whatever the nature of the scheme, the previous administration was of the view there should be no charge where the individual becomes entitled to a serious ill-health lump sum or dies.

Calculating and collecting the restriction of relief

This will be delivered through self assessment. The previous administration was considering the way in which employers should be obliged to identify employees to whom they provide gross pay and benefits of £130,000 and over and whose pension they contribute to, their idea being that the employer should request, on the employee's behalf, a benefit statement from any pension scheme they sponsor. Mr Darling had intended that the precise scope of obligations for employers and pension schemes with regard to the information to be provided to individuals to enable them to meet their tax obligations would be set out in regulations in autumn 2010, so again, this would require the new administration to bring forward legislation if they are to embrace the charge.

Mr Darling also intended that individuals who incur charges of over £15,000 should be able to ask their pension scheme to pay the charge on their behalf and to reduce their pension pot for the year by an actuarially appropriate amount in return, known as "scheme pays", (whether the scheme is DB or DC). That said, he would have been likely to introduce some exemptions to that general rule, for example, where the scheme is underfunded or it would unfairly favour the individual over other scheme members. Where the individual is in more than one scheme, the intention was that he/she would need to elect which scheme is required to pay, but the scheme would only have to pay the portion of the charge due to contributions (or deemed contributions) to that scheme.

The previous administration intended that individuals with charges exceeding £15,000 where the scheme does not pay should be able to spread payment of the charge over three years, with an interest payment on the deferred element being incurred. Again, it's not clear what the new administration will do.

Exceptions and exemptions

To mitigate the impact on individuals receiving a redundancy payment, the previous administration had intended to exempt the first £30,000 of a redundancy payment from the income definition. As mentioned above, there was also to be an exemption for individuals who draw a serious ill-health lump sum or die in that tax year. Where schemes wind-up before April 2011, surplus funds distributed to members were intended to be outside the scope of the charge.

And finally...

The previous administration had decided not to align pension input periods with the tax year and confirmed that the restriction of relief should apply in the year of drawing benefits, to operate an "income look-back test" in the relevant year to determine the restriction.

Though some of the previous administration's proposed intentions were relatively clear, it will not be until the remaining legislation has been drafted that we will know the final shape and scope of the charge.

And what does the change in government mean? Hopefully, all should become clearer after the budget on 22 June 2010. Watch this space!