High earners and pensions - special annual allowance charge (tax years 2009/10 and 2010/11)

In order to prevent individuals from trying to make additional pension contributions prior to the reduction of tax relief in April 2011, the previous administration introduced "anti-forestalling" provisions, featuring a "special annual allowance charge" in the Finance Act 2009 (with retrospective effect from 22 April 2009).

Very broadly, the anti-forestalling provisions impose a charge on people whose income is more than £130,000 who change their normal ongoing regular pensions savings and whose total pensions savings (including Additional Voluntary Contributions (AVCs) and regardless of whether the contributions are made by the employer or the employee) in the relevant tax exceed the "special annual allowance". The special annual allowance is £20,000 but rises to £30,000 in limited circumstances and is reduced to nil in other circumstances. The charge is 20% for the tax year 2009/2010 rising to 30% for the tax year 2010/2011.

Since the introduction of the anti-forestalling provisions, the Treasury introduced certain relaxations, in part to assuage industry concerns.

Is the individual a "high-income individual"?

The charge applies only to "high-income individuals". This is where the individual's "relevant income" is £150,000 or more up to 8 December 2009 or £130,000 from 9 December 2009. What is "relevant income"? This is widely defined and extends beyond an employee's normal earnings. It includes all income from whatever source (e.g. dividends, IP rights, property letting) so the individual has to identify his or her "total income". Once that has been determined, the individual then has to add various amounts (e.g. amounts deducted from employment income such as pension contributions deducted under net pay arrangements) and deduct certain reliefs. If the individual's employment income has been reduced by post 22 April 2009 (or post 9 December 2009 as appropriate) salary sacrifice schemes, the amount which would otherwise be employment income also has to be added back in. Employer's contributions are not taken into account when working out whether the individual reaches the £130,000 level.

The rules are complicated so anyone "on the border line" needs to take care to ensure that the correct deductions and additions to their "total income" have been made. If the individual is not a "high-income individual" for the tax year 2009/2010, if he/she would have been for any of the previous two tax years, he/she will be deemed to be a high-income individual. For instance, anyone whose income has reduced for the tax year 2009/2010 will need to consider whether the charge applies by virtue of their income in the previous two years.

Once it has been established that the individual is a "high-income individual", the next step is to determine their pension savings for the tax year.

Is there a charge then?

For high-income individuals, the charge is 20% (rising to 30% for the tax year 2010/2011 to reflect the 50% tax charge on the top slice of earnings) of the amount by which their "total adjusted pension input amount" exceeds the amount of their special annual allowance.

Broadly speaking, the charge is aimed at high-income individuals who increase their pension savings from 22 April 2009 over and above their normal regular pension savings made under arrangements that were in place before 22 April 2009 (or 9 December 2009 as appropriate). Consequently, if the high-income individual simply continues with ongoing arrangements, the special annual allowance charge should not apply.

The next step is to calculate the high-income individual's pensionable savings and see whether or not the charge applies, taking into account his/her "normal" savings pattern and the special annual allowance.

What is the high-income individual's "total adjusted pension input amounts"?

The high-income individual needs to determine how much pension contributions have been made by or on his/her behalf for the tax year in question. This is their "total pension input amount". Once that figure has been determined, the individual then deducts any "protected pension input amounts". These depend upon the type of pension schemes in which the individual participates and vary according to whether the schemes are defined benefits arrangements, money purchase arrangements or personal pension scheme arrangements.

In defined benefit schemes future accrual will be protected (and hence comprise a protected pension input amount) provided there has been no "material change" in the rules of the pension scheme to the way that benefits to or in respect of the individual are provided under the arrangement after 22 April 2009. HM Revenue & Customs' (HMRC's) guidance suggests that material changes are likely to include such things as changes in the method of calculating pensionable salary, increasing the accrual rate and including bonuses as pensionable salary. That said, there will still be protection where there is a material change to the way in which the benefits are provided if it affects at least 50 active members of the scheme (provided it is not done for the purposes of tax avoidance).

In relation to a new or reactivated arrangement (e.g. introduced after 22 April 2009), there can be no protected pension input amounts if:

• either the benefits the employer provides under the arrangement fall outside the normal pattern of benefits that the employer provides to its employees generally; or
• fewer than 20 other persons who are also employees of the same employer accrue benefits on the same basis as the individual.

All these rules are complicated and there are a number of scenarios which could take the individual out of the above exemptions, and mean that their pension contributions are no longer protected. Consider, for example, a situation where a company is closing its defined benefit scheme to future accrual and placing all employees (i.e. being more than 50 of them) into an existing/new defined contribution arrangement for future accrual. If employees with income over £130,000 are placed into an arrangement in which there are less than 20 employees (e.g. an arrangement providing higher employer contributions than for other employees) such contributions may be subject to the new tax charge.

The high-income individual may need to take further advice to determine his/her "total adjusted pensions input amount" but at least in theory (even if it is not that easily identifiable in practice), it is his/her "total pension input amount" less "total protected pension input amounts". If this calculation produces a positive figure, he/she must go on to calculate what his/her special annual allowance is in order to determine whether there is a charge.

Does "the total adjusted pension input amount" exceed "the special annual allowance"

To the extent that the high-income individual's "total adjusted pension input amount" exceeds the special annual allowance there is a charge at 20% for tax year 2009/2010, rising to 30% for the tax year 2010/2011. Consequently the individual needs to determine his special annual allowance. It starts off as £20,000 but is reduced (but not so as to be less than nil) by the individual's "protected pension input amounts".

This means that, where an individual's protected pension input amount is £20,000 (£30,000 in limited circumstances), the individual's special annual allowance for that year will be reduced to nil so any additional pension contributions made during the course of that year would therefore be subject to the new tax charge.

And it's the individual's responsibility to pay the charge, via self assessment. So don't forget - make sure your tax assessment for 2009/2010 is correct!

And what does the change in government mean? Who knows! If the new administration decides to abolish the charge, legislation would be required to achieve any change, given that it is already in place. All should become clear after the budget on 22 June 2010. Again, it's unfortunately a question of watch this space.