Pension claw backs for higher income earners
From 6 April 2011, people with annual income of £150,000 or over will see the higher rate tax relief on their pension contributions (including the value of any employer contributions) tapered. The taper will reduce the relief by 1% for every £1,000 of income over the level of £150,000 until the basic rate is reached. This means that where income reaches £180,000 and over, tax relief on pension contributions shall be restricted to 20%.
The claw back of this relief will be via a new high income excess relief charge payable through the self assessment system.
Anyone considering making large pension contributions prior to the introduction of the new rules will be caught by the anti-forestalling regulations already in place. These rules restrict tax relief on 'irregular' pension payments to 20% (the 'special charge') and care needs to be taken for anyone with income over £130,000. These rules are complex.
The impact of the relief claw-back can lead to eye watering effective tax rates.
For example, if an individual earning £165,000 makes a contribution of £40,000 into a pension plan, under the new rules their pension relief will be tapered to 35% (£14,000). If their earnings increase by just £10,000, the level of pension’s relief is reduced to 25% (£10,000) so the claw back is an additional £4,000. On top of the additional claw back is the normal income tax and national insurance contributions they pay on the additional earnings of 52% (£5,200). So from a £10,000 salary increase an individual will receive just £800 in their pockets.
In a further blow, there will be no further increases to the lifetime allowance and annual contribution limits. These limits will now be frozen at £1.8 million and £255,000 respectively for a further five tax years.