High earners need to act now or risk surprise tax bill
More employees could be hard hit by both the intended and ‘unintended consequences’ of lifetime allowance and tapering changes unless they take action now, warns Darren Laverty, partner of employee benefits specialist Secondsight
Radical changes to pension schemes being introduced by government from 6 April 2016 could leave high earners with unexpected and unwanted tax bills of up to £13,500.
From 6 April 2016, the annual allowance will be tapered from £40,000 for those with earnings of £150,000 or more down to £10,000 for those with income of £210,000 or more.
Income will no longer just be comprised of someone’s salary, it is ‘adjusted’ to include employer pension contributions or any other income including savings, bonuses or even an individual’s buy-to-let property rental – taking many more people into a higher earnings bracket. The annual allowance will reduce by £1 for each £2 of adjusted earnings above £150,000 until it reaches £10,000.
Many individuals and employers aren’t aware of the impact of the tapering of annual relief. If employees earning £150,000 or more don’t reduce their pension contributions from 6 April, they will be taxed at 45% on any excess and face a surprise tax bill of £13,500 when they submit their tax return. This bill will be due for payment to HMRC by the 31 January following the end of the tax year.
If people act now, they can reduce the possibility of their tax liability. They can either carry forward any leftover pension allowance from previous years or take advantage of the transitional Pension Input Period (PIP), which will provide the opportunity of making a total payment of up to £80,000 into their pension pot this year.
“As little as £1 paid into the pension after 6 April,
could unwittingly lead to a tax liability of £137,500″
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 may be liable to 55% tax on any amount over the limit if the excess is taken as a lump sum. If any of the excess is instead taken as income, the tax charge is 25% although the income itself will still be subject to income tax at the recipient’s marginal rate.
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 £358,000 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 £463,000 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.
So what should companies and individuals do to mitigate these risks and protect themselves?
Employers and individuals need to understand who will be affected and consider all their options before 6 April. Individuals can apply for fixed protection, at £1.25m, but they will need to stop their pension contributions completely by the 5 April, at least whilst they consider their options.
However, those who switch jobs need to be aware that joining any new pension based group death in service 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 up to£137,500. If people don’t take action before April, it will be too late. As little as £1 paid into the pension after 6 April, could unwittingly lead to a tax liability of £137,500.
From now until April, employers have a window of opportunity to communicate the pension changes to their employees, educate them on their options and take action to protect them from the impact of these changes.
Secondsight is part of Foster Denovo Limited
Visit the Secondsight website