Pension savings: lifetime allowance and annual allowance to be frozen for five years from 2011/12
Individuals who are members of registered pension schemes are subject to a lifetime allowance on the total cumulative value of the pension benefits they draw from those schemes, whether they receive them in the form of a lump sum or a pension. The value of the benefits is measured at the time they commence. If an individual breaches this limit they are subject to a lifetime allowance charge. The rate of charge is 25% if the excess benefits are taken as pension income and 55% if taken as a lump sum.
The lifetime allowance for the current tax year is £1.65m and is due to grow to £1.75m for 2009/10 and £1.8m for 2010/11. The Chancellor today announced that the allowance will then be frozen at £1.8m for 2011/12 through to 2015/16 inclusive.
For example, an individual who, in 2008/9 takes a lump sum of £250,000, and an associated pension with a capital value of £750,000, would have 'crystallised' total benefits of £1m. Provided he/she had not previously crystallised benefits from any other pension arrangement, no lifetime allowance charge would arise, because the total cumulative benefits of £1m are less than the 2008/9 lifetime allowance.
The annual allowance is also being frozen for the tax years 2011/12 to 2015/16 inclusive, at £255,000. The annual allowance provides a cap on the total annual amount of tax-relieved contributions, or benefit accrual, that may be made into one or more registered pension schemes by or on behalf of an individual. Savings above this amount are subject to an annual allowance charge of 40%, payable by the individual. The rate for the current tax year is £235,000, rising to £245,000 in 2009/10 and £255,000 in 2010/11.
Potential effect of income tax rate increase to 45% from 2011/12
The top rate of income tax for individuals earning in excess of £150,000 will be 45% from 2011/12. This appears to mean that these individuals will be able to obtain tax relief at 45% on contributions to registered pension schemes out of the top slice of their taxable income.
The freezing of the lifetime allowance means that it will be even more important for those individuals with pension rights built up in approved schemes before 6 April 2006 to protect them, where appropriate, from the lifetime allowance charge. The deadline for doing so is 5 April 2009.
Those individuals for whom transitional protection (as above) is not appropriate, and who are aiming to save up to the lifetime allowance, will need to carefully assess their future contributions bearing in mind that the growth of their pension funds will count towards the lifetime allowance.
With pressure on annuity rates due to increasing longevity, anticipated low inflation and interest rates, retirees will potentially need to look for other savings vehicles to fund their retirement.
The potential increase in tax relief on pension contributions for those within the new 45% tax bracket from 2011/12 will mean that those individuals will have an extra 5% tax rebate to either spend or invest. This may explain in part why the pension allowances have been frozen.