David Revell, Senior Pensions Specialist, gives us his thoughts on whether the pension tax system is actually simpler
In my humble opinion, I believe the answer is no – but let me explain why. With limited space (and time) in this newsletter, I cannot go into all the facets of the simplified regime so let me just focus on the Annual Allowance (AA) and how this has changed over the past decade for now.
As those in pensions will all know, the AA is the annual limit against which pension accrual (Defined Benefits (DB)), or contributions (Defined Contributions (DC)) is tested to see if there is a tax charge on the excess.
The AA limit
At its inception on 6 April 2006, the AA limit was set at £215,000 and this progressively increased over the next four tax years to £255,000. At this time there were few (if any!) members that breached this limit and, in reality, things were indeed ‘simplified’ – gone were the complex pre-6 April 2006 rules governing the maximum contributions that could be paid in!
Then, on 6 April 2011, the AA decreased to £50,000, with a further reduction on 6 April 2014 to £40,000. Legislation is now in place to increase this by the Consumer Prices Index from April 2018.
Factors, tax charge, scheme pays and carry forward
The original factor used to convert DB pension accrual when testing against the AA limit was 10:1, but this changed to 16:1 in the 2011/2012 tax year.
When it comes to the rate of the AA charge on pension savings over the AA, until 5 April 2011, this was 40%. Under the Finance Act 2011 the AA charge rate was changed to the individual’s marginal rate of income tax (which could, at this time, be 50%). The Government believed certain individuals would maximise contributions in the tax year running up to this change and so they brought in anti-forestalling requirements (under a Special AA) that would effectively reduce the AA to £20,000 or £30,000 under special conditions, but these complexities were just a short term measure and were removed the following year.
Following the reduction of the AA to £50,000, two mechanisms were introduced to help impacted members deal with the change. These were “scheme pays” - which allowed the AA charge to be paid by the scheme and “carry forward” - which allowed unused AA (up to £50k or £40k from 6 April 2014 onwards) from the previous three tax years to offset the tax charge in the tax year in question.
DC Flexibility – The Money Purchase Annual Allowance (MPAA)
The next change came with the arrival of DC flexibility on 6 April 2015, this date heralded DC flex and also the MPAA. This new AA restricted (from the trigger date), all future DC contributions to a pension scheme to a MPAA of £10,000. It also meant that, if a member was also in a DB scheme, their DB accrual would be restricted to the alternative annual allowance (currently £30,000).
Aligning Pension Input Periods (PIP’s) and the Tapered Annual Allowance (TAA)
On 8 July 2015, the Government announced that all open PIP’s (this is the period in which accrual/contributions are measured and could previously be any period within the tax year lasting normally 12 months) would be aligned with the tax year from 6 April 2016. This then gave the Government the opportunity to introduce the last of the changes to date, the so-called Tapered Annual Allowance which effectively reduces the AA of the high earning members by up to as much as £30,000 if they have an adjusted income (all taxable income and pension contributions) of £210,000 or more.
So, is this a simplified system - I’ll let you make your own mind up!