Annual allowance case studies
All case studies are high level/simplified examples to highlight possible scenarios where the change to the annual allowance could cause problems or raise opportunities.
No impact scenario
My name is Steve and I’m in my late forties. Over the last three tax years my relevant income has been £65,000. My financial adviser has already confirmed that the level of my income isn’t high enough for my pension contributions to be impacted by the anti-forestalling rules currently in place.
In theory I could contribute up to 100% of my income to my pension and still receive full tax relief. As it is, I’m quite happy with the contributions I’ve been making which are normally in the region of £20,000 a year. I’ve already built up a pension fund close to £300,000 and with a number of years before I’m considering retiring, I feel that I’m on track for a comfortable retirement.
I’ve heard that things are changing from April 2011 so spoke with my adviser to better understand my position.
He confirmed that from 6 April 2011, the amount that I’ll be able to contribute into my pension and receive tax relief on (known as the ‘Annual Allowance’ ) will be reducing to £50,000 each tax year, but as this is significantly more than I can currently afford to contribute, there won’t be any impact on my immediate pension planning.
He also confirmed that, as the Government are reintroducing ‘carry-forward’, if I don’t pay in £50,000 in a tax year, I’ll be able to contribute the difference between my contributions and £50,000 in one of the three following tax years. So, if I was to come into any money on top of my expected income, I’d be able to make a one off contribution in excess of £50,000, still get my tax relief at 40%, and I wouldn’t generate an annual allowance charge.
My adviser also told me that the lifetime allowance, the total amount of pension saving that I can build up without a tax charge when I come to purchase an annuity, is decreasing from £1.8m to £1.5m from April 2012. As I am not expecting to retire with a fund size in excess of £1.5m, we agreed that this doesn’t represent an immediate concern unless I radically change the level of my pension contributions in the near future.
Worst case scenario
My name is Isabella, I’m in my early fifties and hope to retire within the next ten years. In order to achieve this, I’ve been paying increasing attention to pension planning. Over the last three tax years, my income has been above £130,000 and I’ve been caught by anti-forestalling legislation which limits my pension savings ahead of changes to the availability of tax relief due to take effect next April.
The anti-forestalling rules could have restricted my contributions to £20,000 a year, but fortunately I’d been making regular monthly contributions totalling £70,000 a year. As a result of what my adviser described as my ‘protected pension input amount’ I’ve been able to continue to contribute at this level for the last two years.
As I’ve been making large contributions for some time now, my pension fund is already worth over £1m.
After the Government announced revised plans for the rules that will apply from 6 April 2011, I spoke with my financial adviser to find out what these changes will mean for my pension planning.
He told me that the anti-forestalling rules that have prevented me from increasing my pension contributions for the last two years are coming to an end. However, rather than meaning that I can now accelerate my pension saving, I’m actually going to have to reduce my contributions. I’m only going to be able to pay in £50,000 a year going forwards – a lot less than I’ve been paying in to date. Apparently my ‘protected pension input amount’ only applies during the anti-forestalling period.
If I decide that I want to carry on paying in £70,000 a year, then I’ll no longer receive tax relief on any amount over £50,000. As tax relief was a key reason for putting money into my pension, I’m going to have to talk this through at length with my adviser to see what alternatives are available to me.
He also warned me that while the government has introduced something called ‘carry-forward’ to let unused annual allowance from previous tax years be used to reduce the likelihood of an annual allowance charge, this won’t apply to me. I don’t have any unused annual allowance so any unexpected spikes in my pension contributions could generate an annual allowance charge.
We then moved on to the subject of the lifetime allowance, which is being reduced from £1.8m to £1.5m. As my fund value is already over £1m, the level contributions I planned to make over the next ten years mean that there is a strong chance that I’ll exceed this limit. Apparently, details of what protection might be available to protect my fund from a lifetime allowance charge haven’t been announced yet, so we are going to have to meet in another couple of months to discuss this. Again, this might involve me having to find additional or alternative ways to invest for my retirement.
Opportunities in this tax year
My name’s Martin and I’m currently 45. I started saving for my retirement later than I should have, but I’m now trying to make up for this by paying in as much as I can afford to. I’d like to retire when I turn 55, but as I started saving late, this is perhaps an aspirational target.
In the last couple of annual reviews with my financial adviser we’ve discussed something called ‘anti-forestalling’, which he described as the rules that the Labour Government put in place to restrict access to tax relief ahead of changes to pensions due to be introduced from 6 April 2011. As I earn £125,000 a year, I’ve been just under the threshold where my pension contributions are effectively restricted by these rules.
My adviser has explained to me previously that I’ve been losing my personal allowance at a rate of £1 for every £2 I earn over £100,000. As such, we agreed that my pension contributions including tax relief needed to be at least £25,000 to offset this. As it is, I can afford to contribute between £60,000 and £70,000 a year. Some of this is made up of regular contributions, and I add a single payment at the start of each year when I normally meet up with my adviser to review my finances.
Having heard about the changes announced by the coalition Government, I booked a meeting with my adviser ahead of our normal January review to see whether there were any opportunities or issues for my pension saving.
He told me that from 6 April 2011 I’m only going to be able to pay £50,000 a year into my pension. As I’m trying to build as large a fund as possible before I turn 55 this isn’t great news from my perspective and we’re going to have to do some additional work together to identify different saving and investment strategies to fund my retirement.
We also discussed my pension input period. Apparently my current pension input period ends on 31 January 2011. This means that the transitional arrangements, which could have limited the contributions I make after 14 October 2010, won’t apply to any contributions I make before 31 January. I have the opportunity to make a one off contribution of up to 100% of my income, and I can receive 40% tax relief on the lot! My employer contributions can be counted on top of this, as long as they don’t lead to total contributions over £255,000 (the level of this tax year’s annual allowance).
As this is a one-off opportunity before the rules change I’m going to make the most of it. I can afford to make a larger than usual contribution on the grounds that I’ll be able to replace the savings I’m using to fund it over the coming tax years when my pension contributions will need to be decreased.
Opportunities in the next tax year
My name’s Kay, I work in advertising and my income is £170,000 a year. I’m currently in my early fifties and looking to start reducing the amount of time I spend working, before retiring fully at 60. I’ve been contributing 10% of my salary to my pension for the past few years, but want to top this up as much as possible over the next couple of years before my income starts to reduce.
I meet with my adviser on a regular basis to discuss my pension planning. Over the last couple of years my contributions have been restricted by anti-forestalling legislation.
When the anti-forestalling rules came into effect, I was making regular contributions to my pension totalling £17,000 a year and receiving full tax relief. The rules meant that while I could continue to contribute this £17,000, if I increased my contributions I’d incur a tax charge to limit my tax relief to the basic rate on any contributions above £20,000. As a result, I increased my contributions to £20,000, but haven’t made any additional pension contributions.
After hearing the coalition Government’s proposed changes to the availability of tax relief planned from April 2011, I immediately booked an appointment with my adviser to see if there was an opportunity for me to start increasing my contributions.
My adviser took me through the changes to the annual allowance. From 6 April 2011 I’ll be able to increase my contributions from £20,000 to £50,000 and receive tax relief at up to 50%. This is good news as it’ll help me to accelerate my pension saving over the next couple of years.
I had been hoping that the new rules would allow me to also make an additional one-off contribution into my pension, but it turns out that the anti-forestalling rules will still apply until 6 April 2011. However, my adviser talked to me about something called ‘carry-forward’. It means that I can make contributions above the £50,000 limit from the 2011/12 tax year onwards by carrying forward any unused annual allowance from the previous three tax years. Admittedly this will use the new lower annual allowance figure of £50,000, but it’s still good news from my perspective.
My contribution history for the last three years has been:
2008/09: £17,000 (£33,000 unused annual allowance)
2009/10: £20,000 (£30,000 unused annual allowance)
2010/11: £20,000 (£30,000 unused annual allowance)
As a result, carry forward means that I can make an extra £93,000 in contributions over the next three years. We discussed a couple of different options for how to get the most benefit out of this opportunity for me.
– In the next tax year, I could make a contribution up to £143,000 (my £50,000 annual allowance and the £93,000 unused allowance carried forward). I’ve got enough relevant income to make this contribution and receive up to 50% tax relief on it, and I’ve got the funds available to make the investment.
– Alternatively, as I’m losing £1 of my personal allowance for every £2 I earn above £100,000, I could, in theory, spread the £93,000 over three tax years, making a contribution of £83,000 in 2011/2012 (£50,000 annual allowance and £33,000 unused annual allowance from the 2008/2009 tax year), followed by £80,000 in the following two tax tears (£50,000 annual allowance and £30,000 unused annual allowance) . These contributions will receive tax relief of up to 50%, and will be enough for me to reclaim my personal allowance.
As I can’t take advantage of the new rules until the start of the new tax year, we’re going to meet again in a month’s time to work out how much I can afford to contribute and exactly how much I benefit from each option.
