Pension relief restricted for high earners

From 2011 pension tax relief for those earning more than £150,000 gross will be restricted and a new tapered regime will apply. Contributions in excess of these new limits will be subject to a 20% tax charge. The finer details of how this will work are still to be finalised.

In the meantime, "Anti-forestalling" measures have been introduced to prevent high earners topping up their pensions before the rules come in. For those whose total earnings are below this threshold, pension contributions up to 100% of their net relevant earnings will still be possible and relief will be granted at their marginal rate of up to 40%.

The measures for those affected will mean that contributions that will benefit from higher rate tax relief will be restricted to £20,000 and will include any employer/company pension scheme contributions. There is, however, a provision which allows this to be increased to £30,000 or part thereof should contributions (whether regular or irregular) in the last 3 tax years when averaged exceed £20,000 but with an averaged limit of £30,000. For example if a contribution of £100,000 had been made in any one of the last 3 tax years then the average over this 3 year period would be £33,333 but the maximum contribution limit would be £30,000.

Any contributions that exceed these limits will be subject to a 20% income tax charge thus neutralising the higher rate relief.

It is important to understand the definition of income for the purposes of this legislation as it covers earnings from all sources including dividends, employment income, self employed income, pension income, rent, interest and employer pension contributions. This test not only applies to the year of the contribution but also the 2 previous tax years. Therefore if income for any one of these years exceeds £150,000 then the provisions apply.

For employer contributions, the limit of £20,000 and up to £30,000 (based on previous years contributions) also applies if the recipient has exceeded the income limit defined above. The company will receive corporation tax relief at their marginal rate, but the employee will then suffer the income tax charge of 20% on the excess over the limit. There can, however, be some benefit derived if, for example, a company is looking to distribute profits from the business and the recipient is a controlling director. The company will still receive the full corporation tax relief and employee and employer National Insurance savings (as long as it meets the existing "wholly and exclusive" test for relevancy), but the tax charge will fall on the individuals concerned if both income and pension contribution exceeds the £150,000 ceiling.