Minimising the impact of the 50p tax rate
Time is running out for high earners to put plans in place to minimise the impact of the new top rate of income tax, which comes into force in April 2010. Not only are high earners being hit by changes to their pension contributions, they are also facing a new 50 per cent tax rate on income of more than £150,000 and rises in the national insurance charge.
For the first time in many years those earning more than £150,000 will give more in income tax and national insurance to the Exchequer than they will keep for themselves. We explain how the changes may affect you and what action you can take.
What are the changes?
A new 50 per cent top rate of income tax comes into force on April 6, 2010, and will affect anyone who has taxable income over £150,000.
The Government is concerned that those affected by the new 50 per cent tax rate will avoid this penal tax rate by paying large sums into their pension pots. In a bid to prevent this, new restrictions will come into force from April 6, 2011, which will reduce the income tax relief on pension contributions paid by those with income over £150,000. The rules will work by tapering the tax relief on your pension payments from 40 per cent at income of £150,000 a year down to just 20 per cent where your income is £180,000. These changes take effect from April 6, 2011.
When deciding whether the £150,000 income threshold for pension purposes will be breached you have to include as income, any pension contributions your employer has made for you. This means if you are a high earner you cannot simply escape the rules by exchanging salary for employer contributions to your pension scheme.
Can I make large pension payments before the new rules come into play?
To make things worse, the Government introduced ‘anti-forestalling legislation’ in April 2009 which affects the pension contributions you make in the 2009/10 and 2010/11 tax years. These measures control the amount of additional contributions you can pay into your pension in the two years ended April 5, 2011. This is bad news if you are looking to reduce your tax bill by paying into your pension before April 5, 2010.
Who is affected by the anti-forestalling rules?
Anyone whose income is over £130,000 in the current tax year or previous two tax years may be affected if they are looking to make one off pension payments before April 5, 2011. This income limit was originally brought in at £150,000, but it was reduced on December 9, 2009, to £130,000 and applies to pension payments made after that date.
How the anti-forestalling rules work
The rules are designed to only capture special one-off pension payments which means any regular pension contributions can be ignored. Regular is taken to mean paid monthly or quarterly, any annual contributions you make are not treated as regular. In summary, if a non-regular pension payment is made of more than £20,000 the excess over £20,000 the Special Annual Allowance will be subject to a Special Annual Allowance (SAA) tax charge at 20 per cent. This £20,000 limit can rise to £30,000 in some instances.
A partner has a profit share for the current year of £200,000 and has historically made monthly pension payments of £1,250. What pension payment can he make before April 5, 2010, without incurring the SAA tax charge assuming he continues to pay his monthly contributions of £1,250? The special annual allowance is £5,000, which is calculated by taking £20,000 less the protected input amount of £15,000 (which is made up of his monthly £1,250 payments). He can therefore make a further pension payment of £5,000 before the SAA tax charge starts. If he pays £20,000 additional pension payments, he will suffer a SAA tax charge of £15,000 @ 20% = £3,000.
The way forward – advice is key
We are already receiving increased interest in partners looking at the options available to them. The sooner you act the sooner you’ll be safe in the knowledge your money will be protected from the tax man. Many professional partnerships are now looking at incorporating their business or bringing in a corporate partner as a member of the firm, in an effort to circumvent the 50 per cent income tax charge on their profits. If you expect your future income to be less than £150,000 you will not be affected by these changes and can you continue to benefit from the 40 per cent tax rate relief on their pension contribution. Pension payments can still play an integral role in planning for your retirement and saving income tax. Due to the complexities of the anti-forestalling provisions, you need to take expert advice before you make any pension contributions for this year. For those who are likely to be affected by the new 50 per cent tax rate now is the time to review your retirement plans as well as your firm’s succession strategy. It is advisable to contact your business advisors sooner rather than later in order to effectively plan for these changes.