For 2011-12 the employee's pension savings for annual allowance purposes are therefore GBP43,734. This is much higher than the employee's actual contributions (probably in the region of GBP6,500) qualifying for tax relief.
When calculating the amount of unused annual allowance from 2008-09, 2009-10 or 2010-11, any pension savings for those years in a defined benefit scheme must be calculated using the new valuation rules that apply from 6 April 2011.
Annual allowance tax charge
Where pension savings are made in excess of the annual allowance (including any brought forward amount), then the surplus amount is subject to the annual allowance tax charge. Previously, this charge was at a flat rate of 40%, but from 2011-12 onwards it is at a person's marginal rate of income tax.
For example, for 2011-12 a self-employed person has taxable income of GBP210,000. She paid gross personal pension contributions of GBP64,000 in respect of the pension input period ending on 5 April 2012, and no brought forward relief is available. The higher rate band will be increased to GBP214,000 (GBP150,000 + GBP64,000), so the surplus amount is GBP14,000 (GBP64,000 - GBP50,000).
GBP4,000 (GBP214,000 - GBP210,000) of this is taxed at the higher rate of 40%, with the remainder taxed at the additional rate of 50%. Therefore the annual allowance tax charge will be GBP6,600 ((GBP4,000 at 40%) + (GBP10,000 at 50%)).
In this example the net effect is to remove the tax relief that should not have been given. However, because of the way in which pension input periods work, there may be a mismatch between the tax relief given on pension savings and the amount of relief subsequently removed by the annual allowance tax charge.
For example, a one-off personal pension contribution may result in tax relief of 50% in 2011-12 (the year of payment), but the surplus amount may only be taxed at 40% in 2012-13 (the year in which the pension input period ends). With the previous flat rate of 40% this mismatch did not occur.
The complicated pension input period rules mean that with the reduced annual allowance it will be very easy for a person to inadvertently incur an annual allowance tax charge, especially where an employee changes employments. It may therefore be advisable where possible for a person to align their input period(s) with the tax year.
The lifetime allowance is currently GBP1,800,000. This allowance applies to the total funds that can be built up within a person's pension arrangements, and there will be a tax charge when that person subsequently withdraws the funds in the form of a pension if the limit is exceeded.
From 6 April 2012 the lifetime allowance will be reduced to GBP1,500,000, but it will be possible to protect existing pension savings of up to GBP1,800,000 from the effects of the reduction.
The new rules that apply from 6 April 2011 were announced on 14 October 2010. It is possible that a person has pension savings prior to that date but which relate to a pension input period ending in 2011-12, and so be subject to the reduced annual allowance of GBP50,000.
Therefore, where a pension input period started before 14 October 2010 but ends in 2011-12, an annual allowance of GBP255,000 will be used to determine whether a tax charge arises. However, the GBP50,000 limit will still apply for any pension savings made during the period from 14 October 2010 to the end of pension input period.
The Coalition Government has estimated that the reduced GBP50,000 annual allowance will only affect 100,000 people. The change does not affect anybody with annual pension savings of less than GBP50,000 regardless of their level of income. Whether people are better or worse off when compared to the previous Labour Government's proposed changes will depend on their level of income and their amount of pension savings.
A person with net income of GBP400,000 and annual pension savings of GBP50,000 is better off. Under the Labour Government proposals tax relief would have been restricted to GBP10,000 (GBP50,000 at 20%), but relief is now GBP25,000 (GBP50,000 at 50%). However, if the annual pension savings were instead GBP200,000 the person is worse off. Tax relief is still only GBP25,000, but under the Labour Government proposals tax relief would have been GBP40,000 (GBP200,000 at 20%).