One announcement in the Summer Budget has an immediate impact for individuals and their pension savings in 2015/16. The aim of the change is to ensure that the new tax relief restrictions on high income individuals can be timely and effectively implemented for 2016/17 and onwards. The change to facilitate this is the alignment of 'pension input periods' with the tax year and transitional rules are needed to effect this change.
The transitional rules allow up to an £80,000 annual allowance during 2015/16 - double the original annual allowance of £40,000! The purpose of the transitional rules is to protect savers who otherwise may have been retrospectively taxed due to the alignment of their pension input periods.
Norman has one pension scheme with an annual pension input period ending 30 June 2015. £3,000 (gross) is contributed on the last day of the month each month by his employer as part of his contractual arrangements. Prior to the change Norman's planned total pension contributions for 2015/16 would have been the pension input period for the 12 months to 30 June 2015 ending in that tax year. The alignment to 5 April 2016 means that the contributions that would count as belonging to 2015/16 would be £63,000! This arises because 21 months of contributions would be attributed to 2015/16 not 12 months - £36,000 for the year to 30 June 2015 plus £27,000 being 9 months contributions to 31 March 2016.
Without transitional protection this would create an additional charge on the excess over £40,000. Under the transitional rules the whole £63,000 is relievable.
How do the transitional period rules operate?
All pension input periods open on 8 July 2015 closed on that date. The period 6 April 2015 to 8 July 2015 is to be known as the 'pre-alignment tax year'. There will then be a second pension input period running from 9 July 2015 to 5 April 2016. This will be known as the 'post-alignment tax year'. All subsequent pension input periods will be concurrent with the tax year from 2016/17 onwards.
All individuals will have an annual allowance of £80,000 for the pre-alignment tax year. Where this amount has not been used in the pre-alignment tax year, it will be carried forward to the post-alignment tax year, subject to a maximum of £40,000. In addition, any unused annual allowance from the previous three years can be added to these amounts if required.
Steph who is a director of a family company has pension savings in the pre-alignment tax year of £27,000. In a normal year this would have meant that she only had £13,000 annual allowance capacity remaining. However, her annual allowance for the post-alignment tax year is set at £40,000. This is a total pensions saving relief of £67,000 for 2015/16 (plus any available unused brought forward amounts from the previous three years). She may be able to arrange for additional contributions to be made by her company or personally to use up this entitlement.
Similar principles but with special calculation modifications will apply where there are cash balances and defined benefit arrangements or where members become deferred or where the money purchase annual allowance rules apply.
A knock on effect of the transitional rules is that it actually creates the opportunity for some additional tax relief to be obtained in 2015/16. This may be particularly welcome for those high income individuals who will see their annual allowance in 2016/17 chopped to as low as £10,000.
The tapered annual allowance from April 2016 will apply for individuals with adjusted income (including the value of any pension contributions) of over £150,000 and who have an income (excluding pension contributions) in excess of £110,000. The rate of reduction in the standard annual allowance of £40,000 is by £1 for every £2 that the adjusted income exceeds £150,000, up to a maximum reduction of £30,000.
In the meantime all taxpayers as well as those who may be affected in 2016/17 should consider reviewing their current tax year position to establish whether this one-off additional opportunity is available.
It goes without saying that there are detailed rules here to observe to get this right and that at the time of writing these rules are not yet law. The provisions are included in Finance Bill 2015 which is currently progressing through its parliamentary procedures before becoming the second Finance Act of 2015 but the first of this Parliament.
For more details on these changes for clients - we have a client letter available with a supporting technical note for your use.