Final salary Pension Scheme members – beware of hidden tax charges!

Perhaps fuelled by a need to improve the health of the public purse it is becoming increasingly difficult not to get caught by Income Tax charges which are not immediately apparent.

The autumn statement of the Chancellor of the Exchequer announced further reductions to the annual pension investment allowance from £50,000 to £40,000 and the lifetime pension fund allowance from £1,500,000 to £1,250,000 with effect from April 2014.  Breaches of these limits can result in punitive tax charges of up to 55% so an understanding of the key regulations and how to lessen the impact of the tax consequences can be very rewarding.

The annual allowance seems easy to understand.  Basically if one invests more than £50,000 this year into approved pensions, an Income Tax charge is triggered on the excess above £50,000 as if the additional investment has been added to gross income.  As Income Tax rates currently top out at 50% this action could be rather expensive when trying to be responsible and save up for one’s old age.  Who could be careless enough to save accidently more than £50,000?  It is a relatively easy trap to fall into for someone who is a member of an occupational pension scheme where the pension entitlement increases each year as a consequence of membership.  From 2014 such an individual, whose pension entitlement increases by just over £2,100 in a year, would be punished.  Such a level of increase could easily be caused by various factors such as inflationary augmentation or promotion and would be further exacerbated by innocent voluntary investment.

To rub salt into the wound, for someone retiring after 2014 and fortunate enough to be entitled to an annual pension in excess of £54,000, an additional tax charge of up to 55% could be suffered.  Guidance should be sought as some simple manipulation of the benefits such as the timing of when the pension is received or changing the balance between pension and lump sum will help reduce and in some instances eradicate the liability.  Successive tightening of the lifetime limit for pensions from £1,800,000 to the new proposed limit of £1,250,000 could cost the unwary an additional tax liability of £302,500.

It is clear that recent legislation has moved to attempt to increase revenue received by HMRC and the ever increasing complexity of the interaction between our incomes and pension entitlement accumulation has made the consequences of financial naivety progressively more expensive.