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Reduced limit for pensions tax relief

Retirement | Pension Rules

By Justin Modray, published 14 October 2010.
Helpful? 32

The Government has announced that the annual allowance for pension contributions that enjoy tax relief will fall from £255,000 to £50,000 from 6 April 2011.

This reduction was widely expected and replaces the confusing system proposed by the previous government, which involved giving taper relief on contributions over £130,000. It's also better than no higher rate tax relief at all, which had been proposed by the Liberal Democrats.

There seems to be provision for individuals to carry forward unused annual allowance from previous years if they exceed the allowance due to a 'one-off spike in accruals', e.g. increased pension benefits due to ill health or redundancy in an occupational scheme.

The pension lifetime allowance is also due to be cut, from £1.8 million to £1.5 million, from 6 April 2012. This heightens the risk of being caught out by high taxes if you save too much into your pension and/or enjoy exceptionally good investment performance.

Based on current annuity rates the pension bought by a £1.5 million pension pot doesn't sound like a fortune - after taking £375,000 tax-free cash the remainder would buy a joint life annual pension of around £55,000 for a 65 year old male (wife same age), or £33,000 if linked to inflation. But it's still a lot and given you'd need to save around £800 a month for 40 years to build up a £1.5 million pot (assuming 6% annual returns) it's not a problem most of us are likely to face.

Any pension fund in excess of the lifetime allowance at retirement is currently taxed at an effective rate of 55%. There's a 25% 'recovery charge' followed by a 40% tax charge. So if your pension exceeds the allowance by £100,000, the 25% tax charge will reduce the excess to £75,000 and the 40% charge to just £45,000.

Although not ideal, these changes are actually a pretty reasonable result for higher earners considering the backdrop against which they're being introduced. The new limits will still allow a more than reasonable level of pension contributions and they keep things simple.

With the Government's Spending Review due next Wednesday we can expect news of cuts and potential tax rises to come thick and fast over the next week or two. And I expect little, if any, good news.

Given the bleak outlook that almost certainly awaits us I'm puzzled as to why stockmarkets are still riding high.

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Readers' Comments (2) - To post a comment please register or login .

Comment by pvcdoc at 5:07pm on 14 Oct 2010:

Justin, perhaps the reason why stockmarkets are doing well (so far) is the absence of good alternatives. Bonds (Gilts) are at record low yields, property is still expensive and commodities (especially gold) are beginning to look like a bubble. You can leave your money in cash, but interest rates are poor and you're likely to loose money after tax and inflation. Shares are "fair value" - neither cheap nor expensive, but you'll probably make money in the long term. Unfortunately, as John Maynard Keynes observed, "In the long run we are all dead".

Comment by justin at 6:19pm on 14 Oct 2010:

Fair points and you're probably right. But I'm still surprised that more people don't appear to be holding safer low return assets (e.g. cash/fixed interest) than stockmarket investments where I think there's a pretty strong likelihood of negative returns over the next year or two given the troubled economic backdrop. I guess only time will tell...