On 14th October it was announced that the pensions annual allowance is to be cut to £50,000 from April 2011. The allowance is currently £255,000 but there are very few circumstances where contributions of this level can actually be made.

This is because “anti-forestalling” rules introduced in April 2009 and amended in December 2009 have effectively limited contributions for most “High Income Individuals” with taxable income of £130,000 or more, to between £20,000 and £30,000 p.a. for 2009/10 and 2010/11.

Given the previous government’s proposal to scrap higher rate relief for High Income Individuals post April 2011 and to tax employer pension contributions for such people as a Benefit in Kind, the new £50,000 allowance is to be welcomed.

Furthermore, it is proposed that unused annual allowances from up to three previous tax years can be carried forward. Therefore, for the purposes of this rule, the annual allowance for 2008/09, 2009/10 and 2010/11 is assumed to be £50,000. Therefore, someone who paid in say £20,000 in each of those three years will, subject to earned income being high enough, have the opportunity to pay in £50,000 in 2011/12 and then £30,000 for each of the three previous years, giving £140,000 in total. Tax relief is at the individual's highest marginal rate.

Those people with defined benefit (“final salary” or “career average”) schemes should note that their pension accrual will be calculated with a 16 times multiplier rather than the current 10 times, although there will be an inflation allowance, expected to be CPI capped at 2.5%. Confusingly, this factor will then be used to calculate deemed defined benefit contributions between 2008/09 and 2010/11 when looking at carry back, rather than the current 10 times.

For example, if someone in a 1/60ths scheme starts the year with 10 years’ membership and a pensionable salary of £100,000, their pension is 10/60 x £100,000 = £16,667 p.a.

If we increase that by a notional 2.5% inflation, that is £17,083 p.a.

If their salary stays the same, at the end of the year they will have 11/60 x £100,000 = £18,333.

£18,333 minus £17,083 x 16 gives a notional contribution of £20,000 towards the £50,000 limit.

However, if this individual’s pensionable salary was increased to £120,000 during the year, they will have 11/60 x £120,000 = £22,000 p.a.

£22,000 minus £17,083 x 16 gives £78,672, so well over the £50,000. This individual then needs to look back at 2008/09, 2009/10 and 2010/11 to see if this extra £28,672 can be offset against unused allowance for those years.

It can therefore be appreciated that for defined benefit pension holders, large salary increases and enhanced early retirement benefits will give rise to the largest tax bills.

Where the annual allowance is exceeded, the tax charge will move from its current fixed 40% level to a variable charge dependent on the rate of tax relief received on contributions.

A word of caution for high earners with a combination of defined benefit and money purchase pension contributions. If in 2009/10 and 2010/11 they kept the combined deemed contribution to £20,000 gross in each of those two years, they might expect to be able to make a carry back £30,000 for each of those two years. However, this is incorrect as they will have to revisit the 2009/10 and 2010/11 calculations when looking at carry back, using a multiplier of 16, not 10. This means that the extra they can pay in in 2011/12 is likely to be less than they had anticipated.

Finally, there is an added complication due to what are known as Pension Input Periods, where the pension contribution you made in one tax year might actually be deemed to have been made in a different year for annual allowance purposes. We will be discussing this with clients affected on an individual basis.