George Osborne’s first post-election Budget provided much food for thought for pensions and financial services, and I wish to summarise some of the salient points as follow:
1. Reduction to the Annual Allowance for high earners
The Government had actually announced before the Summer Budget that the Annual Allowance that applies to pension savings, currently £40,000, will be reduced on a tapered basis for high earners. We now have the details and, as we had feared, the mechanics of this are fairly complex and painful.
Those affected are those individuals whose ‘adjusted income’ in the 2016/17 tax year, and later tax years, exceeds £150,000. ‘Adjusted income’ means the individual’s income after adding back any employer pension contributions to prevent individuals from avoiding the restriction by exchanging salary for employer pension contributions. [For those in defined benefit or cash balance arrangements, the value of the employer pension contributions will be calculated by determining the pension input amount for the arrangement less the amount of any contributions made by or on behalf the individual during the tax year.] New anti-avoidance rules will apply so that any salary sacrifice set up on or after 9 July 2015 will be added back to income for the purpose of the £150,000 income test.
Note: ‘Income’ is not explicitly defined in the announcements and it could well include investment income, e.g. dividends, rent, interest, etc., in addition to income from employment or self-employment.
For those individuals affected, the Annual Allowance will be reduced by £1 for every £2 that the ‘adjusted income’ exceeds £150,000, up to a maximum reduction of £30,000.
The existing rules that allow unused Annual Allowance to be carried forward will continue to be available, but the amount available will be based on the unused reduced Annual Allowance.
2. Changes to Pension Input Periods
As part of the changes to the Annual Allowance, changes will be made to align Pension Input Periods to the tax year from 6 April 2016, as explained below.
All Pension Input Periods open on 8 July 2015 will be closed on that date with the next Pension Input Period running from 9 July 2015 to 5 April 2016. All subsequent Pension Input Periods will be based on the tax year.
Individuals will have an £80,000 Annual Allowance for the 2015-16 tax year, which will be split into two notional periods, 6 April 2015 to 8 July 2015, the ‘pre-alignment tax year’, and 9 July 2015 to 5 April 2016, the ‘post-alignment tax year’.
Any part of the Annual Allowance of £80,000 that has not been used in the ‘pre-alignment tax year’ can be used in 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 in the normal way.
- Individual has paid £61,000 for pension input periods ending in the ‘pre-alignment tax year’. This leaves up to £19,000 (i.e. £80,000 minus £61,000) available for the ‘post-alignment tax year (plus any available carry forward for the three previous tax years).
- Individual has paid £10,000 for pension input periods ending in the ‘pre-alignment tax year’. This leaves up to £40,000 (i.e. £80,000 minus £10,000, restricted to £40,000) available for the ‘post-alignment tax year (plus any available carry forward for the three previous tax years).
The calculation of the pension input amount for the 2015-16 tax year will be modified for cash balance and defined benefits arrangements. Rather than having to calculate separately the pension input amount for pre-alignment and post-alignment tax years, the pension input amounts will be based on the total of the increase in the value of the individual’s rights across the combined pension input periods for the arrangement ending in the period to 5 April 2016, but apportioned to the pre-alignment and post-alignment tax years.
3. Taxation of lump sum death benefits
There is a tidying-up change, which was promised last year, to the tax charge that applies to taxable lump sum death benefits paid from registered pension schemes.
Following the changes made in April 2015, lump sum death benefits are taxed at 45% if the member dies aged 75 or over. From 6 April 2016 taxable lump sum death benefits will, instead, be taxed at the recipient’s marginal rate of income tax under PAYE. If the recipient does not have a marginal rate of income tax, e.g. if the recipient is a trust or a company, then the 45% charge will continue to apply.
4. Consultation on pensions tax relief
As part of the Summer Budget the Government has published a consultation on pensions tax relief which seeks views on the various options that have been suggested for how the system could be reformed. These range from a fundamental reform of the system, e.g. moving to an ISA-type system (where there is no tax relief given on the amounts saved but there is no tax on the investment income or growth or when funds are withdrawn) with a Government top-up on contributions, to less radical changes such as retaining the current system and simply altering the Lifetime and Annual Allowances, as well as options in between.
We remain amazed at the ability of Governments of all persuasions to constantly fiddle with the pension system.
5. Inheritance tax Relief on bequests of main home to children and/ or grandchildren
The Government will introduce a new IHT nil rate band of up to £175,000 where the family home is passed to children or grandchildren. This is in addition to the current nil rate band of £325,000 which has been frozen since 2009 and will remain frozen for the next 5 tax years, until the end of 2020/21.
Who will benefit The extra nil rate band will be fully available to anyone who:
- passes the family home to their children or grandchildren on death; or
- or had a family home, then downsized (passing on assets of equivalent value to children/grandchildren); and
- has an estate below £2M.Like the existing nil rate band the new property nil rate band can be transferred between spouses or civil partners. This means a married couple could pass £1M in 2020/21 to their children tax free on death provided the family home is worth at least £350,000, saving £140,000 in IHT.It will only apply to transfers to children and grandchildren. Meaning those without children will miss out. And it is not possible to use the exemption for lifetime transfers which may discourage some clients from passing on their wealth during their lifetime.
- Clients who could benefit from the property nil rate band may need to revisit their existing wills to ensure they continue to reflect their wishes and remain as tax efficient as possible.
- Who may miss out But not everyone will benefit from the additional IHT free allowance. Anyone with a net estate over £2M will begin to see their property nil rate band reduced until it is completely lost once the estate is over £2.2m (2017/18) £2.25m (2018/19), £2.3m (2019/20) or £2.35m (2020/21).
- However, the full £175,000 won’t be available until 2020/21. The allowance will first become available in 2017/18 at £100,000 and increase to £125,000 in 2018/19, £150,000 in 2019/20 and £175,000 in 2020/21. It will then increase in line with the Consumer Price Index (CPI).
6. Restriction of Mortgage Interest Tax Relief on Buy-To-Let Properties
Landlords will no longer be able to deduct all of their finance costs from their property income to arrive at property profits. They will instead receive a basic rate reduction from their income tax liability for finance costs.
Landlords will be able to obtain relief as follows:
- 2017-18 75% finance costs deduction and 25% given as a basic rate tax reduction.
- 2018-19 50% finance costs deduction and 50% given as a basic rate tax reduction.
- 2019-20 25% finance costs deduction and 75% given as a basic rate tax reduction.
- 2020-21 all financing costs incurred by a landlord will be given as a basic rate tax reduction.
As I am sure you realise, there were a plethora of other changes brought in by the Budget, including changes to income tax personal allowances, an increase in the amount of income that can be earned at the 20% basic rate, the introduction of a “Living Wage”, and the reduction in company corporation tax, to name a few. As is always the case with Budgets, the “devil is in the detail” when the official Treasury Budget summaries are produced with additional clarification of the changes—–so watch this space.