Today's Budget statement announced that limits to pensions tax relief for high earners will be more sweeping than previously trailed and that they will come in a year earlier. Towers Watson says that the policy will lead to penal marginal tax rates for high earners, particularly if they choose to save the money they get from a pay rise in a pension.
The Chancellor confirmed that individuals will lose 50p of the £40,000 Annual Allowance for each £1 of income above £150,000; for people with incomes of £210,000 or more, the Annual Allowance will be £10,000. This will now be effective from April 2016 rather than April 2017. In what appears to be a change to the Conservatives' original proposals, employer pension contributions will count towards income when determining what someone's Annual Allowance will be. This means that people with salaries below £150,000 can be affected.
Stephen Green, a senior consultant at Towers Watson, said:
"If someone with an income on the taper is saving up to the limit, they will pay £675 in tax for each £1,000 of additional income unless they cut back their pension contributions at the same time.
"It gets worse if they want to save their extra income in a pension; if you include the tax due in retirement, they could eventually lose £975 of their £1,000 pay rise to the taxman! In extreme cases, the tax rate can even exceed 100%.
"This policy will make it much harder for high earners to plan their pension saving. First, they won't know their income until the end of the year, so won't know how much they can save without incurring tax penalties. Second, cutting back on pension contributions to avoid penal rates of tax may not always be the right thing to do: it can mean losing matching contributions from the employer – though we expect that many employers will respond to this change by offering cash alternatives to affected staff.
"High-flyers will now have to do more of their pension saving before their earnings peak – that is, when they have less disposable income. For people who expect to be on big salaries in a few years' time, it could be now or never to save large sums in a pension.
"Rather than just reducing their future pension savings to avoid incurring Annual Allowance tax charges, some high earners may choose to stop saving in pensions altogether. If they do this before 6 April 2016, they can keep a £1.25 million Lifetime Allowance."