‘Scorched earth’ pension rules turn heat on high earners

Tax changes aimed at the wealthy may change the whole face of funding retirement for the rich, says HSBC Bank.

The Government’s ‘scorched earth’ pensions policy will discourage those with a high income to look for alternative investments as new rules make pensions less attractive than other options.

Patrick Power, associate director, Financial Planning in HSBC Private Bank (UK) Specialist Tax Group, says: “The proposed new rules add yet another layer of complication to pension funding and the need for advice has never been greater.”

“We believe higher income individuals should at the very least make use of the special annual allowance, much in the same way that they should fund their annual ISA allowance and manage their capital gains tax allowance,” said Power. “Making pension contributions above the special annual allowance should not be ruled out.”

Pension changes take effect from April 6, 2011 and immediate forestalling measures were introduced in the Chancellor’s recent pre-Budget Report to prevent tax avoidance.

Who is affected by the new rules?

Those most affected are the wealthy with a ‘relevant income’ of more than £180,000 a year, who will no longer receive any higher rate income tax relief on pension contributions.

Those with a relevant income between £150,000 and £180,000 will lose 1% relief for every £1,000 of income above £150,000. These taxpayers currently receive 40% tax relief on pension contributions compared with the standard rate of 20%.

‘Relevant income’ includes unearned income such as dividends and interest, as well as earned income.

For those with relevant incomes of £130,000 or more, the Pre Budget Report of 9 December 2009 has further added the value of employer pension contributions to the ‘relevant income’ calculation.

Recent research shows that 500 wealthy directors and partners left the UK in the past year, and these numbers could rise following the new pension rules announcements as the wealth of many directors lays in their pensions rather than property and assets.

The estimate is more than 400,000 high earners are caught in the pensions and 50% super tax trap.