In view of the changes to pensions tax relief effective 6 April 2011, Financial Secretary to the Treasury Mark Hoban recently announced details of how the facility for meeting high annual allowance (AA) charges from pension benefits will work in practice. Additional draft legislation and revised guidance has also been published.

To quickly recap on the forthcoming changes announced in October 2010, from April 2011 the AA for pension saving will be reduced from £255,000 to £50,000. A year later, the lifetime allowance will be reduced from £1.8 million to £1.5 million.

As part of the changes, there will also be a three year carry forward rule to allow carry forward of unused annual allowance from the last three tax years, but only if pension savings have been made in those years. The new rules also mean that there will be no blanket exemption from the annual allowance in the year benefits are taken. There will however be an exemption in the case of serious ill health as well as death. In addition, from 6 April 2011 the exemption from the annual allowance for those with enhanced protection will no longer apply.

Schemes incurring an AA charge will have a considerable amount of time to complete the payment and information provision process, with additional flexibility being granted in the first year. However, recognising that in some circumstances, individuals could still see high charges reflecting significant uplift in pension value in a given year, the Government has now considered various options to enable individuals to meet these charges from their pension benefits.

As a result, individuals with AA charges above £2,000 will be able to elect for the full liability to be met from their pension benefit. Schemes will be required to operate this facility only where an individual has exceeded the AA outright within that scheme in the relevant year. For individuals not able to avail of this election, the AA charge will be operated through the Self-Assessment system.

The Government has stated that it anticipates the reduction of these allowances to generate around £4 billion annual revenue in steady state. As a result of the changes, it expects most individuals and employers to adapt their pension saving behaviour to avoid incurring a charge by exceeding the AA.

Readers should note that at this time the legislation and guidance is currently in draft format and any revisions to the annual and lifetime allowance draft legislation published on 9 December 2010 as a result of the Finance Bill consultation responses will be reflected in the Finance Bill published on 31 March 2011.

To find out more about the changes go to http://www.hmrc.gov.uk/budget-updates/pensions-tax-relief.pdf and http://www.hmrc.gov.uk/pensionschemes/annual-allowance/index.htm