Just as pension law reforms promised unrestricted contributions to pension schemes last April, The Revenue promised to penalise “excessive” pension contributions, all the while not saying what ‘excessive’ exactly meant. The local tax inspector is to decide. Contractors should stick close to their pension advisors for guidance, as there is not much coming from official sources.
Just when everyone thought that pensions would get easy to handle, the HMRC came out with a regular ‘sockdollager.’ The result—and this seems to happen a lot—is there are no clear guidelines on what to do about our pension income. More guidance has been promised by HMRC—although that’s what they said the Pensions Simplification rules would provide.
Here at contractorcalculator.co.uk, we would love to be able to tell contractors how to handle all this, but even the great boffins of the tax consulting world are unable to provide any advice for the moment.
So for now, it’s a game of ‘chicken’ for all of us with our pension contributions (for our younger readers, a game of ‘chicken’ is played when two numbskulls drive their cars directly at each other and the one who stops first loses). How much can we put in? We don’t know, but if it’s too much, The Revenue threatens to penalise us. And it’s all being decided on the ground, so what the people at IR in Cornwall call and excessive contribution could be quite different from what goes on in St. John O’ Groats.
First the new Pensions Simplification Rules were issued back in April. We all thought we understood what they meant, and that the outlook was bright. For those of us who take salary and dividend income—that would be most of us—we now have the right to make unrestricted contributions, be they from salary or from dividends, to our pension funds. Under the new rules you are theoretically free to invest an employer pension contribution of up to £215 thousand a year, and we can do this whatever our salary and dividend income may be. We are supposed to be able to swell our pension funds, and this is supposed to be good for all of us as the burden of retirement pay is removed from the terribly irritable shoulders of the taxpayer.
But now The Revenue is telling us that life won’t be that simple. “Excessive” contributions to pension schemes will be policed and penalised, the revenue says. So here we are, nine months later, and we still don’t really know what to do. Contribute too much to your pension scheme, and you’ll be playing ‘chicken ‘ with The Revenue. Will they say it’s too much? Will they say so in Cardiff, but not in Croyden? Such guidance as is already available hasn’t done much to clear up matters. What we have learned is that The Revenue has an unusual way of calculating percentages on income, be it dividend or salary, and that this idiosyncratic approach makes it even more difficult to know what will be considered an excessive contribution or not. .
But as Tom McPhail, pensions specialist at Hargreaves Lansdown points out, an increase of 100 to 115 is not a 15% increase according to The Revenue. The Revenue calculates this as a rise of 30% for some reason.
Take a look at the information on the tax authority Web site if you want, but you will emerge very little the wiser for it. A pension contribution must be “wholly and exclusively for the purpose of trade’ and it must not be ‘excessive.’
You also will have to be careful about moving money from one pension scheme to another. Anyone who takes a tax-free lump sum from one scheme and uses it to boost payments it into another, a process known as "recycling", faces a punitive 55% tax charge if they pay in too much. Too much is when the increase is more than 20 per cent of the original contribution. In the example provided by the Revenue, the taxpayer draws £20,000 from one pension plan and uses it to increase his annual contribution to his new pension scheme from £10,000 to £10,500, a rise of 5%. In year two, he adds another £500, taking the contribution to £11,000 or 10% more than the original amount. In year three, he adds another £500 and pays in £11,500, 15% more than the original contribution, so still less than the 20%.
So how can we avoid playing ‘chicken’ with our contributions? There is some hope. By choosing to make personal contributions from our own individual funds—as opposed to our employer contributions—we can avoid the attention of the tax authority. These are permitted at a high level, and no special test of ‘excessivity’ will apply to them.
And when will we know better about how much of a contribution is allowed, and how much proves “excessive?” Pension advisors say that they will work closely with the revenue to determine the local limits, and this is still the best guidance available. Readers should make as much use of it as possible, to avoid getting into a game of ‘chicken’ which is also known as a ‘no-win’ situation.