The consulting actuaries Lane Clark & Peacock LLP has praised the new Chancellor’s proposals to repeal the complex system of pensions tax on savings for high earners from April 2011 in place of an “annual allowance” of pension savings for all.

Mark Jackson, Partner at LCP, commented: “The Chancellor has proposed a much simpler, and fairer, system because it allows a reasonable level of pension saving for all. Employers are much more likely to continue their sponsorship of tax-approved pension schemes for all employees if higher earners are not forced to opt out.”

The previous Chancellor had proposed that employees with income above £130,000 would have tax relief on pension savings limited to 20%, with a benefit in kind charge on employer contributions in addition. A consequence of this was that many of those affected were likely to opt out of tax-approved pension schemes to avoid having to pay tax both on pension savings and again on the pension when received.

LCP had lobbied earlier this year for reducing the current annual allowance from £255,000 to £45,000.

The Government has stated that it will work with the pensions industry to develop the proposals for use of an annual allowance as long as it will raise the initial target tax revenue for the Treasury of £3.5bn proposed under the previous Government’s more complex proposals. The new Government estimates that the annual allowance would need to be set somewhere between £30,000 and £45,000 to achieve this.

The principle of the annual allowance is simple. Members of defined contribution (DC) schemes enjoy full tax relief on employer and employee contributions up to a maximum of the annual allowance. Contributions that exceed the annual allowance are subject to a tax of 40%, payable by the individual. Members of defined benefit (DB) schemes need to think a little harder to work out the “value” of their pension savings during the year. Currently, this is the increase in pension during the year multiplied by an HMRC factor of 10. The excess of this “value” above the annual allowance is subject to tax of 40%, payable by the individual.

Mark Jackson added: “Employers need to review their plans for April 2011 and assess the impact of a reduced annual allowance. Employers with defined contribution schemes can identify the level of annual pension saving relatively easily, but those with defined benefits schemes need to tread more carefully, because this level of pension saving can be reached more easily than expected.”

LCP calculates that, under the current system, an employee earning £90,000 in a 60ths defined benefit plan has annual pensions savings worth £15,000. If the annual allowance is set at £30,000, then this employee faces no further tax. If the same employee has earned a full pension of two-thirds of their final salary, and receives a 7.5% pay rise, then the value of the pension savings triples to £45,000. In this case, the employee faces a new pensions tax of £6,000 ( = 40% of the excess over the annual allowance).

Mr Jackson added: “A tax will arise where an employee has enjoyed a significant, often hidden, increase in pension. Employers are amending their pension schemes to control, and limit, such increases because they ratchet up their pension liabilities. In this respect, the Chancellor’s proposals are a good fit with the objectives of many employers.”