As part of the wide ranging spending review the government has announced changes to pension legislation; we thought we would take a look at what has changed and how you will be affected.

So what has changed?

Firstly, the maximum amount that you can pay into a pension and qualify for tax relief, known as the Annual Allowance, will be reduced in April 2011 from £255,000 to £50,000.

Secondly, the maximum amount that can be held in a pension, known as the Lifetime Allowance, without incurring an additional tax charge, has been reduced from £1.8m to £1.5m. Pension funds with a value above £1.5m will be subject to a tax charge, although the Treasury has indicated that for those who have a pension fund in excess of £1.5m transitional arrangements will be put in place to ensure that they are not penalised.

Why have they made these changes?

The cost of tax relief on pension contributions has risen dramatically over the past few years and now costs the government about £20bn a year. The new proposals are expected to save about £4bn per year.

The previous government also wanted to tackle the problem but introduced a horribly complex set of rules; these latest charges are a dramatic simplification of the rules, and for that we should be thankful.

Will I still get tax relief on my contributions?

Yes, providing that they are within the annual allowance you will still get tax relief at your highest marginal rate of tax.

This news again is to be welcomed; many had thought tax relief could have been limited as part of the new proposals. Leaving it in place, and at the highest marginal rate payable, will mean pensions are still sufficiently differentiated from other forms of savings to make them attractive.

So who are the losers after these changes?

Three groups of people seem to have been negatively affected by the proposed changes:

1. Investors who were planning to put significant sums into their pensions will now be restricted to a maximum payment of £50,000

2. The lower Lifetime Allowance will affect people whose pension funds are approaching the £1.5m level and who plan to continue contributing. This is likely to mean they have to look at other options when planning for their retirement. The Treasury have signalled that those already with pension funds above the £1.5m level will benefit from transitional arrangements

3. The law of unintended consequences means that members of final salary schemes could lose out from these changes. If you are in such a scheme and receive a significant pay rise, the amount that your pension fund is deemed to have risen by could be in excess of the new £50,000 limit and therefore create a tax liability.

This is because any increase in pension contribution used to be multiplied by a factor of 10 to work out the deemed additional value. The new rules will us a multiple of 16 times meaning that some people receiving significant pay rises could be deemed to be contributing more than the permitted maximum in a single year and as a result incur an unforeseen tax charge.

The Treasury has however recognised that a tax bill on a pension that is not yet in payment would be incredibly unpopular and has have therefore put in place transitional arrangements allowing unused allowances, up to the £50,000 limit, over the past three years to be used.

The government said that changing the allowance to £50,000 would affect 100,000 pension savers a year, and 80% of those had incomes of more than £100,000 a year

How should these changes be viewed?

Once you accept the need for the Treasury to save money on the amount it pays annually in tax relief it is possible to view the changes reasonably positively.

The majority of those affected are likely to be higher earners and it is a relief transitional protection seems to have been put in place to help out those caught by the new rules.

The new rules certainly simplify previous announcements and the fact that tax relief will continue to be paid at the highest marginal rate is also welcome particularly at a time when everyone should be incentivised to make independent provision for their retirement.

Do I need to take action now?

If you were thinking of making pension contributions above the new £50,000 Annual Allowance you should think about doing so before April 2011 when the new rules change.

Furthermore if your pension fund is approaching the £1.5m you should think about ways in which you can mitigate any potential tax liability by using alternative investment vehicles.

As always advice is crucial and can be the difference between the right and wrong decision, if you believe you are affected by these changes or would simply like to discuss what they mean to you in more detail do not hesitate to contact one of our advisers.