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Protect Your UK Pension Lifetime Limit Before 5 April 2012

April 6 is not only the time to wish you “Happy New Year” as it is the beginning of the 2012/13 UK tax year, but it is also the date that the “lifetime allowance” in respect of contributions made to UK pension plans are substantially reduced.

The lifetime allowance is the amount that you (or an employer) can contribute to a UK pension plan.  This currently stands at £1.8 million but will decrease to £1.5 million from 6 April 2012.   Any contributions in excess of this lifetime limit will result in an additional tax charge when the client takes benefits. The charge is based on how the excess amount is taken. If taken as a lump sum there is a charge of 55% of the excess. If benefits are taken as income there will be a 25% charge levied on the excess amount. The charge will be taken by the pension provider before benefits are paid out. If you are close to this limit you are able to make an election before 5 April 2012 which will protect your lifetime limit at £1.8 million.

The obvious benefit of making contributions to a UK pension plan is that you would obtain 50% UK tax relief on your earnings (on the basis that you are a 50% tax payer) thereby reducing your UK tax liability for the year.  The added benefit of this for US taxpayers is that this provides the opportunity to use up some of the “foreign tax credits” that have been carried forward from previous years on their US return.

Depending on how much of your lifetime allowance you have used up to date, there is also the potential to bring forward your 2012/13 annual allowance and any unused allowance from the 3 prior years (assuming you have not contributed over £150k in the past 3 years) to the current 2011/12 tax year which would enable you to potentially contribute £250,000 to your pension during the current year.   The Annual Allowance is discussed in more detail below.

1.    The “Annual Allowance” set by HMRC which for 2011/12 is £50,000 (taking into account employer and employee contributions) so you may contribute this amount into your pension scheme during the current year on which you will receive UK tax relief at your highest marginal rate of tax, i.e. 50% if you currently fall within the 50% top rate of UK tax. This is on the basis that you will have in excess of £50,000 of “net relevant earnings” during this period. Contributions in excess of this amount are unlimited but will give rise to a tax charge on these excess contributions.

2.    If you have not used all your annual allowance in one or more of the last three tax years, the unused amount may be added to the annual allowance for the current tax which will give you a higher amount of available allowance.  For example if you have not made any contributions- employee or employer-  into a UK company pension scheme in the last three tax years (2008/09 to 2010/11) nor any in the current tax year (2011/12), then you could potentially contribute £200,000 in the current tax year (such contributions would need to be made before 5 April 2012). Again you would need to have net relevant earnings in excess of £200,000 during 2011/12 to contribute the £200,000 as outlined in this example.

Please note that you must have been a member of a registered pension scheme to have an unused annual allowance to carry forward from an earlier year.

3.    The obvious benefit of making the contributions outlined at points 1 and 2 above are that you would obtain 50% tax relief on your 2011/12 UK tax liability. Depending on your historical level of earnings, then this may be a very attractive way to minimise your UK taxes during 2011/12.

On the flip side, any such reduction in UK tax will mean less available foreign tax credits to offset any US income tax liability.  That said, if you have foreign tax credits carried forward from 2010 and before these should absorb any US tax liability in this regard.

4.    One other point to be aware of on the US tax front is that from 2011 there is an ever increasing amount of compliance needed to report your foreign financial assets including your employer pension. You will now be required to complete Form 8938 “Statement of Specified Foreign Financial Assets” (in addition to the annual FBAR filing requirements) which could add many many pages of additional information reporting to your US tax returns.  Nothing is secret, the value of all non-US pension plans will be reported annually, the value of every non-US investment, every partnership, every insurance policy, every PayPal account – even online gambling accounts and accounts held as funeral plans or to give to the grandchildren when they are old enough will have to be disclosed. Valuing all these assets alone will make completing every US tax return hugely more time consuming.

The new forms can be found here:

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