It was generally thought that the maximum tax rate would be 20% on employers' pension contributions.
However, the Treasury has confirmed that the budget proposals, which will be introduced in April 2011, could add thousands of pounds to individual tax bills. The new policy is in addition to two other budget changes;
Firstly, a 50% income tax rate for higher earners over £150,000 a year in 2011. Secondly, to stop these high earners claiming 50% relief on their pension contributions income tax relief on pension contributions by individuals is going to be tapered from 50% at £150,000 a year to just 20% at £180,000.
The plan to start taxing these high earning staff on their employer’s pension contributions as well as their own will work like this:
Income tax relief for individuals will reduce by 1% for every extra £1,000 earned above £150,000
A person earning £150,000 a year will get 50% tax relief on all their own pension contributions and pay no tax on their employer's pension contributions
If they earn £160,000 a year they will get from 40% income tax relief. The difference between that and the new 50% income tax rate is 10%, so they will be taxed 10% on their employer contributions
If they earn £170,000 a year they will receive 30% tax relief. The difference between that and the new 50% rate is 20%, so they will pay 20% on their employer's contributions.
If they earn an income of £180,000 or more, they will receive 20% tax relief on their income. The difference between this and the new 50% tax rate is 30%, so they will pay 30% on their employer's contributions.
There is still uncertainty for Final Salary schemes. It remains to be seen whether be based just on the contributions made, or the pension benefits accrued during the year.
Assuming an employer is paying in the equivalent of 15% of their staff's salaries into their pension fund, then someone earning £180,000 a year would benefit from employers' contributions of £27,000. But paying an extra 30% tax on that would present the individual with an extra tax bill of £8,100 a year.