There are many thousands of pages of pension and pension tax legislation, meaning it isn’t always possible to be fully conversant with the minutia of all aspects of the overall legislation.
Invariably, there are occasions when a question is posed that necessitates a degree of digging through the details to find an answer. In so doing, I sometimes come across quirks that can have interesting outcomes.
In recent years the Technical Support Unit has written a number of Tech Talks on the annual allowance (AA) and so in this article, I’ll skim over most of the aspects of the AA and concentrate on some of the subtle nuances.
The purpose of the AA is to limit the maximum amount of pension savings the individual can make in a particular tax year, while, in most cases, enjoying the appropriate amount of tax relief. In the majority of instances, the individual will be well within the AA of £40,000, and indeed, even where there is also an employer element to their pension savings, the majority will still fall within their AA.
The value of pension savings that are measured against the individual’s AA is called the pension input amount (PIA). For other money purchase arrangements, it’s the actual amount of contributions paid in the pension input period (PIP). For other types of arrangements (e.g. defined benefits) it’s the increase over the PIP in the value of benefits that is tested, and not the amount of actual contributions.
In circumstances where an individual exceeds the AA, they’ll be subject to an AA charge on the excess over the AA, unless they’ve sufficient unused AA to carry forward from previous years. If not, the excess, or ‘chargeable amount’, is added to their ‘reduced net income’ for the year and taxed at their marginal rate of income tax. The liability for this charge falls on the individual taxpayer themselves, however, if they satisfy certain criteria, known as ‘scheme pays’, they can ask their scheme to pay the charge on their behalf in return for an appropriate reduction in their pension benefits, meaning the scheme and the individual are jointly and severally liable for the charge.
Defined benefit arrangements
To determine the PIA, for a defined benefit (DB) arrangement, it’s not, as mentioned previously, simply a case of totalling the percentage of employee and employer contribution levels.
Instead, it’s a notional amount derived from the increase in value of their pension rights over the PIP in question.
In the context of the topic of this article it’s worth perhaps briefly revisiting an earlier piece on The Annual Allowance where I considered a scenario in which two individuals with all parameters being equal, other than length of service, had significantly different PIAs. In addition, this was compounded when looking at any unused AA from earlier years.
When confronted with such scenarios, it’s therefore critical when reviewing a client’s circumstances to fully reflect their individual position and not presume that because the funding levels in percentage terms are the same then, the PIA will also be the same.
Exploring further the funding levels in terms of the contribution percentage for DB arrangements relative to the PIA throws up some other anomalies, particularly so for someone caught by the tapering of the AA. The reality is that there isn’t necessarily a correlation between the capital values of the funding, based on the percentage of pensionable salary, and the PIA. Equally, discrepancies can arise between the actual amount of the employer’s contribution and what is factored in for calculating the employer’s contribution for determining an individual’s adjusted income. You can find a case study for this, along with the scenarios mentioned throughout this piece here.
In a situation where the individual has an AA charge to pay, they’ve to complete the boxes in the ‘Pensions savings tax charges’ section of their online tax return, or the additional information pages SA101 in a paper return.
While the liability for the AA charge falls on the individual taxpayer, there are several ways the liability can be met. They can pay the charge themselves, or alternatively, if they satisfy certain criteria, they can ask the scheme to pay the charge, meaning the scheme administrator becomes jointly and severally liable with the member for the charge.
For ‘scheme pays’ to apply, the criteria are:
- their AA charge liability for the tax year has exceeded £2,000 and
- their PIA for the pension scheme for the same tax year has exceeded the AA amount of £40,000. (Note: that the tapered AA and/or money purchase annual allowance is ignored).
A final option is where the scenario doesn’t satisfy the ‘scheme pays’ rules, but the individual still asks the scheme to pay the charge on their behalf.
If the scheme were to accept this request, it would be on a voluntary basis, though the liability remains with the individual. There are potential pitfalls with this option, even where some of the liability falls under scheme pays with the remainder on a voluntary basis.
It should be remembered that whenever the scheme meets any of the charge, there must be an appropriate reduction in the person’s pension benefits.
Taking benefits and scheme pays
In most PIA scenarios, the relevant amount is calculated over a complete tax year.
Where there is an AA charge to pay and scheme pays is also being considered, the individual isn’t normally able to give the scheme such notice until after the end of the tax year in which the liability has arisen.
However, there are a couple of exceptions to this where the PIA may have to be calculated part of the way through the year. One is where the individual takes all the benefits from their scheme and the other is where they’re still potentially accruing benefits and attain age 75 part way through the year.
For most people the annual allowance is of little concern as they’re unlikely to be in a situation where their pension savings in a year exceed the annual allowance of £40,000. However, there are some subtle little nuances in the legislation, that in certain circumstances can cause some issues, even for those people.
I’ve mentioned it many times in the past, but when it comes to pension tax legislation, the devil is in the detail, and for those unfamiliar with the legislation, it’s easy to be caught out. It therefore goes without saying that any individual finding themselves in a situation where their position is likely to deviate from their norm, they should seek the help of a financial adviser. Early planning and considerations of all the options may help alleviate the impact of a potential tax charge.
For more tax year end support do take a look at our dedicated TYE hub.