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Claire Trott: Pension schemes and the annual allowance charge

annual allowance chargeWhile there is potential for a client’s pension scheme to pay an annual allowance charge, it is not always the best option

I am often asked about how to deal with clients who have exceeded their annual allowance, specifically whether they can force their scheme to pay the tax charge for them.

Quite often this tax bill is the only one the client will have ever received because they are paid PAYE and do not have anything else requiring self-assessment. It can be quite upsetting for them as it feels like they have done something wrong, but it is usually not their fault in the slightest.

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Although a self-assessment is required if the client has exceeded the annual allowance after taking account of carry forward, deciding how and when the tax should be paid is another matter.

Some schemes are quite willing to pay the charges whatever the circumstances, but these tend to mainly be money purchase schemes where it is easy for them to administer.

In other cases, the scheme can be forced to pay the tax charges. The rules are very clear about this, so ensure they have understood your request if they refuse. The last option is just to pay up under self-assessment.

Mandatory scheme pays
Mandatory scheme pays applies if certain requirements are met. First, the pension input amount to the scheme in question must exceed £40,000.
It is very important here that it is £40,000 and not the tapered annual allowance, the money purchase annual allowance or even the client’s annual allowance after carry forward has been applied.

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The scheme has no right to know if the client has any carry forward (the required information on the request omits any reference to it) so there should be no dispute here.

The second test is that the client’s total tax charge is more than £2,000. Carry forward must be considered here to determine the charge. This charge does not have to relate entirely to the scheme in question but it may request confirmation that it is more than £2,000.

The client can only use mandatory scheme pays to pay the charge that relates to that scheme. So, should the client have multiple schemes, one of which has a pension input amount of, say, £41,000, they would only be able to ask that scheme to pay a tax charge relating to £1,000 under the rules.

This scheme must still adhere to the request, provided the client’s total tax liability is £2,000 for that year.

The deadline for requesting the scheme to make the payment is 31 July in the tax year following the year in which the charge became payable. So, for the 2018/19 tax year, the deadline will be 31 July 2020.

Voluntary scheme pays
Voluntary scheme pays is simpler. Here, the scheme does not have to offer it, but it can. There are no minimums.

As the scheme is not compelled to pay, the deadline is in line with the usual self-assessment one. Bear in mind, though, that this is not the deadline for request but the deadline for payment.

Is scheme pays the answer?
So, should the client use scheme pays? This could be a very simple question if they simply do not have the funds to pay the charge themselves.
For those who do, it is a more difficult one to answer. For those in defined benefit schemes, it will come down to issues such as:

For those in defined benefit schemes, it will come down to issues such as:

  • What is the commutation rate used to convert the pension into cash to pay the charge?
  • How will it impact future accrual?
  • How is it dealt with at retirement?
  • How willing is the client to give up the tax efficient savings and guaranteed income in the scheme?

As with many things in a DB scheme, there are so many unknowns in the future that it will be difficult to judge. A lot will come down to the clients’ feelings on the matter and your own calculations.

It is a little simpler for those in a money purchase scheme. The amount paid is taken directly from the funds and the amount left to grow is clear to see.

That said, you are taking money out of an environment that would have grown tax-free up until retirement.

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Thanks to the introduction of the tapered annual allowance, more people are being caught by the charge who cannot do anything about it unless they opt out of their pension scheme. In addition, many of them will not be eligible for mandatory scheme pays at all or only in part.

It has all become a bit of a minefield, especially for those who do not have an adviser.

Claire Trott is head of pensions strategy at Technical Connection



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