The threat of reductions to the current tax- relieved pension savings allowance and the fast approaching end of tax year mean many people’s thoughts will be turning to last-minute contributions. In relation to this, a common question from clients is: “What is my annual allowance?”. My reply is: “How long have you got?”
As we know, the annual allowance is a limit on the amount that can be contributed to your pension each year, while still receiving tax relief. Most people assume the headline annual allowance of £40,000 will apply to them but a number of factors influence this, most notably earnings and whether they have drawn benefits from a scheme already.
To start off, an individual’s tax relief on personal contributions is limited to their earnings in the tax year, so those with earnings below £40,000 will have a reduced contribution allowance, although everyone is entitled to a minimum of £3,600 per annum.
That is not to say their annual allowance is reduced, as, if they are employed, it is possible for their employer to make contributions which, when aggregated with those of the individual, can still be up to the standard £40,000 annual allowance.
Employer contributions should always be considered to ensure they fit within the “wholly and exclusively for the purposes of the business” rule. This prevents employers making unjustified contributions for certain individuals, where relief can be disallowed when there is an identifiable non-business purpose for the employer’s decision to make the contribution, or for the size of the contribution itself.
Significant changes came into force with effect from 6 April 2016 in determining what an individual’s maximum contributions could be. Taxable income includes all income an individual receives and all earnings, investment income and so on.
If an individual’s taxable income, after deducting gross personal contributions and adding any salary sacrifice arrangement, effective after 8 July 2015, is less than £110,000, then the new tapering restriction will not apply.
If this is not the case, then the employer’s contributions will be added to the taxable income and, if less than £150,000, the new tapering restriction will not apply.
If, however, an individual’s taxable income and employer’s contribution is in excess of £150,000, then the individual will be subject to the tapered annual allowance. This restriction has the effect of reducing the standard annual allowance by £1 for every £2 of income above the £150,000 set threshold. The taper has a maximum reduction amount of £30,000, meaning an individual’s annual allowance will not reduce below a minimum £10,000 level.
The problem with a pension contribution calculation that might involve the annual allowance is that an individual’s earnings cannot be accurately assessed until close to the end of the tax year, which makes pre-planning difficult.
Should an individual wish to make allowable contributions in excess of their annual allowance, they may do so using a carry-forward facility of unused allowances from up to three previous tax years. In order for carry forward to be allowed, the individual must have been a member of a registered pension scheme during the tax year from which the allowance is being
An individual’s annual allowance may also be restricted if they have drawn income benefits from a pension scheme. The money purchase annual allowance is currently £10,000 per annum, although in the Budget last week it was confirmed this will reduce from April to £4,000 per annum.
There are numerous trigger events for the MPAA, including:
- Using uncrystallised fund pension lumps sums
- Drawing of income after designation of funds to flexi-access drawdown
- Drawing in excess of the permitted maximum “capped drawdown”
- Use of scheme pension in schemes where membership is under 12
- Transfer from pre-2015 flexible drawdown.
The drawing of a tax-free lump sum in isolation will not trigger the MPAA, nor will the drawing of benefits under the “small pots” rules. Small pots (deemed as up to £10,000) allow benefits to be drawn from up to three non-occupational money purchase funds (unlimited number for occupational schemes) in the manner of 25 per cent as a tax free sum and the balance as taxable income in the same manner as an UFPLS.
Drawing benefits outside the flexibility regime, such as fixed annuities or through a scheme pension from a large scheme, will also not trigger the MPAA. Unlike the standard annual allowance, unused MPAA cannot be carried forward into future tax years.
If the client is a member of a defined benefit scheme, it is necessary for the scheme to calculate the value of any benefit increase within that scheme, which will also be subject to the annual allowance. It is worth remembering contributions paid in excess of the annual allowance are taxable at the individual’s marginal rate.
Martin Tilley is director of technical services at Dentons Pension Management