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Updates to annual, lifetime and tapered annual allowances and more.  

Why make a pension contribution?
When you save into a pension, the government usually gives you a top-up as a way of encouraging you to save for your future. If certain conditions are satisfied, tax relief on member contributions will be available on up to 100% of their relevant UK earnings or £3,600 whichever is the greater.

Tax relief on contributions to registered pension schemes that are paid by members can be given in a variety of ways:

  • the pension scheme can obtain basic rate tax relief from HMRC to add to the member’s contribution to create the gross contribution in the fund. This is called the relief at source method of giving tax relief or
  • where a member pays contributions to their employer’s occupational pension scheme tax relief can be given automatically through the PAYE system. Neither the member nor scheme administrator need take any action. The employer deducts the member’s contributions from their gross pay before income tax is calculated on the balance. The employer passes the contribution to the scheme administrator or other body. This is called the net pay arrangement of giving tax relief; or
  • the member makes a claim to HMRC for tax relief on their contribution. The amount of the gross contribution is then deducted from the amount of the member’s total income for the tax year in which the payment is made to calculate tax on the balance subject to normal taxing rules, allowances etc. This may be done through Self-Assessment.

HMRC does not impose limits on the level of contributions that members can pay into registered pension schemes.

The member must be a relevant UK individual for such contributions to qualify for tax relief and relief can only be given if the contribution is made to a scheme that operates the relief at source (RAS) system.

What is annual allowance?

The annual allowance has applied from the tax year 2006-07 onwards. The annual allowance is the maximum amount of pension savings an individual can make each year with the benefit of tax relief. This includes pension savings that individuals make plus any made by someone else on behalf of the individual – for example, their employer.

The annual allowance is not a restriction on the amount of tax relief given out when pension savings are made. Instead the annual allowance works by applying a tax charge when the annual allowance is exceeded. The annual allowance charge will be added to the rest of your taxable income for the tax year in question when determining your tax liability. Alternatively, if the annual allowance charge is more than £2,000, you can ask your pension scheme to pay the charge from your benefits. This means your pension scheme benefits would be reduced.

The annual allowance is currently capped at £40,000 although a lower limit of £4,000 may apply if you have already started accessing your pension. The annual allowance applies across all of the schemes you belong to, it’s not a ‘per scheme’ limit and includes all of the contributions that you or your employer pay or anyone else who pays on your behalf.

Unused allowances may be carried forward for three years and used on a first in, first out basis. If pension contributions exceed the annual allowance (plus unused allowances brought forward), the excess is subject to income tax at the individual’s marginal rate.

The annual allowance charge does not apply in the tax year that the individual dies, retires due to severe ill-health, or is a deferred member whose benefits do not increase beyond certain levels.

What is the Tapered Annual Allowance?

The Tapered Annual Allowance came into force as of 6 April 2016 for high earners. For every £2 of ‘adjusted income’ above £150,000 p.a. (gross income including pre-pension contribution earnings, including savings and pension income as well as the value of your employer’s pension contributions), £1 of annual allowance will be lost. The maximum reduction was £30,000 meaning that anyone earning over £210,000 had their annual allowance capped at £10,000.

Anybody who earns under £110,000 p.a (post-pension contributions) known as ‘threshold income will not be affected by the tapered annual allowance.

From the 2020/21 tax year the £110,000 limit is being raised to £200,000.

From the 2020/21 tax year the £150,000 limit is being raised to £240,000, and Annual Allowance is reduced to £4,000 when your income is £312,000 or more.

People affected by the tapered annual allowance will still be able to carry forward unused Annual Allowance from previous tax years and if their income subsequently drops to below the threshold they will be restored to the normal Annual Allowance for that tax year.

HMRC guidance on determining the adjusted income and threshold income can be found here.

What is lifetime allowance?

The lifetime allowance is the maximum amount of tax relieved pension that you can build up over your life. The lifetime allowance for most people in the tax year 2020-21 is set at £1,073,100 and will remain at this level up to and including 2025-26.

The legislation sets out the occasions when a scheme administrator must check whether the pension benefits arising (‘crystallising’) at that point exceeds a member’s available lifetime allowance, this is known as ‘benefit crystallisation events’(BCE)

Generally speaking, the type of event which is a BCE includes: taking pensions, taking lump sums, reaching age 75 death, transferring to qualifying recognised overseas pension schemes.

When a BCE occurs, the scheme administrator compares the amount being crystallised to the member’s lifetime allowance that is still available. Where the member has died, the personal representatives of the member may be responsible for carrying out this comparison. Any crystallising amount that exceeds the level of lifetime allowance available is charged to tax.

What is the lifetime allowance charge?

The lifetime allowance charge applies when at a BCE the value crystallising in an individual’s pension scheme is worth more than their available lifetime allowance:

  • if the excess is a pension, there’s a 25% charge
  • if the excess is a lump sum, there’s a 55% charge.

It is the scheme administrator who must establish whether a chargeable amount arises at a BCE in a member’s lifetime. But responsibility for paying any lifetime allowance charge is a joint one between the scheme administrator and the member.

When can you access your pension?

People aged 55 or over, will be able to access pension savings. Since 2015 it has been possible for individuals to place their pension funds in drawdown, which allows the individual to take as little or as much from their pension funds as they like, and there is no longer a requirement to use the funds to purchase an annuity. It is possible to take a tax-free lump sum of up to 25% of the pension savings (subject to the lifetime allowance). The remainder (within the lifetime allowance) is subject to income tax at the individual’s marginal rate.

This article has been shared from ACCA In Practice, to whom copyright belongs.  Whitefield Tax are an ACCA Member Firm