Introduction to the annual allowance

Out-Law Guide | 25 Oct 2019 | 11:29 am | 2 min. read

The amount a person can save each year in a pension scheme before tax charges (known as the annual allowance) is £40,000.

From April 2016, it will be tapered for those with annual incomes (adjusted to include their own and employers' pension contributions) over £150,000. For every £2 of adjusted income over £150,000, an individual's annual allowance is reduced by £1, subject ot a maximum reduction of £30,000.

Tax relief on member contributions

A pension scheme member can claim tax relief on their pension contributions as long as, in each tax year, they contribute no more than 100% of their annual UK earnings or £3,600, if higher.

However if pension savings, including employer contributions, exceed the annual allowance, tax relief is effectively lost on the excess savings.
Those members earning less than £3,600 a year can claim tax relief on their pension contributions up to that amount.

The pension savings of a member of a DC scheme are equal to the amount contributed by both the member and the employer during the tax year.

The pension savings of a member of a DB scheme are equal to the increase in value of that member's benefits during the tax year.  The Government has specified how this increase is calculated.

The tax charge

A member whose pension savings exceed the annual allowance will have to pay an annual allowance charge. If the annual allowance charge is less than £2,000, the member must pay it through their self-assessment tax return. If it is more than £2,000, the member can arrange for the charge to be paid from the pension scheme. The trustees will need to adjust benefits to reflect any tax payments made. They will not be able to impose a charge to recoup the additional administrative costs.

 

A member may offset excess pension savings against any unused annual allowance in the previous three pension input periods. This will help some members who might otherwise be caught because of a spike in their pension savings, such as a pension augmentation on redundancy or a one-off pensionable bonus.

Avoiding the tax charge

Members, trustees and employers have taken steps to avoid the annual allowance charge. This isn't a problem for members of DC schemes who can reduce their contributions to ensure they do not exceed the annual allowance. Some DB schemes have amended their scheme rules to ensure that no annual increase in a member's benefits exceeds the annual allowance.

The £10k money purchase annual allowance

The £10k money purchase annual allowance is an allowance which, once triggered for a particular individual, limits the annual level of contributions in respect of that individual to any DC arrangements in the future.  It is generally triggered when an individual receives pension benefits from DC savings other than through an annuity, for example by taking money from a flexible drawdown fund. It operates in a similar way to the standard annual allowance and is designed to limit the extent individuals may obtain excessive tax relief by churning money in and out of a DC scheme.

Trustee communication

Trustees must send a pension savings statement to all members who exceed the annual allowance by 6 October following the end of the tax year. The statement gives a member the information they need to decide whether they have exceeded the annual allowance and whether they have any unused annual allowance to carry forward. All members have the right to request a statement, whether or not they have exceeded the annual allowance. Trustees should ensure systems are in place to prepare and issue these statements.