The Annual Allowance is a limit to the total amount of contributions that can be paid to defined contribution pension schemes, and the increase in the total amount of benefits that you can build up in defined benefit pension schemes each year, while still remaining eligible for tax relief.
The Annual Allowance is currently capped at £40,000 and applies across all of the schemes you belong to, rather than being a ‘per scheme’ limit. It includes all of the contributions paid into pensions by you, your employer, or anyone else in a tax year.
Your Personal Annual Allowance
For the vast majority of pension savers their Personal Annual Allowance will be the full £40,000 described above. However, there are two circumstances when a lower Personal Annual Allowance may apply.
Firstly, if you have earnings in excess of £150,000 then your Annual Allowance may be reduced below the £40,000 cap as a result of the ‘Tapered Annual Allowance’. In basic terms, under the Tapered Annual Allowance, £1 of Annual Allowance will be lost for every £2 of ‘adjusted income’ above £150,000 per annum. Adjusted income for these purposes is income from all sources plus any employer or employee pension contribution. The maximum reduction is £30,000 meaning that anyone earning over £210,000 will have their Personal Annual Allowance capped at £10,000.
The tapered annual allowance does not apply if an individual’s income excluding pension contributions is below £110,000 (this is known as “Threshold Income”).
Secondly, a lower allowance of £10,000 will apply if you have already started drawing an income from your pension savings. This is known as the Money Purchase Annual Allowance (MPAA).
Please note that the MPAA will not be triggered if the only withdrawal from pension savings has been through the payment of a Pension Commencement Lump Sum (Tax Free Cash).
Exceeding your Personal Annual Allowance
You won’t receive tax relief on any contributions that exceed your personal annual allowance and you will be faced with an Annual Allowance Tax Charge.
In simple terms the excess amount over your Personal Annual Allowance is treated like any other income and is added to the top part of your taxable income for Income Tax calculation purposes. The part of the excess that falls within the basic rate band is taxed at 20%, that within the higher rate band is taxed at 40%, and any excess falling in the additional rate threshold is taxed at 45%.
If the resulting Annual Allowance Tax Charge is more than £2,000, you can ask your pension scheme to pay the charge from your pension fund. This means your pension scheme benefits would be reduced.
Mitigating an Annual Allowance Tax Charge
Unless you have already started drawing your pension (and are therefore subject to the lower MPAA), you may be able to bring forward any unused Annual Allowance from the previous three tax years, to either reduce, or completely remove, any Annual Allowance Tax Charge.
Annual Allowance Changes 06 April 2017
In the 2016 Autumn Statement, the government announced a proposal to reduce the MPAA from £10,000 to £4,000 with effect from the 6th April 2017. A twelve week consultation period, seeking views on the possible impact of the reduction, is currently running until the 15th February 2017. Further updates are due in future.
Assuming this proposal is implemented, anyone currently affected by the MPAA will therefore face a tax charge on any pension contributions above £4,000 per year from the 06 April 2017.
Planning Around the Personal Annual Allowance
Hopefully it is clear from the above that the whole subject of the Annual Allowance within pension planning can be very complicated for those people on relatively large earnings, those with high levels of pension savings, those people still accruing benefits in Defined Benefit Schemes and those people aged over 55 who have started to access income from their savings.
For all of these people, as well as others who feel they may fall foul of the limits in future years, it is extremely important that they consider taking Financial Advice. Such service is available to you through Creative and you should contact your normal consultant, or email us on firstname.lastname@example.org to arrange a private one to one meeting or conversation. You should contact the same person if you have any questions on the content of this document.