Pension savers should keep within annual allowance to avoid tax bill

HMRC has issued guidance for pension savers on use of the annual allowance and clarifying rules on carrying forward unused allowances, particularly where scheme members are planning to use 2015/16 split allowances or have withdrawn money from pensions

The reminder comes as the three-year limit for using the carry forward allowance for tax year 2015-16 nears the deadline for use of the higher relief. The annual allowance is the limit on the amount of pension savings that can be made to all of an individual’s pension schemes in a tax year before they have to pay tax on the pension contributions.

It is important to check the exact allowance for any claims for relief dating back to 2015/16 when the rules were first introduced as the allowance changed mid year because of policy decisions. This followed sweeping pension reforms introduced by former Chancellor George Osborne, which saw the government slash the annual allowance to £40,000, from the then £80,000.

However, gradual erosion of the pension annual allowance has raised tax compliance issues and created tax risks for taxpayers when they use money drawdown from pensions.

While the government has encouraged pension freedoms with significant changes to pension rules to remove mandatory annuity purchases, which came into effect in 2015, at the same time it has tried to curb excessive withdrawals by introducing the money purchase annual allowance. This allowance effectively stops tax breaks for those who withdraw money from a pension while at the same time paying into a pension scheme.

If a pension scheme member flexibly accesses their pension pot they will trigger the money purchase annual allowance rules. This means that they will have a £10,000 money purchase annual allowance for money purchase pension savings for that tax year. This does not apply to any money purchase savings made before they flexibly accessed their pension pot.

It is important to note that use of the money purchase annual allowance will also cut into the annual allowance, reducing it to a £30,000 annual allowance (plus any carry forward from the previous three tax years) for their defined benefit pension savings.

For those with pension savings over their annual allowance, it is important to carry forward unused annual allowances from previous years to offset the tax liability. It is possible to carry forward unused allowance from the three previous tax years.

There was split treatment of the allowance in tax year 2015/16 which also needs to be taken into account.

Annual allowance rules for 2015-16 tax year

Due to changes in government policy, the allowances in 2015-16 tax year were revised several times, making it vital to calculate the annual allowance correctly.

6 April 2015 to 8 July 2015 annual allowance

The annual allowance for 6 April 2015 to 8 July 2015 (known as the ‘pre-alignment tax year’) was £80,000. This allowance was available against pension savings made in pension input periods ending in that tax year.

If the money purchase annual allowance rules applied, the pension saver would have had an alternative annual allowance of £60,000, plus a money purchase annual allowance of £20,000 for that tax year.

9 July 2015 to 5 April 2016 annual allowance

The annual allowance for 9 July 2015 to 5 April 2016 (known as the ‘post-alignment tax year’) was zero.

It was possible for pension scheme members to carry forward up to £40,000 of unused annual allowance from the pre-alignment tax year in that year. Likewise, if money purchase annual allowance rules applied, this provided an unused alternative annual allowance of up to £30,000, and unused money purchase annual allowance of up to £10,000 to use in the post-alignment tax year.

Post 6 April 2016 annual allowance

The annual allowance is £40,000 for standard and higher rate taxpayers, while there is a tapered reduced allowance for those earning over £150,000 per annum. The reduced annual allowance applies for taxpayers whose ‘adjusted income’ is over £150,000 and ‘threshold income’ is over £110,000.

This annual allowance only applies to pension savings made to UK registered pension schemes, or to overseas schemes where either the saver or employer qualifies for UK tax relief.

The annual allowance covers all pension schemes held by the individual, including:

defined contributions arrangement - where the pensions savings is the total contributions made by the saver (or a third party like an employer) have made; and

defined benefits arrangement - where the pension savings is the increase in the value of promised benefits under the pension scheme, from the start to the end of the period the pension savings are measured (for example, from 2016 to 2017 this is the tax year).

However, changes to the rules on unused annual allowances are now affected by the money purchase annual allowance, which means that in certain instances it is not possible to carry the allowance forward, but you can carry forward any unused alternative annual allowance.

It is important to ensure that all allowances are used correctly and in the right order, with the oldest tax year first. It is also possible to part use the annual allowance and keep it aside for future use.

Tax liability

Where pension savings are more than the annual allowance for the tax year, and there is no unused annual allowances from the three previous tax years to cover the difference, tax will be payable.

HMRC guidance, Check if you have unused annual allowances on your pension savings, issued 9 August 2018

Report by Sara White

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