Pension annual allowance contributions – have you fallen into the trap?
When it comes to understanding the pension annual allowance (AA), it’s easy to fall into a trap.
The most that you can contribute to your pension savings in a tax year before a tax bill is triggered is limited to the AA.
The AA applies to the total of all contributions you or anyone else e.g. your employer, pays to your pension schemes.
It also applies to any increase in the value of any defined benefit (final salary) schemes you belong to.
The AA is currently £40,000 but can be less in a number of situations. You need to be aware of these if you want to know when to report the charge or avoid it.
What if you don’t use the annual allowance?
If you have an active pension but don’t use the AA in full, you can carry the unused part forward and add it to your AA in any of the following three years.
Your AA can be less than £40,000 if your adjusted income in a tax year is more than £150,000. It’s reduced (tapered) by £1 for every £2 of the excess, but no lower than £10,000.
The £150,000 income ceiling is reduced if your company contributes directly to your pension savings. However, you don’t need to worry about this if your annual income is less than £110,000.
Your AA is also reduced if you’ve flexibly accessed your pension savings. Broadly, this applies where you have taken money from one or more of your money purchase (defined contribution) type schemes.
The AA is reduced to £4000 and unlike the normal AA there’s no right to carry forward any money purchase annual allowance (MPAA) that you don’t use.
The Money Purchase Annual Allowance
Where the MPAA is triggered it only affects money purchase type schemes. The balance of your normal AA, £36,000 (£40,000 – £4000), still applies to final salary schemes you belong to.
The bad news is that even if your pension savings for a year are less than your AA, a tax charge is still triggered if your earnings from employment or self-employment are lower.
For example, John is a director of ABC Ltd. His only income is from the company.
He takes an annual salary of £30,000 plus dividends of £60,000. He receives a windfall of cash and decides to top up his pension savings. He contributes £40,000 in total for the year.
Because his relevant earnings are only £30,000 (dividends don’t count) he’s liable to an AA charge on £10,000.
HMRC’s recent statement is a warning that its attitude to those who fail to declare an AA charge is getting tougher.
Because of the complexities of the pension savings rules, it has been relatively understanding so far but there might be stiffer penalties in future…
Having trouble working out your pension planning? Get in touch and we can help.