Many of you will be aware there is a limit on the total tax relieved pension contributions that can be paid in a tax year.
Known as the “annual allowance”, the limit if you have not yet drawn on your pension funds is £40,000 and covers your personal contributions and any by your employer. To the extent that aggregate contributions exceed the annual allowance, you will be denied tax relief on your excess contributions and/or pay income tax on your employer’s excess contributions.
Where more than the allowance is paid in a tax year, it is possible to bring forward any unused allowance for the three prior tax years to reduce or eliminate the excess.
The annual allowance for 2012/13 and 2013/14 was £50,000, before reducing to £40,000 for 2014/15 and 2015/16.
2016/17 sees the introduction of a tapered annual allowance. It remains £40,000 for those with total income of £150,000 or less, however, it reduces by £1 for every £2 of income above £150,000. For total income of £210,000 or more the allowance will be £10,000.
“Total income” for this purpose means income from all sources, not just earnings. So dividends, interest, rent, State and private pension income are all included. Furthermore, the value of any employer’s pension contribution is also added when arriving at the total. If you are a member of a “final salary” scheme, you may be surprised at how large this value might be.
When preparing your 2016/17 self-assessment tax return, you will need to ask your employer and/or pension provider for more information about pension contributions, employer sponsored arrangements in particular. Only then will you know your “total income”, be able to work out your tapered annual allowance and calculate any additional pension tax charges.
In the meantime
Give serious thought to favouring pension contributions over other forms of saving while higher and unused allowances are still available. For example, consider paying an extra pension contribution before 5 April 2016 so as to use up any allowance that can still be carried forward from 2012/13 otherwise it is lost.
Paying the tax charge
Where you exceed the allowance and have tax of £2,000 or more to pay, it is normally possible to have the tax paid from one of your pension schemes. There are procedures and deadlines to observe but “Scheme Pays”, as it is known, is useful if money is tight.
But beware, your pension benefits are reduced and “Scheme Pays” could end up costing you a lot more than you think.
Having said which, it is not normally sensible to opt-out of an employer sponsored pension scheme just to avoid an annual allowance tax charge, especially if there is no cash alternative.