Pensions were simplified in 2006. One of the new things to come out of this was the annual allowance, an overall limit on the annual amount of pension savings that could be made without a tax charge – the annual allowance charge.
Since then the annual allowance has changed greatly. It has reduced from over £250,000, making it irrelevant for most, to £40,000, making it relevant for many.
There are two variations on the theme. The money purchase annual allowance, a £4,000 limit on money, purchase contributions, and the tapered annual allowance, where those deemed to be high earners see a reduction in allowance for all benefit types of up to £30,000.
The tapered annual allowance is complicated and was introduced from 2016 with the policy intention being to reduce tax relief on pensions for high earners. Tax relief is unaffected, but the reduced allowance can create tax charges. It also affects those who are not necessarily high earners.
Whose affected?
There are two limits: an adjusted income of £150,000 and a threshold income of £110,000. Anyone who breaches both limits loses £1 of annual allowance for every £2 of adjusted income over £150,000, with a maximum reduction of £30,000.
Both limits are based on the individual’s net income for the year (steps one and two of the calculation in section 23 of the Income Tax Act 2007).
To get there you add all taxable income received, which would include pension income, salary, dividends (even if they are under £5,000), rental income and the full (not sliced) amount of any bond gains.
Then deduct from this any relief (s24 ITA 2007), which the individual is entitled for the tax year. The most common of these would be trading losses or pension contributions paid to schemes where a claim has to be made (contributions to schemes operating on a net pay basis are taken off when arriving at employment income at step one). This brings us to the net income, that is, the taxable income.
From the net income you deduct the amount of any taxable lump sum death benefit the individual has received in the tax year. This would happen where they receive a lump sum death benefit from a pension scheme where the scheme member died after age 75.
Key points
- The money purchase annual allowance has changed dramatically since it was introduced in 2006
- Any unused annual allowance from the previous three years can be carried forward
- Individuals are subject to the money purchase annual allowance rules under certain conditions
At this point the calculations differ. For adjusted income you add back the value of the individual’s own pension contributions that have already been deducted and also the value of any employer pension provision. The value of the employer provision for money purchase arrangements is the monetary amount of the employer’s contribution. For defined benefit, it would be the pension input amount (broadly 16 times the pension accrued within the pension input period) less the individual’s contribution to the scheme.
Where adjusted income has the individual’s pension contributions and employer provision added back in, threshold income allows the deduction of pension contributions. This means for threshold income the next step of the calculation is to deduct the gross value of the individual contributions to relief at source schemes; generally this would be contributions to personal pensions and group personal pensions. Once these are deducted, you then have to add back any employment income given up for pension contributions, that is, salary sacrifice arranged on or after 9 July 2015. There are other anti-avoidance provisions in place to prevent people manipulating their income figures.
