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The Annual Allowance

The annual allowance:
  • Sets the maximum amount of tax relieved pension savings an individual, or someone on their behalf, for example an employer, can make to a pension scheme within each tax year.
  • For the current tax year (2017/18) it is set at £40,000.
  • For those individuals affected by the Tapered Annual Allowance or Money Purchase Annual allowance, a different limit will apply (see our technical briefing notes on the Tapered Annual Allowance and/or Money Purchase Annual Allowance).

Pension Input Period (PIP) - this is the period by which all contributions or benefit accrual is measured between a start point and end point. Since 6 April 2016, PIPs have been aligned to the tax year and run from 6 April - 5 April.

The Pension Input Amount (PIA) is the value used to measure pension savings against the annual allowance. The way this is calculated will depend on the type of scheme as follows:

DC schemes - it is the total gross contributions (any personal or third party contributions, for example, an employer) that are tested

DB schemes - it is the total increase in benefit rights that is tested (not contributions). This will be based on the difference between the opening (start of the PIP) and closing values (end of the PIP) and will include things like:

  • Earnings,
  • Length of service;
  • Accrual; and
  • Any separate lump sums

For a Defined Contribution (DC) scheme:

The Pension Input Amount (PIA) will be the total of all the contributions made within a tax year (or PIP) for each pension plan.

So where contributions start or cease at some point within the tax year, they will still form part of that years’ PIP. The total amount within that PIP will then be the PIA for that scheme for that tax year.

Pension contributions will include:

  • All gross contributions made by the member (or on behalf of the member)
  • All employer contributions made into the plan.

The total of all the PIAs for all DC schemes within the tax year will need to be added up and this will be the total DC contribution to measure against the annual allowance.

Example - Susan

Susan has contributed on a monthly basis to three different schemes within the tax year, where the total contributions to those schemes are as follows:

Scheme 1 - £12,000 (total monthly contributions made consistently throughout the tax year)

Scheme 2 - £4,500 (total monthly contributions, which ceased after three months into the tax year)

Scheme 3 - £3,000 (total monthly contributions which started six months in to the tax year)

So Susan’s total DC contributions measured against the annual allowance is £19,500, which is the total contributions from all three schemes for the tax year (i.e. 06 April – 05 April)

For a Defined Benefit (DB) scheme:

The Pension Input Amount (PIA) will be the increase in benefit rights between the start and end date of the Pension Input Period.

Firstly you need to determine the opening value for the start of the Pension Input Period (PIP) as follows:

Opening value

At the start of the Pension Input Period, the opening value will be calculated based on salary, length of service and accrual rate, uplifted by CPI for the 12 month period from the previous September. This is then multiplied by a factor of 16. Any separate lump sums will also need to be factored into the calculation.

Once you have completed the opening value, you will then you need to calculate the closing value.

Closing value

Next you would need to calculate the annual pension built up at the end of the PIP, using salary, length of service, accrual rate and multiplying this by a factor of 16.

Again, if there is any lump sum paid separately, then this should also be added into the calculation. Finally you can then calculate the Pension Input Amount.

Valuing the Pension Input Amount (PIA)

By subtracting the opening value from the closing value the individual’s deemed PIA can be calculated for annual allowance purposes.

Other factors

Where an individual has any of the following events occurring within the PIP year these will need to be taken into account:

  • Transfers in/out
  • BCEs
  • Pension debits/credits
  • Reduction in benefits (due to scheme pays annual allowance charge)

Example - John

Calculate the opening value

At the start of the PIP year, John’s earnings were £29,644.00 and he had completed 25 years’ service within a 1/60th accrual scheme, where CPI over the 12 month period to last September was 1.2% The opening value would be as follows:

  • DB opening value = £29,644.00 x 25/60 x CPI (1.2%) x 16 = £200,000

Calculate the closing value

At the end of the PIP year, John’s earnings were £36,058.00 and he has now completed 26 years’ service within a 1/60th accrual scheme.

  • DB closing value = £36,058.00 x 26/60 x 16 = £250,000

Calculate the Pension Input Amount (PIA)

Closing value less Opening value equals Pension Input Amount

  • £250,000 less £200,000 equals £50,000

In this example John would have exceeded his annual allowance by £10,000 and unless he had some unused annual allowance to carry forward, he would face an annual allowance charge on the excess.

Carry forward of unused allowance allows an individual to bring forward unused annual allowance from the previous three tax years to make contributions larger than their annual allowance in the current tax year.

The conditions that need to be met are as follows:

  • The individual must have used up their annual allowance for the current tax year.
  • The individual must have been a member of a UK registered pension scheme over any of those previous three tax years they wish to use carry forward from.
  • They must have unused annual allowance to carry forward from those tax years.
  • If the individual is making the contribution, they must have relevant UK earnings in this tax year to cover the size of any proposed contribution to be made.

Step 1 – work out the pension savings for each plan in the tax year

  • Determine the level of pension savings for each pension plan for the tax year, known as the pension input amount.
  • This will need to be done for all Defined Contribution (DC) and Defined Benefit (DB) scheme for the tax year in question.
  • Remember, since the 6 April 2016, the pension input period (PIP) has been aligned with the tax year and so there is no longer scope to change the end date.

Step 2 – determine the annual allowance available including any carry forward

  • Determine whether the annual allowance applies or does the reduced Money Purchase Annual Allowance (MPAA) or Tapered Annual Allowance apply (see our Technical Briefing Notes on these subjects)
  • Then calculate how much annual allowance is available – this will be a combination of the annual allowance for the tax year in question plus any unused annual allowance that can be carried forward from the previous three tax years

Step 3 – subtract the total pension input amounts (PIA) from the available annual allowance (including any carry forward)

  • Subtract the total Pension Input Amounts (PIAs) from the annual allowance; and
  • If it is within the available annual allowance limit (including any unused carry forward), then an annual allowance charge will not apply.
  • If the total of the PIAs exceeds the annual allowance and available unused carry forward of unused allowance, then the individual will face an annual allowance tax charge.

The annual allowance charge will apply where pension savings are above the level of the annual allowance and unused annual allowance carried forward from the previous three tax years.

The amount of the charge will be based on the excess over the annual allowance (or chargeable amount) which is then added to the individual’s total income for the tax year.

The rate will then depend on which income tax bracket it falls into when added to the individual’s salary. Therefore any charge will be at the individual’s marginal rate of income tax.

Individuals affected by the annual allowance can elect for their schemes to pay any annual allowance charge providing that:

  • The charge exceeds £2,000;
  • The total pension savings within that scheme exceeds the annual allowance (for example £40,000).

The scheme is only obliged to pay that part of the charge that relates to their scheme although an individual can request that their scheme pay the whole charge. However, the scheme can decline to pay any amount that does not relate to an over payment to their scheme, where the two bullet points above apply.

  • Maximising contributions where possible
  • Making use of any carry forward of unused annual allowance
  • Consider alternatives to pensions where annual allowance restrictions apply

This briefing note is also available as a PDF document

This briefing note has been prepared for professional advisers use only.

Please note that we are providing this information and comment based on our current understanding of tax law, HMRC practice and legislation which may change and it should not be considered a definitive statement in law. We are also providing this on the strict basis that they are for your consideration only and that ultimate responsibility for any advice given to your client lies with yourself. Canada Life and Canada Life International Limited cannot be held responsible for the results of any action or inaction the client may undertake.

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