In 2006 as part of the Pension Simplification rules the Government introduced the concept of the Annual Allowance.
With effect from 6 April 2006 the maximum amount that could be paid into a pension each year and qualify for tax relief became subject to a cap. This cap is known as the Annual Allowance and in 2006 was set at £215,000. It then gradually increased to £255,000 in 2010/11, before reducing sharply to £50,000 in 2011/12. It has been at £40,000 since 2014/15.
The Annual Allowance is a limit to the total amount of contributions that can be paid to defined contribution (Money Purchase) pension schemes and the total amount of benefits that can be built up in defined benefit (Final Salary) pension schemes each year, for tax relief purposes.
If you have already started accessing your pension a lower cap of £4,000 may apply. This is known as the Money Purchase Annual Allowance (MPAA).
The Annual Allowance applies across all the schemes you belong to, it’s not a ‘per scheme’ limit and includes all the contributions you, your employer or anyone else who pays on your behalf make to a defined contribution pension scheme, during the year. For defined benefit schemes, the Annual Allowance is calculated by reference to the increase in pension benefits over the year, multiplied by a factor of 16:1, not the actual contributions.
If you exceed the Annual Allowance, you won’t receive tax relief on any contributions you paid that exceed the limit and you will be faced with an Annual Allowance charge, which will be added to your taxable income for the tax year in question to determine the tax liability.
You may be able to carry forward unused Annual Allowances from the previous three tax years, to reduce your Annual Allowance charge to a lower amount (unless you have a MPAA).
Your pension provider or scheme administrator should provide you with details of the contributions or increase in pension benefits for that scheme, each year.
The Annual Allowance rules were complicated further by the Tapered Annual Allowance, which was introduced on 6 April 2016 for high earners. If your total income exceeds £150,000 per annum your Annual Allowance will be tapered by £1 for every £2 of income above £150,000. The maximum reduction will be £30,000 so if you have income over £210,000, your Annual Allowance will be capped at £10,000.
The rules surrounding the Tapered Annual Allowance are complicated. Calculations to determine if you have exceeded the Threshold Income limit of £110,000, where pension contributions are excluded and the Adjusted Income limit of £150,000, where pension contributions are included, will indicate whether your Annual Allowance will be tapered.
However, the challenge for those in defined benefit (Final Salary) pension schemes, where the scheme administrator provides details of the increase in pension benefits, is that often an individual is not aware that they are affected by the Tapered Annual Allowance until they are subject to an Annual Allowance charge.
As always it is so important that you obtain advice from an advisor who is qualified in this area.
Sue Williamson is a Chartered Financial Planner at Acumen Financial Planning in Aberdeen.