The Annual Allowance
The annual allowance (AA) is a limit on the amount that can be contributed to a pension each year, while still receiving tax relief. It is based on earnings for the year and is capped at £40,000.
The AA is a much more complex area than the lifetime allowance that we discussed in our last issue of this briefing. In the table below, you can see that the allowance steadily increased up to a maximum of £255,000 by 2010/11 and was then reduced drastically to £50,000 albeit with a new ‘carry forward’ rule.
Table 1 shows the changes that have been made to the annual allowance since 2006.
* Transitional rules apply to the 15/16 tax year
** The 16/17 may be a low as £10,000 for higher earners.
If the allowance is breached in any one year, the individual can carry forward any unused allowances from the three previous tax years. If there is still a breach after using carry forward the excess is added to the individual’s income for the tax year and taxed at their marginal rate of income tax.
• Any private pension/AVC contributions (exc. added years) taken at their gross value.
• The NHS input depends on inflation, the individual’s service history in the NHS and their pensionable salary. Inflation is measured as the published CPI rate from the preceding September (0% for the 2016/17 tax year). A high inflation rate means benefits can go up by more each year before breaching the allowance. Conversely, a low inflation rate (as we have now) means there is a higher chance of a breach.
If the individual’s pensionable salary increases, their benefits will increase as a result leading to a higher input. Pensionable salary is increased by reaching the next increment of the consultant contract, receiving new local or national Clinical Excellence Awards (CEAs), statutory pay rises or taking on a pensionable management position.
The new ‘tapered’ annual allowance
There are also a different set of rules which came into force this tax year for anyone who earns more than £150,000 gross from all sources. This group may see their annual allowance reduced to as low as £10,000 depending on the level of income they receive.
The new ‘tapered’ allowance reduces the savings limit by £1 for every £2 of income for individuals with ‘adjusted income’ of over £150,000 with a maximum reduction of £30,000 for those earning £210,000 or more. Adjusted income includes not only salary but bonuses, benefits in kind and pension contributions which adds to the complexity of the earnings calculation for those with several income streams.
There are differences in the way money purchase pensions are measured for AA purposes when compared to defined benefit schemes. Any contributions to money purchase schemes are taken at face value so if the contribution is £500 gross pm (after basic rate tax relief) that totals £6,000 per annum. The saver’s ‘input’ is therefore £6,000 for the tax year.
For defined benefit schemes it is more difficult. The accrued benefits are measured at the start of the input period and again at the end of the period. An allowance for inflation is made and the difference between the start and end values are deemed the ‘input’ for the year.
It is imperative for an individual to check their own position as the onus is on them to inform HMRC if they have exceeded the allowance.
What options do your clients have?
Planning ahead is crucial in terms of managing contributions to private pensions as well as the NHS pot. The individual will receive statements of their pension contributions from the NHS Pension Agency but these will be received in the autumn long after the relevant tax year has closed. Little can be done retrospectively.
Any resultant tax charge has to be paid via self-assessment (by amending the previously filed tax return and paying any penalty necessary) or choosing to use ‘Scheme Pays’ (if the tax sum is greater than £2,000). The NHS pension scheme will pay the tax bill on the individual’s behalf, setting this against future pension benefits as a ‘debt’ which increases with interest until retirement. The debt is ‘repaid’ via a reduction in pension benefits at retirement.
Your medical clients may choose to decrease their contributions to private pensions or look to alternative investment products such as ISAs to reduce the chance of them accruing annual allowance liabilities. They may also consider moving assets which generate income (such as rental property) to a partner or spouse in order to reduce overall adjusted income.
For more details on the annual allowance, please contact either Patrick Convey (Technical Director) or Simon Bruce (Managing Director) on 020 7636 7006.