With an ageing population, pensions are a key focus and often a political hot-potato. The Government faces a continual balancing act of wanting to encourage people to save for their retirement by providing tax incentives, while balancing the budget.
The constant changes to the rules around pensions have resulted in a very complex regime, which unfortunately includes potential tax charges that can be inadvertently triggered.
We focus on just one of these, caused by making contributions that exceed your Annual Allowance.
What is the Annual Allowance?
The Annual Allowance is the maximum amount that can be contributed to an individual’s pension scheme, on which tax relief can be received in a tax year. Since 2023/24, the maximum has been £60,000.
It is essential to note that this includes all personal and employer contributions.
To muddy the waters, the Annual Allowance is reduced where an individual meets two measures, referred to as ‘Threshold Income’ and ‘Adjusted Income’. Although outside the scope of this article, the latter is broadly the former, plus any employer pension contributions.
The Annual Allowance reduction is subject to a minimum level of permitted contributions (currently £10,000 but has been £4,000).
The ‘Threshold Income’ and ‘Adjusted Income’ levels have changed over the years, with the current levels set at £200,000 and £260,000 respectively.
It is worth mentioning that the income threshold was increased substantially in 2020/21 in response to several representations to help NHS doctors, however, the increase was not limited to NHS doctors. As with most announcements, the generous increase to the income thresholds coincided with the reduction to the minimum Annual Allowance. The response in 2020/21 came too late for a number of high earners who had utilised the brought forward unused allowances (see below) and unknowingly created a pension tax charge. The phrase ‘high earners’ is subjective, but for 2016/17 to 2019/20, the Threshold Income level was £110,000 and the Adjusted Income level was £150,000.
It is possible to carry forward unused Annual Allowances from the previous three tax years to be added to the current year’s Annual Allowance. The introduction of the tapered Annual Allowance in 2016/17, and the interaction of carry forward of unused allowances, meant that we didn’t really start seeing the full impact of the new rules until 2019/20. That said, it is down to the individual to monitor their own Annual Allowances and report any charges on their Tax Return. The complexity and the fact that employers pay percentage-based contributions can easily pass everyone by. Thus, a number of individuals have unknowingly triggered pension tax charges due to excessive contributions, which are surfacing on the back of a review or HMRC communication.
To proactively and accurately plan pension contributions you need to know what your Annual Allowance position is, both from the previous three years and in the current year. It is easy to make a mistake, especially where your employer makes contributions and where they are based on a percentage of your earnings, as well as receiving bonuses.
