Making the most of allowances

Introduction 00:00 - Kimberley Dondo

Welcome to Money Talks a special podcast series in collaboration with Royal London. In today’s episode we explore one of the most requested topics that Royal London’s technical team encounters, carry forward. Understanding how to correctly utilise unused allowances from previous years can be a game changer for your clients but the calculations are rife with potential pitfalls. Joining us to breakdown the rules, eligibility and common ‘gotchas’ are Fiona Hanrahan and Justin Corliss from Royal London.

Hello and welcome to today's episode of Money Talks. In today's episode, I'm joined by Fiona Hanrahan and Justin Corliss from Royal London. So before we get into the meat of today's podcast, Justin, would you like to give a bit of an intro to yourself? I know you've been on our podcast before, but for those who may not have listened to that episode.

Justin Corliss
Yeah, thank you very much Kimberley. Hello everyone. I'm Justin Corliss. I'm part of the technical marketing team here at Royal London. So, I’ve been a pension expert and involved in pensions for over 20 years. A little bit of a specialism in public sector, but also in all things workplace and decumulation as well.

Kimberley Dondo
Amazing. And Fiona?

Fiona Hanrahan
Hi there, I'm Fiona Hanrahan from Royal London. I've worked for Royal London for over 10 years now. Prior to that, I've worked for a couple of other providers and worked as a chartered financial planner during that time too. My sort of main area of specialism is pensions and that's definitely what we're talking about today.

Kimberley Dondo
Yes, so we'll be talking about carry forward. So Fiona, I wanted to start by asking you, why have you chosen to talk about carry forward?

Fiona Hanrahan
Yeah, that's definitely worth asking. And between January and the tax year end every year, carry forward is the most popular topic our technical support area gets asked about. And I can understand that the rules have changed over the years and it can be complicated. So, you know, I do get why we get asked lots of questions about it. And it's also pretty tax year end specific. So it makes sense that if you don't deal with something every week, every day, every month, you'll end up having questions, you know, if you're only looking at it once a year. And also, the consequences of getting the calculation wrong can mean that a client ends up with a tax charge or even contributions needing to be refunded. So again, it's worth confirmation that your calculations are correct.

Kimberley Dondo
Okay. And Justin, so for those who may not know, what is carry forward? And is it important or relevant as it used to be with the increase of annual allowance? And will it also be different for company directors?

Justin Corliss
A few questions in that, all good ones actually. So let's just have probably a little bit of background first to it. Each tax year, there's a limit on how much you can pay into your pension, or of course have paid in on your behalf before a tax charge applies.

Now, that's called the annual allowance. It's currently £60,000 per tax year. So that's not the maximum you can pay into your pension. It's the maximum before a tax charge applies. So £60,000 is the standard annual allowance. No doubt later on in this podcast, we will come on to clients who will potentially have less of an annual allowance.

If they don't have a standard one, so they'll have a little bit less than that. Now, carry forward then is the ability to use the previous three years annual allowance and add those to the current year's allowance, making potentially four years available. So in other words, this increases the amount that you can pay into a pension before a tax charge applies.

Now, it's important to highlight that annual allowance and tax relief are different things. It's unused annual allowance that you carry forward, not unused tax relief. If your client is paying an individual contribution, then they're still limited 100% of relevant earnings in the year of payment of the contribution for tax relief purposes. So for example, you could have £100,000 worth of annual allowance available, including your carry forward, but if your earnings are £50,000, you'll be limited to an individual pension contribution of £50,000, less whatever else you've already paid in, if that's anything. Now, it's also just worth saying any tax relief you are claiming on a contribution, whether carry forward is being used or not, will be for the current year. It's too late to claim any tax relief for a previous year.

Now, if it's an employer contribution, which is being paid, for example, a company director making an employee payment through a business, then that 100% of earnings rule doesn't apply. Employer contributions can be paid which are above the client or the member's earnings. These contributions will not be subject to corporation tax, provided that wholly and exclusively condition is met.

Probably won't go into that now, but people could have a look at what that was if necessary. So if somebody asks you how much they can pay into their pension, they probably mean how much can they pay in and get tax relief as well as avoid an annual allowance tax charge. And this will mean likely working out how much carry forward or unused annual allowance is available.

It's worth knowing early on too whether it's an employer contribution or an individual contribution, as remember individual contributions have that 100% of earnings cap. The maximum carry forward available in theory then is £220,000. That's the annual allowance of £60,000 for the current tax year plus £40,000 for the tax year 22-23 and £60,000 for tax years 23-24 and 24-25. And you've probably gathered from that that the annual allowance increased from £40,000 to £60,000 on the 6th of April 2023.

Kimberley Dondo
Okay. And Fiona, could you clarify the eligibility around carry forward?

Fiona Hanrahan
Of course, that's a fairly often asked query. Anyone who was a member of a pension scheme in the year they are carrying forward from is eligible to use carry forward to the current tax year. And that definition of member is very broad for this purpose and includes an active member of a pension scheme, meaning you are actively contributing in that year. A deferred or paid-up member, meaning you were in a scheme, then left, you're still a member for the purposes of carry forward. A pension credit member, meaning you set up a pension plan with a pension credit in respect of a divorce. So again, you're a member for carry forward purposes. Or lastly, a pensioner member, meaning you are in a receipt of a pension from a pension scheme.

So really then the only clients not eligible to use carry forward would be those taking out a pension for the very first time because they wouldn't meet any of those definitions of member for carry forward purposes. Also, we're saying it's not necessary to make contributions using carry forward to a current scheme or one you already have. These can be made to a brand-new scheme.

It's also not necessary to have made a pension contribution in the year you're carrying forward from. Both of those are quite often asked. Even if the client, for example, lived abroad during one of those previous years, carry forward will still be available for that year if they meet one of the member definitions, probably deferred in that instance. And if they're eligible to make contributions in the current year, probably that they're back in the UK with earnings, then, you know, they can use carry forward.

It's also worth mentioning the lifetime allowance. And although it was completely removed from the 6th of April 2024, the lifetime allowance and lifetime allowance protection can still be a valuable benefit, potentially allowing a higher lump sum allowance or higher lump sum and death benefit allowance. And clients with lifetime allowance protections secured before the 15th of March 2023 can pay into pensions without their pensions being affected. So carry forward could then in theory allow for large contributions, because they wouldn't have paid in, with no tax charge applying in cases where enhanced or fixed protection applies.

Kimberley Dondo
Okay. And Justin, from my perspective, this seems kind of complicated in terms of maths. Is it complicated? How do you calculate how much carry forward is available and what information is useful to have in advance?

Justin Corliss
Kimberley, it does have its moments, but no, by and large, it's not too bad, I suppose. Now, some information gathering is required first. I hope that's come across already. I would first check if we're looking at an employer or an individual contribution. I know I've already touched on that, but it is really important.

For example, if it's an individual contribution and earnings are £50,000, carry forward isn't required as contributions above £60,000 aren't being made, and you maximise the current year first before going back to the earliest of the three years. So in that instance, if you've only got 50,000 of earnings, you can't maximise the 60,000. So there's no carry forward to be done.

So next I would check eligibility. It's really only those taking out a pension for the very first time, as Fiona mentioned, that won't be eligible, but still important to check. Then get a history of contributions for the previous three years, and of course the current year as well. All contributions, whether they are individual, employer or third party (somebody else that's not an employer but has made a contribution on someone else's behalf), they all count towards the annual allowance.

So the current year's earnings are important, obviously, as it's an individual contribution that's being made. The earnings from the previous years probably are only required if the tapered annual allowance applies, as you'd need to work out
the tapered annual allowance for each of those years and total income subject to income tax is needed for that. So earnings plus any other taxable income. Then using a table or one of the available calculators will be useful. Now for each year,
calculate the standard annual allowance or the tapered annual allowance, less what was paid. Then add those four figures together and that's the maximum that can be paid without a tax charge applying. I guess another way of thinking about that is if the taper doesn't apply, and it doesn't to the vast majority of people,
and there's been no previous carry forward it's £220,000 less the contributions which have already been paid. Sort of simplifies it a little bit, I hope.

If carry forward has been used in one of your previous years, that will be obvious if a contribution has been paid of more than the available annual allowance for that year. No annual allowance will be available to carry forward from that year. This year can just be crossed off in your calculation. Remember, you will have maximised that year first before going back to the earliest years in the calculation, so that's why you know that you can cross that one out.

Kimberley Dondo
Okay. And Fiona, so a common question or gotcha is, can you use carry forward if you've triggered the money purchase annual allowance?

Fiona Hanrahan
Okay, now if the client has triggered the money purchase annual allowance, then it's not possible to use carry forward to increase contributions to defined contribution or money purchase schemes above £10,000. That's the money purchase annual allowance without an annual allowance tax charge applying. Carry forward will still be available for any defined benefit or DB schemes though.

Remember, once the money purchase annual allowance has been triggered, it applies for the rest of your life or unless some legislation changes it for you. So you're stuck with it, I'm afraid.

Kimberley Dondo
And can you use carry forward if the tapered annual allowance applies or applied in a previous year?

Fiona Hanrahan
So this is different. The tapered annual allowance rules apply from tax year 2016-17 onwards, so in theory could apply to all four years in the carry forward calculation. And if the taper does apply, carry forward can still be used and the standard annual allowance of £60,000 or £40,000 for tax year 2022-23 is simply substituted by the tapered annual allowance for each year that it applies. And I would say if the taper applies to all four years in your calculation, then, that's pretty bad luck because this is about as hard as a carry forward calculation can get. And that's because you would need to do a taper calculation for each year. And you'd also have to remember that the rules or parameters changed from 6th of April 2023, so pretty horrific.

Kimberley Dondo
Okay, and do you have to tell your provider or HMRC you're using carry forward?

Fiona Hanrahan
Now, you do not have to tell your pension provider or HMRC you're using carry forward and you used to, so you know I get why someone would ask that. It's definitely worth keeping good records of any calculations in case a contribution is queried in the future though.

Kimberley Dondo
Yeah. And Justin, what happens if you make an error in the calculations and pay too much? Nightmare.

Justin Corliss
First of all, I suppose I should really clarify what we mean by too much. If the client is paying an individual contribution, and it ends up above that 100% of earnings for the current year, so in other words, above the limit on which that they can get tax relief, the excess will probably be refunded by the provider. Most providers can't accept contributions not entitled to tax relief and will refund the excess. I can't say that that is universally true, but it is pretty likely.

If the carry forward was calculated incorrectly and the client pays contributions from any source above the available annual allowance, and that's including any carry forward, then these will still potentially receive tax relief, but the client would face an annual allowance tax charge on the excess above the available annual allowance. Now, the excess wouldn't be refunded in this situation. Remember, if it's an employer contribution is paid above the available annual allowance, it's still the client who would pay the annual allowance tax charge. Now the annual allowance tax charge would be levied at the marginal rate of income tax for that individual that received the contribution on the excess above the available annual allowance after carry forward.

Kimberley Dondo
Right. And I'm sure this might be a lot of information for our audience to have taken in and they probably want further information and support. So what support is available from Royal London, Fiona?

Fiona Hanrahan
There's tonnes of support on our Technical Central website. This includes a sample table you can use for the calculations as well as some case studies. But speak to your usual Royal London contact if you need some more assistance.

Kimberley Dondo
Okay. And Fiona, Justin, thank you for sharing your expertise. You clearly know your stuff. It's clear that while carry forward is a brilliant tool, the devil is very much in the detail, especially when tapering and the MPAA are in play. It's something that I don't think I could personally deal with. But I'm glad there's people out there who are capable to. So, thank you for speaking with me today.

Fiona Hanrahan
You're welcome.

Justin Corliss
Thank you very much.

Outro - Kimberley Dondo
Thank you for tuning into this episode of Money Talks in partnership with Royal London. If you need to double check your figures you can find a suite of technical guides, case studies and calculation tables over at the Royal London adviser site.

We look forward to seeing you in the next episode. See you next time.