Tax relief and the annual allowance

Hello everyone. Thank you for taking the time to listen to this webinar on tax relief and annual allowance. My name is Keith Symon and I am joined by Jennifer Irvine, who will be talking us through carry forward and case studies. We are part of the Technical Support Team at Royal London. 
 
My aim today is to give you an overview of the annual allowance and tax relief and how they interact with each other. This slide shows the learning objectives of this session which are to have an understanding of limits on tax relief, relationship between the annual allowance and tax relief, what triggers the money purchase annual allowance, how to calculate the annual allowance when the taper applies, how to calculate unused annual allowance using carry forward. 
 
Now, let's have a look at the first learning objective, the limit on tax relief. 
 
First of all, employer contributions. These are paid gross. The corporation tax relief is usually claimed by deducting the contribution from the taxable profits as an expense of the business. Tax relief is not automatic for employer contributions, but in theory, HMRC will accept any level of contribution as being an expense of the business, so long as it is made wholly and exclusively for the purposes of the trade or profession. Now, there's a lot of rules and examples of what this means on the HMRC's website. 
 
They're designed to make sure that the rules, essentially, they are designed to make sure that the rules on corporation tax relief aren't abused. For example, by contributing for a close relative or a controlling director that's out of proportion to their worth to the company. 
 
Now let's look at personal contributions. Individuals get tax relief on their contributions within limits, either by the relief at source system or the net pay arrangement. Let's have a look at this in a bit more detail. 
To qualify for tax relief on their personal contributions or contributions made by a third party, excluding the employer, an individual must be a relevant UK individual. This means they must either have relevant UK earnings chargeable to income tax for that tax year, be resident in the UK at some time during that tax year or have been resident in the UK at some time during the five previous tax years and when they joined the pension scheme. 
 
The last point allows people going abroad to continue paying tax relievable member contributions to their UK pension scheme for up to five tax years after leaving the UK, that is. Assuming they don't have relevant UK earnings, tax relief will be restricted to £3,600 a year gross. Relevant UK earnings are basically employed or self-employed earnings that are subject to UK income tax. It doesn't include savings, income, dividends or pension income. 
 
If a relevant UK individual does have relevant UK earnings, the maximum tax relievable contribution they can pay is the higher of £3,600 a year and 100% of relevant UK earnings in the tax year. Most providers can't accept new applications for anybody who isn't habitually resident in the UK. This means that if they're already a member of an existing plan and move overseas, the provider will continue to accept contributions at the existing level to that plan up to £3,600 gross, less any contributions they may be making to other pensions schemes. This can be done for up to five complete tax years after they have left the UK. 
 
Relief at source is the method used to give tax relief on contributions to non-occupational schemes, such as personal pensions. Basic rate tax relief is given by the provider, adding basic rate tax relief, which is currently at 20%, and that's off the gross contribution. That is added to the net contribution and claiming that tax relief from HMRC. So someone paying a gross contribution of £100 will only pay £80 out of their own pocket, with the tax man paying £20. Since the 20% tax relief is based on the gross contribution, this results in tax relief increasing the net contribution by twenty-five percent, as £20 is 25% of 80. 
 
If someone pays income tax at a higher rate than 20%, they can claim the difference between basic rate and whatever higher rate they're paying via their tax return or by writing to HMRC. Now taxpayers in England, Wales and Northern Ireland can pay tax at 20%, 40% and 45%. In Scotland, it can be 19, 20, 21, 42, 45 and 48%. It's important to remember that under relief at source, any tax relief higher than 20% must be claimed. It is not given automatically. It is also important to note that this extra tax relief is only given to the extent that the individual pays tax at this level. In other words, if someone paid tax at 40% on £1,000 of their taxable income and paid a gross contribution of £3,000, they'd only get higher rate tax relief on £1,000 of the contribution. Any tax relief at a higher rate than basic is given by extending the basic rate tax band by the amount of the gross contribution. This means that it can also help reduce the tax due on investments, such as investment bonds, but that's a whole other story. 
 
Now let's have a look at an example of how relief at source works. Currently, if someone has a taxable income of £51,270 and the standard personal allowance of £12,570 applies, they won't pay income tax on the first £12,570 of their taxable income. 
In England, Wales and Northern Ireland, they'll pay at the basic rate of 20% on the next £37,700. So, basic rate tax will amount to £7,540. On the £1,000 balance of their taxable income, they'll pay tax at the higher rate of 40% producing a tax amount of £400. Their total tax bill, therefore, will be £7,940.  
 
In Scotland, the bands and rates are different, but the principle is the same. For simplicity, we're just showing the situation with English, Welsh, and Northern Irish taxpayers. 
 
If they pay an individual contribution of £1,000, they're entitled to tax relief at the higher rate of tax. This is given by expanding their basic rate tax band by the gross amount. So, using this example, their basic rate tax band is increased by £1,000 so it becomes £38,700. The basic rate tax payable on £38,700 now becomes £7,740 and no part of their taxable income is taxed at the higher rate. Their total tax bill is now reduced to £7,740 and they've saved £200 in tax. Remember, the individual has already had £200 of basic rate tax relief at source by paying a net contribution of £800. So, they have effectively received tax relief for £400 which is 40% of the gross contribution of £1,000. In other words, they've had full higher rate tax relief on all of the gross contribution. 
 
If the individual makes a pension contribution of £3,000, their basic rate tax band is again expanded by the gross amount. In this case, the basic rate tax band is expanded from £37,700 to £40,700. Although, as their taxable income is only £51,270, basic rate tax will apply to £38,700 of their income. That's the £51,270 minus the £12,570. 
 
However, before the contribution was made, the individual was only paying higher rate income tax on the £1,000 income above the £50,270. That's the £12,570 plus the £37,700. So, as they are only entitled to receive an additional higher rate tax relief on £1,000 of their £3,000 contribution, this is because only £1,000 of the individual's taxable income will have been taxed at the higher rate had the contribution not been paid. You can therefore see that the individual's total tax bill is still £7,740, which is £200 less than if no pension contributions had been paid. However, a further tax saving of £600 will have been received when the individual paid their net contribution of £2,400 i.e. 80% of £3,000. 
 
By making a pension contribution of £3,000, the individual has therefore received tax relief of £800 on their contribution, which represents 26.67% of their £3,000 gross contribution. This is less than the 40% because the individual would only have been entitled to higher rate tax relief on £1,000, the amount of taxable income that would have been in the higher rate tax bracket if no pension contribution had been made 
 
Another method of claiming tax relief on individual contributions is by net pay. Net pay arrangement is only available to members of occupational schemes. Under this method, the employer deducts the individual contribution from the employee's salary or pay before deducting income tax. In this way, taxpayers who pay tax at a rate higher than basic get immediate tax relief at their marginal rate. The individuals don't get any more tax relief than is available under the relief at source method, but they don't have to claim any tax relief through their tax return. It's received immediately through a reduced taxable income. Now it does mean, however, that currently those who don't pay income tax, at least at the level of the member contribution, miss out on the tax relief they would have had if the relief at source system was used. However, those in that position receive a top-up payment paid directly to them by HMRC. National Insurance contributions are still based on the pre-contribution salary, however, only salary sacrifice arrangements escape National Insurance contributions. 
 
Now let's have a look at the annual allowance. The annual allowance effectively limits the amount of total pension contributions that can be paid into a pension plan without a tax charge applying. The maximum that can be paid by or for an individual within the annual 
Allowance is £60,000 over the tax year. Another important point is that the annual allowance isn't a limit per plan. It applies to total pension contributions paid to all plans. 
 
Employer, individual and third-party contributions all count towards the annual allowance, but it is the member who is liable for any charge. As we've seen, the tax relief rules mean that someone with UK earnings of £80,000 in the tax year could pay a gross contribution of up to £80,000 over that tax year and get tax relief on it. If the relief at source system is being used, that means paying a net amount of £64,000 pounds, with basic rate tax relief of £16,000 being added by the provider and claimed from HMRC. Tax relief due at a rate higher than basic rate can be claimed through their tax return or by writing to HMRC. 
 
However, although tax relief is given on the gross contribution of £80,000, an annual allowance charge is payable on the £20,000. That is the pension contribution of £80,000 less the annual allowance of £60,000. The amount of the charge is at the individual's marginal rate of income tax and so it's designed to remove all tax relief from the excess contribution. If there is unused annual allowance from the previous three years, this can be carried forward to boost the amount of annual allowance available. We'll have a look at that later to see how that works. 
 
The pension input amount is the amount paid into the plan or the value of benefits accrued over the tax year that's measured against the annual allowances available. For money purchase schemes, it's very straightforward, it's the amount of contributions paid over the tax year, whether that's individual, employer or third party or a combination. For defined benefit schemes, however, it's more complicated, and we'll go on to discuss that in the next slide.  
 
For a defined benefits scheme, the pension input amount is calculated as follows -  
You start by calculating the amount of pension accrued at the beginning of the tax year and multiply this by 16. If the tax-free cash builds up separately, as it does in some public sector schemes, you then add this on.  Then increase the total by the appropriate CPI increase, the CPI rate you use is the annual rate for the September before the start of the tax year. This gives you the adjusted opening value.  
You then calculate the accrued pension value at the end of the tax year and multiply it by 16. Add any tax-free cash that builds up separately. This is the closing value.  
Finally, you deduct the adjusted opening value from the closing value. 
 
Now, given the complexity of this calculation and the knowledge of the scheme rules required, it is generally safer to rely on a pension savings statement from the scheme. You'll have to request this if the scheme, if the pension input amount for the scheme is less than the annual allowance. You'll have to estimate it for the current year, as the scheme won't have this information until the end of the tax year. However, full details of the calculation can be found in Technical Central in our annual allowance article. 
 
We'll now move on to the money purchase annual allowance. The money purchase annual allowance further restricts the amount of contributions that can be paid to a money purchase scheme without a tax charge. We'll see in a minute what events trigger the money purchase annual allowance, but if it is triggered, the maximum amount that can be paid into money purchase schemes without incurring an annual allowance charge is £10,000 and once triggered, it applies for life. It operates over the same tax year as the ordinary annual allowance, and the amount of the charge is again the individual's marginal rate of income tax. However, unlike the ordinary annual allowance, carry forward of unused money purchased annual allowance from previous tax years can't be used to boost the amount of money purchased annual allowance available. 
 
As its name suggests, the money purchase annual allowance doesn't affect defined benefits schemes. 
 

There are different scenarios that can trigger the money purchase annual allowance, the most common of these being:

• taking income from a capped drawdown plan that exceeds the GAD limit
• receiving a lump sum from uncrystallised funds, for example, taking an UFPLS
• taking income payments from a Flexi Access drawdown plan.

Now, the following do not trigger the money purchase annual allowance:

• taking income from a capped plan that is within the GAD limit,
• additional fund designation to an existing cap drawdown plan,
• receiving a scheme pension from an occupational pension scheme,
• receiving tax-free cash only,
• taking a small pot lump sum,
• trivial commutation under a defined benefit scheme, or
• buying a lifetime annuity.

 
Let's go through an example of how this works. 
If John has triggered the money purchase annual allowance and pays contributions to schemes of £9,000, he has a further £51,000 annual allowance left, of which a further £1,000 can be paid to money purchase schemes. 
If you paid contributions of £12,000 to money purchase schemes, there will be an annual allowance charge of £2,000 pounds, and there will be £50,000 of annual allowance available for pensions savings in defined benefit schemes. 
 
Now, let's move on to the topic of the tapered annual allowance. For 26/27, those with an adjusted income of £260,000 or more in the tax year have their annual allowance reduced. 
The reduction is at a rate of £1 for every £2 by which the adjusted income exceeds the £260,000. The annual allowance can't reduce below £10,000, so anyone with an adjusted income of £360,000 or more will have an annual allowance of £10,000. However, the taper doesn't apply where the threshold income is £200,000 or less. 
 
To make sense of all of this, we obviously need to know what the terms threshold income and adjusted income really mean. So, the starting point for both terms is taxable income. This can be complicated where individuals are eligible for all sorts of reliefs and allowances and may need the input of their accountant. But for most, it's relatively straightforward. It would include things like salary, commissions, bonus, overtime, shift allowances, and any taxable investment income they have, including rental income. From there, you can calculate the threshold and adjusted income. The main difference between them being that threshold income includes no pension contributions, whereas adjusted income includes all pension contributions. 
 
Some individuals could have relatively low income and relatively high pension contributions. HMRC has made it clear it's not their intention to restrict the annual allowance for individuals where a relatively high proportion of their adjusted income is made-up of pension contributions. So that's why there is an income floor below which the reduction doesn't apply. This is called the threshold income and is currently set at £200,000. As mentioned, the starting point is taxable income. You can deduct any taxed lump sum death benefits received in the tax year and if a salary sacrifice agreement is set up on or after the 9th of July 2015, the employment income given up must be added back in. 
 
Individual contributions are usually already included in the taxable income amount. When someone says their salary is, for example, £160,000, they don't usually mean that that's their income after pension contributions have been deducted. Any gross personal contribution paid, whether by relief at source system or by the net pay arrangement, can be deducted. So, an individual could pay more individual contributions to a personal pension or an additional voluntary contributions to an occupational scheme to reduce their threshold income. If the threshold income isn't exceeded, there's no need to go any further. The taper doesn't apply. If it is exceeded, you then need to go on to look at the adjusted income. 
 
For adjusted income, starting point again is taxable income, but adjusted income includes pension contributions. As before, individual contributions are usually already included in the taxable income amount, but you also must add any employer contributions as adjusted income includes all pension contributions. Finally, if the individual received a taxable lump sum death benefit in the tax year, this can be deducted. If the final amount exceeds £260,000 and the taper applies to this individual, their allowance will be reduced by £1 for every £2 of excess. Again, the annual allowance can't be reduced below the £10,000, which means that £10,000 is the reduced annual allowance for everyone with an adjusted income of £360,000. 
 
So the diagram might make this clearer. 
For threshold incomes, you deduct gross individual contributions paid, add any employment income given through salary exchange agreements set up after 8th July 2015 and deduct any taxed lump sum death benefits. 
For adjusted income, add any employer contributions and deduct any taxed lump sum death benefits. It's worth noting that the employer contribution for a defined benefit scheme is deemed to be the pension input amount less any member contributions. 
 
I'll talk you through an example which should help bring this to life in practice. So, Mike's got a salary of £270,000 a year and investment income of £10,000 a year. He pays £12,500 a year to his occupational pension scheme under the net pay arrangement and his employer pays £17,500. So, would his annual allowance reduce, and if so, to what level? 
 
First, we'll look at Mike's threshold income. Remember, if it's £200,000 or less, his annual allowance won't be reduced. As it stands, his threshold income is his £270,000 salary plus his investment income of £10,000, less his contributions of £12,500. So, this gives us £267,500. Although the employer's pension contribution of £17,500 isn't included, he's still well over the limit of £200,000. And it's possible that the tapered annual allowance reduction will apply. 
 
If he paid a net contribution of £54,000, this would be grossed up to £67,500 and would be enough to get him down to the required level. However, such a payment on top of the existing employer and member contributions of £30,000 would bring pensions contributions up to £97,500, he therefore needs at least £37,500 of unused annual allowance to carry forward in order to avoid an annual allowance charge. 
 
Now, for his adjusted income, the £270,000 is Mike's earnings before the deduction of his £12,500 contribution to his occupational pension scheme. So, there's no need to add it back in again. We do, however, need to include his £10,000 of investment income and the employer contributions of £17,500. 
 
This totals £297,500, which is £37,500 over the £260,000 limit. His annual allowance will therefore be reduced by half of this, and so £18,750 will be deducted from the standard annual allowance of £60,000, resulting in an annual allowance of £41,250. 
 
We've seen that individual employer and third-party contributions all count towards the annual allowance and that in defined benefit schemes, it's the value of the benefits accrued over the year. Any excess of the pension input amount over the annual allowance available attracts an annual allowance charge. It's the individual that pays the charge, though, regardless of the source of the pension input amount. 
 
Any excess contribution is added to the individual's taxable income to see what the marginal rate of tax would be on that basis, and this is then the rate of annual allowance charge applied to the excess. This is all done through the individual's tax return, and the aim is to remove the tax relief on the excess contribution. 
 
It's also possible for the individual to pay the charge out of their pension pot, known as scheme pays. If the charge is more than £2,000 and the pension input amount for that pension scheme is more than £60,000, the scheme must apply scheme pays on request. If the conditions aren't met, the scheme can apply scheme pays on a voluntary basis. If asked, however, some schemes will not allow this. That's all from me now. I'm going to hand you over to Jennifer. 
 
Hi, I'm Jennifer Irvine and I'm going to move on to talk about Carry Forward, including talking through a few examples to bring it to life. By the end of this part of the webinar, you should have a clear idea of what carry forward actually is, where people go wrong and how to prepare for it. We'll also run through a few examples. 
 
First of all, I'm just going to run through the rules around carry forward. Any unused carry forward from the previous three tax years can be added to the individual's annual allowance for the current tax year. 
 
The current tax year's annual allowance is used first, then the unused annual allowance from the oldest of the previous three tax years, followed by the next oldest. And finally, the unused allowance from the previous tax year. Annual allowance can only be carried forward from a tax year in which the person was a member of a registered pension scheme. 
 
It's important to note that carry forward is just in relation to unused annual allowance. You cannot carry forward unused tax relief. As I mentioned previously, it's not possible to carry forward unused annual allowance against the money purchase annual allowance. 
 
So, where do people go wrong? 
First of all, they get mixed up between annual allowance and tax relief, which hopefully will not happen to you now that you've been through this webinar. They forget about the taper, other money purchase annual allowance, and that includes in earlier years, as well as whether they are applying now.  
 
Other common mistakes are they don't handle employer contributions or a previous carry forward correctly, or they get confused about eligibility for carry forward, or they try and do defined benefit calculations for themselves. 
 
So what information do you need in advance for carry forward? You need to establish the eligibility for carry forward, which is basically that they must have been in a pension scheme in the year they're carrying forward from and they need the current income. You possibly need the income from the previous three tax years as well, just to establish whether the taper applied or not during these tax years. You'll need the contribution history from at least 22/23 onwards, plus earlier if previous carry forward. You'll also need a simple way of keeping track of contributions paid and how much annual allowance has been used in each tax year. 
 
We've got a template in our carry forward article that you might find helpful. We tend to avoid calculators because they can differ in how you input the data and how the results are displayed. We think a simple table makes things much easier to follow. 
 
I'm now going to talk through the first carry forward example. Sam has his own limited liability company and in tax year 26/27, he'll pay himself a salary of £5,000 and dividends of £100,000. He took out a personal pension plan on 1st of August. 
2014 and he's been saving £1,200 a month in employer contributions ever since. He has no other retirement savings and he wants to make a substantial single contribution before the end of the 26/27 tax year. So, he wants to know how much he can 
contribute without triggering an annual allowance charge. He hasn't triggered the money purchase annual allowance and the tapered annual allowance doesn't apply to him. So, Sam wants to know how much can be contributed as an employer contribution without triggering an annual allowance charge. 
 
As you can see in this table, we've got each of the tax years in different lines and the annual allowance that applies for that tax year. The annual allowance was £60,000 for all these years and total contributions were £14,400 each year. For the purpose of this example, we'll assume that for 26/27, the contributions carried on until it was £14,400 for the entire tax year. In each of the tax years shown, the carry forward is £45,600, as this is £60,000 minus £14,400. So, an employer contribution of up to £182,400 can be paid in this tax year without an annual allowance charge applying. Assuming the wholly and exclusively conditions are met, it will also be eligible for corporation tax relief.  
 
Now, on to the second example. Amy is a finance director of a large manufacturing company earning £230,000 in the 26/27 tax year. Her employer has been making single contributions into a GPP for her since the 1st of May 2013. She hasn't been contributing herself and doesn't have any other retirement savings. 
 
Her employer will make a contribution of £33,400 in tax year 26/27. She wants to make a large single contribution herself before the end of the 26/27 tax year, but wants to do this without incurring an annual allowance charge. She hasn't triggered the money purchase annual allowance, but the tapered annual allowance may apply because of her earnings and the employer's pension contribution. The tapered annual allowance hasn't applied to her in previous tax years. 
 
As you can see, the amount of contributions paid given the carry forward remaining for each of these tax years, adds up to a total of £120,000. So, if Amy makes her individual gross contribution of £120,000, this will reduce her threshold income to £110,000 which is £230,000 less £120,000 and this means her annual allowance will be £60,000 for tax year 26/27 as a taper will not apply.  
 
The payment of £120,000 is within her relevant UK earnings for the tax year and so she will receive tax relief at her highest marginal rate. Remember, she will have to claim any tax relief above the basic rate from HMRC, usually via her self-assessment. 
 
Now, on to the last example. Brian is a partner in an accountancy firm and he'll earn £110,000 in the 26/27 tax year. He's been making occasional single contributions into his personal pensions since September 2021. He's already contributed £25,000 in 26/27. He's never been a member of any other pension scheme and now wants to make a substantial further single contribution before the end of the 26-27 tax year. He wants to know how much he could contribute without triggering an annual allowance charge. He hasn't triggered the money purchase annual allowance and the tapered annual allowance doesn't apply. 
 
So, looking at this table. You'll be able to see that a total of £65,000 unused annual allowance was available in 24/25 from tax years 22/23 and 23/24. The £20,000 excess over the annual allowance that was paid in 24/25 is covered by the £20,000 carried forward from 22/23. So, the £45,000 carried forward from 23/24 is still available to be used in 26/27. So, after paying the single contribution of £25,000 in tax year 26/27, a further individual contribution of up to £100,000 can be paid before the end of the tax year without an annual allowance charge applying. This total contribution is within Brian's relevant UK earnings, so he'll be eligible for tax relief. 
 
If Brian had had carry forward from 21/22, that could have been used to partially or completely offset the excess in 24/25. That would have meant that more carry forward would be available in 26/27. If it had completely offset the excess, that would have meant another £20,000 of carry forward could be used in 26/27 given £120,000 that could be paid without an annual allowance charge applying. This is still less than his earnings and so would have been eligible for tax relief. 
 
We've gone over a fair bit of ground here. The idea is straightforward, but putting them into practise can be complex, especially if an individual is a member of a number of pension schemes or has tapered annual allowance issues in the current tax year and or previous years. 
 

The main points, however, are that:

• Tax relief on individual contributions and pension input periods operate over the tax year.
• It's possible to pay a contribution that gets tax relief, but which also attracts an annual allowance charge.
• Carry Forward can boost the annual allowance available.
• Any annual allowance charge is paid by the individual, although they might be able to take the charge from their pension pot.
• The money purchase annual allowance can limit contributions to money purchase plans, without an annual allowance charge applying, to £10,000 a year.
• High earners can have a tapered reduction in their annual allowance.

 
And that's it. I hope you found this presentation useful and that you now have a better understanding of how tax relief and the annual allowance interact. Copy of this presentation can be found in the webinar and CDS section of Technical Central. 
 
Thank you for listening.