Frequently Asked Business Question:
I am completing my annual tax return for 2016/17 and am surprised to find that I have a tax bill because of my pension contributions?
Many unsuspecting higher earners have been caught by the new Pension’s Annual Allowance Taper Charge and could face substantial tax bills. From April 2016, higher earners have been subject to a reduced “tapered” annual pension allowance which restricts the amount of tax relief they are entitled for saving via a pension. The maximum pension allowance contribution is currently £40,000 however those earning more than £150,000 have an annual allowance lower than the standard. When earnings exceed £150,000, the allowance is gradually tapered down to a floor of £10,000 – for every £2 of income earned above £150,000 the allowance is reduced by £1. High earners therefore who have breached the amount that they are entitled to put into pension under these tapering rules could face significant tax liabilities.
There are two types of pension schemes, Defined Contribution Schemes and Defined Benefit Schemes. Taxpayers contributing to a Defined Contribution Scheme will find it relatively easy to work out how much they have paid into their pension annually as normally they or their employer physically transfer money into the scheme on a monthly basis or via periodic lump sums. However the members of Defined Contribution Schemes are often unaware how much money is being contributed to their pension scheme on an annual basis.
The calculations for Defined Benefit Schemes are very challenging and involve calculating how much your annual entitlement has increased by since the previous tax year taking into account inflation and then multiplying that by 16 having regard for any lump sums paid by the scheme.
At present, you can ask your retirement scheme to pay any tax charge related to an annual allowance breach directly from the pension fund – this is known as “Scheme Pays” which spares you from having to find the cash from your non pension savings to pay your tax bill.
Because this is not mandatory, some schemes do not offer this facility and furthermore (the facility is not necessarily available to individuals and) even if it is available the deadline for using “Scheme Pays” is normally 30 September following the end of the tax year. Taxpayers therefore who have exceeded their annual pension allowance and who are filing their tax returns after 30 September may have to personally settle their tax bill.
The tax charge for a member of a Defined Contribution Scheme could be £13,500. This charge would be faced by a taxpayer who is earning more than £210,000 and who had contributed £40,000 into their pension scheme in the tax year. The tax charge is based on applying a 45% tax rate to the excess contributions above £10,000 i.e. (£40,000 – £10,000) x 35% = £13,500. In limited circumstances members of Defined Benefit Schemes could be faced with even higher tax charges.
If you are caught by these rules and if you have not maximised your pension contributions in the previous 3 years you may avoid the tax charge by assessing the amount of unused pension relief available to carry forward.
Finally, this is one of the most complex areas of personal taxation and any high earners faced with a tax charge arising from pension contributions should seek urgent professional advice without delay.
The advice above is specific to the facts surrounding the questions posed. Neither FPM nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.