Taxpayers with modest levels of pension contributions can be caught out by one of two restrictions on their annual allowance. Any excess contributions above their allowance must be declared on the SA tax return.
Where the pension contributions made by, or on behalf of, an individual taxpayer exceed that taxpayer’s annual allowance for the year, the taxpayer must declare the excess contributions on their tax return to self-assess the annual allowance charge. This charge is levied at the taxpayer’s highest marginal income tax rate to claw back tax relief on the excess pension contributions.
Many taxpayers don’t realise that they have to make such a declaration, as HMRC noted in its latest pensions scheme newsletter.
The declaration of excess pension contributions must be made, even where the pension scheme will pay the annual allowance charge under a “scheme pays” arrangement. In April 2019 Simon Nicol explained how “scheme pays” operates for doctors’ pensions, but the same principles apply for all occupational pension schemes.
An excess payment of pension contributions can arise unexpectedly due to the operation of two different pensions traps: the money purchase annual allowance (MPAA) and the restriction of the annual allowance due to the taxpayer’s net adjusted income exceeding £150,000 for the tax year.
The MPAA reduces the standard £40,000 annual allowance to exactly £4,000 when the taxpayer has accessed pension benefits from their money purchase (aka defined contribution) scheme, as Simon Nicol explained in February 2019.
It is important to note that once the MPAA has been triggered it remains in place for the current year and all future tax years. It is a permanent reduction in the taxpayer’s annual allowance.
Tax advisers should ask their clients if they have received a “flexible access statement” from their pension provider at any time since April 2015. The MPAA for 2015/16 and 2016/17 was £10,000, but no part of an unused MPAA can be carried forward to a later tax year.
The standard annual allowance (AA) is restricted by £1 for every £2 that the taxpayer’s adjusted net income (which includes all pension savings made by and on their behalf) exceeds £150,000. The taxpayer’s threshold income for the year must also exceed £110,000.
The HMRC guidance on how to work out the taxpayer’s adjusted net income and threshold income is quite difficult to follow.
Essentially, the threshold income is all income taxable income (not gains) excluding pension contributions but with adjustments for any salary which has been sacrificed in favour of pension contributions. Adjusted net income is the threshold income plus all pension contributions, less any lump sum death benefits paid in the year.
The restricted AA applies even if pension benefits have not been accessed by the taxpayer in the tax year. However, the restricted AA only applies for the current tax year. A new calculation of the restricted AA must be done for every tax year.
Calculate the charge
The problem for many high earners is that they don’t know exactly how much has been added to their pension pot in a particular tax year.
For defined contribution (money purchase) pension schemes this figure should be the sum total of employee and employer contributions. In theory, it should be possible to calculate this if the contributions are a straight percentage of total pensionable pay, but you need to check exactly what the pension scheme rules say.
For defined benefit (final salary) schemes, the amount added to the pension scheme is the product of a complicated formula dependant on the value of the fund, the years of pensionable employment, and the level of pensionable pay. In practice, the taxpayer needs to get this figure from their pension fund administrator in order to make the correct declaration on their tax return.
However, some pension schemes, particularly the NHS clinical schemes, do not provide timely information to scheme members, with some waiting months for statements.
What to do
If your client needs to declare excess pension contributions for 2018/19 but hasn’t received the necessary information from their pension scheme, you need to make a best estimate of excess contributions to report on the tax return.
Remember to note on the SA return that the figure of excess contributions has been estimated. When the pension scheme administrators deliver the exact amount of added value to the pension fund, you can provide that figure as an amendment to the SA return.