My VIP Tax Team question of the week: Pension relief and the annual allowance

Q. I have a client who has made pension contributions of £70,000. This is formed of employee contributions of £20,000 and employer contributions of £50,000. Their total income for the year was £300,000, all from employment. How much tax relief will they receive and are there any penalties if they exceed a certain limit – I read somewhere that relief can be withdrawn. 

A. The response below applies to the tax years 2023/24 and 2024/25. The annual allowance (and pension taper) limits changed from April 2023 and were different for earlier years.

Amount of pension tax relief and interaction with Annual allowance

Firstly, and this is often misunderstood, there is a distinction between the amount of pension tax relief an individual is entitled to receive and the annual allowance, although the two closely interact.

There is no limit regarding the amount of pension savings an individual can make to a registered pension scheme each year but there is a limit on the tax relief provided for those pension savings.

In accordance with FA 2004, s 190, tax relief for an individual is given on the greater of £3,600 or the total amount of an individual’s relevant UK earnings chargeable to income tax for that year (FA 2004, s 190). Relevant earnings are comprised of all forms of earned income, such as employment income or trading profits, but do not include unearned income such as dividends or rental profits (although FHL profits do count) (FA 2004, s 189). See PTM044100.

Relief for an employer is given under FA 2004, s 196 and, for a trading business, simply has to be wholly and exclusively incurred – relief is not based on relevant earnings.

Annual Allowance

What is it?

The annual allowance is the maximum amount of pension savings an individual can make each tax year without penalty. For most people, this will be £60,000 – FA 2004, s228. For individuals with high levels of income, this can be progressively reduced to a minimum allowance of £10,000 per tax year through tapering. The annual allowance applies to all forms of pension savings including member contributions, employer contributions and contributions made on behalf of the member by a third party.

The annual allowance is not a restriction on the amount of tax relief provided when pension savings are made (see above). This is particularly important in the context of an individual claiming relief for pension contributions. If the amount being claimed in one tax year is over the annual allowance for that year, the amount of relief provided is not restricted to the level of the annual allowance.

However, the annual allowance works by applying a tax charge when the annual allowance is exceeded. The tax charge effectively recovers the amount of tax relief given to the part of the increase in pension savings that is over the annual allowance – FA 2004, s 227.

Who does it apply to?

As confirmed by HMRC at PTM05110:

The annual allowance rules apply to members of registered pension schemes. The rules also apply to members of overseas pension schemes where either they or their employer qualify for UK tax relief:-

• under a double taxation agreement
• under section 307 Income Tax (Earnings and Pensions) Act 2003
• due to migrant member relief (see PTM111200), or
• due to transitional corresponding relief (see PTM111500).

Pension contributions made to a UK pension scheme that is not a registered pension scheme do not count towards the annual allowance.

Not all insurance policies falling within ITEPA 2003, s307 will be affected, only those linked to a pension scheme.

Reduced Annual Allowance – Tapering

Under FA 2004, s 228ZA, the tapered annual allowance applies to an individual in a tax year, if:-

• Their ‘threshold income’ is more than £200,000, and
• their ‘adjusted income’ is more than £260,000.

An individual’s annual allowance is reduced by £1 for every £2 their ‘adjusted income’ is above £260,000. However, the annual allowance can never be reduced to less than £10,000 per tax year. See PTM057100.

Carry Forward Annual Allowance

If the annual allowance for the year is exceeded, any available unused annual allowance from the previous 3 tax years can be carried forward and added to the individual’s tapered annual allowance under FA 2004, s 228A. The amount available to carry forward from any tax year depends on whether or not the tapered annual allowance, and/or the money purchase annual allowance applied to the individual for the relevant tax year from which they wish to carry allowance forward.

Where the individual has either no, or insufficient carry forward annual allowance to offset against the pensions savings in excess of the annual allowance in the current tax year, a charge will apply when the individual submits their self-assessment tax return. See PTM057100.

If the individual does not wish to pay the charge themselves, they could consider making the pension scheme ‘jointly and severally liable’ to pay the charge (subject to meeting certain conditions), via ‘scheme pays’ under FA 2004, s 237B. See PTM056400.

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