When an individual contributes to their pension, they must ensure that the amount they contribute is less than 100% of their ‘relevant UK earnings’ for that tax year or £3,600 (£2,880 net). Any personal contributions made above that amount will not get any tax relief. The individual must notify their pension provider if they go above this amount so the pension provider can ensure the correct amount of tax relief is claimed or refunded to HMRC.
A list of ‘relevant UK earnings’ chargeable to income tax is provided in the section entitled ‘Earnings that attract tax relief’ within the HMRC Pensions Tax Manual at PTM044100. This does not include dividends. An example of other income not included is rental income, except so far as it relates to a furnished holiday letting business.
As well as the above, the contributions made by both the employee and employer combined must not exceed the annual allowance or the lifetime allowance. If the annual allowance is exceeded, the individual must pay income tax on the excess via self-assessment. Alternatively, the individual can ask their pension provider to pay HMRC the tax out of their pension pot if the tax is more than £2,000. Apart from the Annual Allowance, there is no limit on the amount of employer contributions that can be made, subject to the usual principles of the amounts being wholly and exclusively for the purposes of trade.
The annual allowance is currently £40,000 per year. Any unused allowance from the previous three years can be added to this (subject to the transitional arrangements for the allowance within the 15/16 tax year).
However, the Annual Allowance is reduced if the individual earns both ‘threshold income’ above £110,000 and ‘adjusted income’ above £150,000. These terms are explained, and a step-by-step guide to calculating the reduced allowance is available at https://www.gov.uk/guidance/pension-schemes-work-out-your-tapered-annual-allowance. Where this tapered allowance applies, it is only the unused element of that tapered allowance that can be carried forward.
There is also a different annual allowance which applies if the individual has started to take money out of their pension pot. This is known as the ‘money purchase annual allowance’ (MPAA) and is currently £4,000. The individual’s pension provider will usually inform them when the allowance has dropped to the MPAA because of a trigger event, and the individual should then inform all their other pension scheme providers. This is a complex area and HMRC guidance can be found at PTM56500 onwards, however, specialist tax advice may need to be sought in relation to this.
The lifetime allowance is currently £1.03 million. The pension provider will notify the individual if this is exceeded (when they turn 75, take money from a pension pot or transfer the pension overseas) and will deduct the tax due on the amounts above the allowance before the pension is paid out.
To ensure that client suffer no unexpected tax charges, it is recommended to keep accurate records of all pension schemes, and the amounts contributed to these pension. This will also help determine the amount of unused annual allowance available when deciding to make larger contributions in any particular tax year.
The above is only a starting point, as each area must be looked at in more detail. HMRC has useful guidance, that can be provided directly to your client, at https://www.gov.uk/tax-on-your-private-pension
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