Even the best laid plans can go awry and with three potential types of pension annual allowances to deal with, it is inevitable that maximising pension contributions for clients might be left close to April 5.
'How much can I contribute to my pension this year?' seems a simple question on the face of it, but the answer requires an analysis of both tax relief and annual allowance rules.
Tax relief is relatively simple for UK resident clients – the maximum personal contribution that can benefit from tax relief is 100 per cent of a client’s relevant UK earnings, or £3,600 gross, if higher. Tax relief works on a discrete basis each year. It cannot be carried forward or back.
However, the annual allowance also needs to be considered. This is an allowance for total pension input made by or for a client each tax year, with any excess meaning the client faces a tax charge, regardless of the source of the excess.
Although the standard allowance has been set at £40,000 since 2014, some clients will have an annual allowance tapered down to as low as £4,000 for the year, while others can benefit from contributions of more than £40,000 without facing a tax charge.
This is because of the ability to carry forward unused annual allowance.
Know your carry forward
- Carry forward can used be used where a client has exceeded their annual allowance (standard or tapered) for a tax year.
- Since 2016, pension input periods for annual allowance calculation have been aligned with the tax year dates.
- Unused allowance is calculated for up to three previous tax years, starting with the oldest tax year.
- Unlike tax relief, unused annual allowance does not need to be claimed from HM Revenue & Customs.
- The client must have been a member of any registered pension scheme in the tax year they are looking to take unused annual allowance from. This can be as simple as being a deferred member.
- The client must have sufficient earnings in the current tax year to get tax relief on personal contributions.
- If an employer contribution is being made to mop up unused annual allowance, this won’t apply but the usual wholly and exclusively rules will.
What about the taper?
Clients with threshold income above £200,000 will have their annual allowance tapered by £1 for every £2 that their adjusted income exceeds £240,000. The minimum allowance is £4,000. Where an individual has a tapered annual allowance, they can still use carry forward.
Available annual allowance will be whatever remains of the tapered allowance for the previous year concerned.
But beware: although they may not be subject to the taper now, the income thresholds in previous tax years (2016-17 through to 2019-20) were lower than they are now, meaning they might have previously been caught by it. The minimum annual allowance due to the taper was £10,000 and you will need to remember this for the calculation of unused annual allowance for those years.
It is not possible to use carry forward with the money purchase annual allowance once it has been triggered. For these clients, a tax charge will arise on total money purchase pension input above £4,000.
What was a simple question about maximum contributions actually requires significant analysis. And woe betide anyone who gets it wrong too, as exceeding the annual allowance is not grounds for a contribution to be refunded.
As experts in their field, navigating the carry forward rules is another great way for advisers to demonstrate value to clients.
Charlene Young is a senior technical consultant at AJ Bell
