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Pension allowances and what it all means

Annual Allowance (AA)

The limit on tax relief for an individual’s gross contributions is restricted to the higher of £3,600 or 100% of relevant UK earnings.  Employer contributions to employees’ plans are not restricted in this way but the contributions need to meet certain conditions in order for the firm to be entitled to tax relief. But an annual allowance (AA) for pension savings applies each year, which is based on a pension input period. If the AA is exceeded it is subject to a freestanding tax charge and it is charged at the appropriate marginal rate. The standard AA has changed several times since it was introduced in 2006 and it is currently £40,000. Under a money purchase scheme the AA used up is simply the value of all contributions paid during the pension input period. However, under a defined benefit (DB) or cash balance (CB) scheme it is the increase in the value of a member’s rights during the pension input period. Contributions are irrelevant.

Carry Forward

Where the current year’s AA has been exhausted, it may be possible to reduce or completely avoid the annual allowance charge using carry forward. Carry forward allows unused annual allowance from pension input periods ending in the previous three tax years to be carried forward and added to the annual allowance for the current pension input period. An individual must have been a member of a registered pension scheme at some point during the tax year from which they intend carrying forward the unused AA although they do not need to have had relevant earnings or made any contributions.

Money purchase annual allowance (MPAA)

This applies when someone has flexibly accessed their pension savings. If the MPAA has been triggered, only £4,000 can be paid to all defined contribution (DC) plans in any pension input period from that point on before a tax charge is applied. The individual’s total pension input will also be tested against the annual allowance.

The MPAA is most commonly triggered by taking income from a flexi-access drawdown plan.  Additonally,  taking an uncrystallised funds pension lump sum. However, other actions can also trigger it.  e.g. Part-way through a pension input period only the contributions made after the trigger are tested against the MPAA.  However the total contributions/accrual in that tax year is also tested against the annual allowance.

The Tapered annual allowance

This impacts people with an adjusted income over £150,000 AND a threshold income over £110,000. For every £2 of income they have over £150,000, their annual allowance is reduced by £1. Their reduced annual allowance is rounded down to the nearest whole pound. The maximum reduction is £30,000. So anyone with adjusted income of £210,000 or more will have an annual allowance of £10,000.   Those of you in a DC scheme with high income and are caught by the restriction.  If so, one might have to reduce the contributions paid by them and/or their employer or an annual allowance charge will apply. However, the tapered reduction doesn’t apply to anyone with ‘threshold income’ of no more than £110,000.

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