To incentivise people to save for retirement the Government provides billions of pounds each year in pensions tax relief, but to avoid this expenditure getting out of control it places a cap on the amount you can save each year and upon which you can receive relief. This cap is known as the Annual Allowance.
To compound the issue, the Annual Allowance has reduced significantly over recent years - from £255,000 in the 2010/11 tax year to just £40,000 from 2014/15 onwards.
All taxpayers receive tax relief at the 20% basic rate, but those who pay tax at the higher (40%) or additional (45%) rates are able to claim the extra 20% or 25% via their tax return.
If you haven’t utilised your Annual Allowance every year it is also possible to go back three years to carry forward unused contributions. Strict rules surround this exercise so advice is essential to avoid potential problems.
Tapered Annual Allowance
If your earnings exceed £150,000 this can affect your Annual Allowance and the Tapered Annual Allowance (TAA) will apply. Once this figure has been reached income from all sources is taken into account, including dividends, rental income, interest and employer pension contributions. For each £2 earned in excess of £150,000 your Annual Allowance will be reduced by £1, so once your income reaches £210,000 you will be left with an Annual Allowance of just £10,000.
This is a complex area, so professional guidance and advice is recommended.
The Money Purchase Annual Allowance (MPAA)
The MPAA was introduced to limit contributions to £4,000 per annum for those who have flexibly accessed their defined contribution (DC) pensions. Situations when you’ll trigger the MPAA are as follows:
• If you take your entire pension pot as a lump sum or start to take ad-hoc lump sums
• If you put your pension pot money into flexi-access drawdown and take an income
• If you buy an investment-linked or flexible annuity where your income could go down; and/or
• If you have a pre-April 2015 capped drawdown plan and start to take payments that exceed the cap (150% of Government Actuarial Department limits)
Before you consider taking any money out of a pension you should seek professional advice, but don’t forget The Lifetime Allowance.
The Lifetime Allowance (currently £1,030,000, but increased each year in line with inflation) is a limit on the amount of pension benefit that can be drawn from pension schemes – whether lump sums or retirement income – that can be paid without triggering an extra tax charge.
The test for the Lifetime Allowance is done each time you access (crystallise) a pension benefit and use up some of your Lifetime Allowance. There are 13 Benefit Crystallisation Events (BCEs), applicable to both Defined Contribution as well as Final Salary/Defined Benefit schemes.
Accessing pension savings above the Lifetime Allowance will trigger a Lifetime Allowance charge, which is currently:
Protection against the Lifetime Allowance
If you have already secured any form of protection against the Lifetime Allowance you should seek professional advice to make sure it still applies and you don’t receive an unexpected tax bill when you access your pension benefits. Changes in legislation have now created many different pension allowances, so the value of expert financial advice has perhaps never been greater.