Putting the brakes on pension contributions


Over the last 12 years (since A-day) there has only been one tax year – 2013/14 – where there haven’t been changes to the tax rules on pensions. Every other year, the amount individuals can put in and/or take out of pensions to get tax relief advantages have changed.

For the first half of this decade we watched the lifetime allowance crumble, and new transitional protections emerge. But the last two years have also seen significant changes to the annual allowances. These have almost sneaked up on us, and are now seriously curtailing pension saving for some individuals.

As part of the pension freedom changes introduced in April 2015, the Government reduced the annual allowance for those who have ‘flexibly accessed’ their benefits to stop recycling of pensions contributions. At the time, the Government warned it would act if it thought recycling was still going on, and, almost inevitably, last month the Money Purchase Annual Allowance (MPAA) fell to £4,000.

This is a big change. There will be some who take benefits who have no intention of building up pension saving again. But others who want to access their benefits under pension freedoms and continue contributing, will find they can’t. It’s important to recognise triggering the MPAA is a life event. Once triggered, the action can’t be undone, and the individual is stuck with a comparatively tiny annual allowance for every future tax year. And carry forward cannot be used to at least allow a higher contribution one year.

So, naturally, it follows flexibly accessing benefits shouldn’t be undertaken lightly. Instead, individuals and their advisers should explore the different ways of accessing pension funds without triggering the MPAA. For example, by first exhausting pension commencement lump sums (PCLS) from flexi-access drawdown and leaving the income intact. Or making use of old capped drawdown plans to provide income. And avoiding uncrystallised funds pension lump sums (UFPLS) if possible.

The other big change to pension contributions is the introduction of the tapered annual allowance, where the annual allowance of those with earnings of over £150,000 is gradually reduced to a minimum of £10,000 (for those earning more than £210,000). This tax rule change is a slow burner. Although it was announced almost two years ago (July 2015), its full impact on individuals’ pension savings is only now being fully realised. The rules are complicated, with various HMRC terminology and definitions.

The problem is many higher earners – and especially the self-employed – won’t know what their earnings are until the end of the tax year, by which point it may be too late and an annual allowance-busting pension contribution has already been paid.

Where someone is aware in advance that their annual allowance will be tapered, they can adjust their pension contributions (if necessary). They could also use carry forward of unused annual allowance to boost their contribution one year.

Individuals might also have the chance to shape their tapered annual allowance. For tapering to apply their earnings must be higher than two thresholds. These are, in very broad terms:

  • Adjusted income of over £150,000 = total taxable income (including member contributions) plus employer contributions
  • Threshold income of over £110,000 = total taxable income less member contributions

So, individuals could pay (further) personal contributions before the end of the tax year to reduce their threshold income and possibly avoid their annual allowance being tapered.

Example – Justin

Justin has been made redundant and his total income for the tax year 2017/18 is £200,000. His employer contributions into his SIPP for the tax year are £15,000. He has unused carried forward tax relief from the previous three years of £75,000.

Justin’s adjusted income is:
£200,000 + £15,000 = £215,000
His tapered annual allowance would therefore be £10,000

However, Justin can reduce his threshold income by paying a member contribution. The maximum he can pay is:
£25,000 (£40,000 – £15,000) for 2017/18
+ Carried forward annual allowance of £75,000
= £100,000

This would reduce his threshold income to:
£200,000 – £100,000 = £100,000

This brings his threshold income below £110,000, and his annual allowance would not be tapered, and instead remains at £40,000.

If individuals do exceed their annual allowances they will pay an annual allowance charge on the excess. Breaking the annual allowance is not grounds to ask for a refund of contributions (although if the individual contributes more than their earnings then the excess can be refunded). The annual allowance charge is usually paid through the individual’s self-assessment, although they can also ask the scheme to pay the charge.

We already know that there will be further changes to the pension tax rules in 2018, when the lifetime allowance increases in line with CPI. But with a general election looming, the question is what other changes will be made to pensions tax rules. As the very least we could expect changes to the lifetime allowance or maybe the tapered annual allowance thresholds. But large scale changes – such as a change to a single rate of tax relief – are surely back on the table.

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