The Annual Allowance Pension contributions are unlimited, however any amount paid in excess of the annual allowance will give rise to a tax charge at an individual’s highest marginal rate of income tax. In order to allow an occasional large contribution, it is generally possible to ‘carry forward’ any unused allowance from the three previous years to offset against any potential excess. Pension contributions are measured differently depending
on the type of pension scheme in question. Contributions to defined contribution pensions are simply valued as the total of all payments to the scheme, whether made personally, or by someone else, such as an employer. However, contributions to defined benefit pension schemes, mainly now only open to public sector employees, are measured very differently. Instead of the actual contributions made, the increase in the value of total pension benefits from one year to the next is what determines the level of deemed contribution.
Due to the nature of the defined benefit calculation,
any large pay rise or promotion, particularly for someone with many years’ service, can create a significant tax liability. Earlier this year, for example, I was advising a recently promoted Headmaster who was facing an annual allowance tax charge of over £30,000 as a result of his new position - a huge shock, as he was completely unaware of the issue.
The Lifetime Allowance It is possible to accumulate an unlimited amount of pension benefits, however there is a limit on the value of those benefits before tax penalties of up to 55% apply. this limit is called the lifetime allowance. Pension benefits from all pension schemes of which an individual is a member count towards the same overall allowance and again it is often public sector employees, whose pension benefits are more difficult to value and manage, who are most affected.
Due to the nature of the
defined benefit calculation, any large pay rise or promotion,
particularly for someone with many years’ service, can create a significant tax liability
Act Now Once a pension tax charge has been incurred, there is little that can be done to reduce its impact and, given that the annual and lifetime allowances are set to fall even further in April 2014, it is inevitable that many thousands more will be caught unawares. With careful planning there are positive steps that can be taken to mitigate, or even eliminate any future liability, however specialised advice is essential in this highly complex area.
Pilot Financial Planning is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.•
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