Guide to scheme pays
When the annual allowance (AA) was introduced back at A-Day it was a generous £215,000, and once reached the dizzying heights of £255,000. This is all a distant memory now as we not only have a much lower limit of £40,000, but also the money purchase annual allowance (MPAA) and tapered annual allowance (TAA) to contend with. All in all this means a lot more people are having to pay annual allowance charges of one form or another.
In September HMRC released its latest pension contribution statistics, which include the 2016-17 tax year. This gives us the first indication of the impact of the tapered annual allowance, and it’s not pretty.
Unsurprisingly the total value of excess contributions reported in the years where the annual allowance was over £200k were minimal, peaking at £8m in 2008-09 with just 190 individuals impacted. The figures jumped into the £100-180(ish)m bracket for the periods 2011-12 to 2015-16 once the AA was cut to £50m and then £40m.
In 2016-17 this figure soared to £517m with 16,590 individuals reporting pension contributions above their available annual allowance.
The annual allowance charge is calculated by adding the excess contribution to income for the year, and applying tax at the appropriate rate. This means the tax charge may be payable at more than one rate if it spans two tax bands (or more – with a greater likelihood for Scottish taxpayers).
It is the individual’s responsibility to report the overpayment of contributions to HMRC via self-assessment. If they haven’t completed a return before then they need to register with HMRC to get one. HMRC help sheet HS345 gives more information on completing the ‘Pension Savings Tax Charges’ section of the self-assessment.
Paying the charge
When it comes to paying the annual allowance charge the individual is personally liable for the charge but may have the option of using scheme pays. Even if scheme pays is available, it may not always be desirable. More on that later.
First, let’s look at the circumstances when a scheme can pay the charge on behalf of the member. There are two variants of scheme pays; what HMRC just calls ‘scheme pays’ – but which, to avoid confusion, I will call compulsory scheme pays – and ‘voluntary scheme pays’.
Compulsory scheme pays
There are strict rules set out by HMRC as to when compulsory scheme pays can be used, but if these are met then the scheme becomes jointly liable with the member for the charge. As compulsory suggests – the scheme doesn’t have a choice about it.
So, what are the requirements? First, the AA must have been exceeded in the scheme concerned. By this I mean the £40,000 AA. So if the charge has arisen due to the TAA or MPAA alone being exceeded this condition isn’t met.
Second, the amount of the annual allowance charge must have exceeded £2,000, and again this must be in reference to the AA rather than the TAA or MPAA.
Once these conditions are met then there is no minimum amount the member can ask the scheme to pay. For example, if the charge was £3,000 the member could ask the scheme to pay £1,000 and pay the remaining £2,000 personally. The maximum the scheme can be asked to pay is the amount arising from exceeding the AA in that scheme.
Case study - Jean
- Higher rate tax payer
- Triggered the MPAA in previous tax year
- Total contributions of £55,000 to money purchase scheme
- No other contributions
The conditions for compulsory scheme pays are met as the £40,000 AA has been exceeded and the tax charge arising above the £40,000 limit will be £6,000 (£15,000 x 40% - assuming the excess doesn’t push her into additional rate tax).
The total annual allowance charge will be £20,400 (£51,000 x 40%) over the MPAA, but Jean can only ask the scheme to pay a maximum of £6,000.
Once it is established that the conditions for compulsory scheme pays have been met then there are certain deadlines that must also be adhered to.
HMRC states that the member must notify the scheme by “31 July in the year following the year in which the tax year to which the annual allowance charge relates ended”. If you find that hard to follow you’re not alone! For 2017/18 the deadline is 31 July 2019, for 2018/19 it is 31 July 2020. The earliest the member can tell the scheme is 6 April after the year in which the charge has arisen e.g. if you know your client has exceeded the annual allowance in 2018/19, the earliest you can ask the scheme to pay will be 6 April 2019.
The exception to this rule is the year in which the member reaches age 75 or fully crystallises all their benefits. In these instances they must notify the scheme before benefits are accessed/their 75th birthday. This is so that schemes can reduce the benefits available to account for the deduction of the charge.
Voluntary scheme pays
So, what are the options when the compulsory conditions are not met? The most obvious one would be to pay the charge personally, but it may also be possible to ask your scheme to pay on a voluntary basis.
The rules for this are much more relaxed – any annual allowance charge can be paid, be it arising from the MPAA, TAA or AA. Technically there are no deadlines – but more on that in a moment. And you can ask any scheme you are a member of to pay it, not just the scheme where the charge arose. But, as you’ve probably already worked out, the scheme doesn’t have to offer it. And even if the scheme does allow it, the liability remains with the member.
Unsurprisingly, since the introduction of the TAA we have seen a big increase in the number of requests for voluntary scheme pays. Under this option the liability for the charge remains with the member, and as such is due by the usual self-assessment deadline – i.e. 31 Jan in the following year. This means that if you want the scheme to pay, it needs to do so by 31 Jan or the member could potentially face late payment charges. And the practical deadline to ensure the scheme pays in time is a lot earlier due to how schemes pay tax to HMRC.
Any tax charges paid under either type of scheme pays are paid to HMRC by the pension scheme via their accounting for tax (AFT) return. These are quarterly returns with tax paid to HMRC as set out below:
|Quarter||Transactions between||Tax paid to HMRC|
|Q1||01/01 - 31.03||By 15/05|
|Q2||01/04 – 30/06||By 14/08|
|Q3||01/07 – 30/09||By 14/11|
|Q4||01/10 – 31/12||By 14/02|
This means that to guarantee that the payment reaches HMRC by the self-assessment deadline the scheme must have accounted for it by 30 September in the previous year. If this deadline is missed and it is accounted in Q4 it may be paid in time – if the scheme administrator sends their return before 31 Jan (but it is under no obligation to do so).
If the deadline is missed then theoretically the member could be charged for late payment. If they have agreement from the scheme then they should still complete the relevant section on the self-assessment form with details of the amount the scheme is going to pay. In practice we have seen cases when we have expected there to be a late payment charge but it has not been applied when HMRC has been informed that the scheme will pay. Obviously this isn’t guaranteed and your clients should be aware of the risk of a penalty. Currently the late payment interest is charged at 3.25%.
Defined Benefit (DB) v Defined Contribution (DC) Scheme Pays
Although all schemes have to offer compulsory scheme pays, many schemes do not allow voluntary, particularly DB schemes. In the public sector most, but not all, schemes have updated their rules to allow voluntary scheme pays since the introduction of the TAA. Most recent was the NHS scheme which introduced this option in October 2018 for tax years 2016/17 onwards. But the question is – is using scheme pays a good idea?
When it comes to DB scheme pays, effectively you are taking a loan from the scheme which is repaid when you take your benefits (or transfer out). At the time you take the loan, you don’t know what it’s actually going to cost you in benefits forfeited. The charge has to be repaid, with interest.
Looking at the NHS scheme as an example, the interest is calculated as the previous September’s CPI figure plus the ‘Superannuation Contributions Adjusted for Past Experience (SCAPE)’ discount rate. This rate is currently 2.8% (reducing to 2.4% from April 2019) and the interest applies from 1 January following receipt of the scheme pays request. Once the debt is calculated the Scheme Actuary will calculate the benefit reduction.
Clearly scheme pays from DB schemes can be an expensive way of paying the annual allowance charge, especially for those furthest from retirement.
Under DC schemes the situation is much simpler as the charge is deducted at the time. What you are foregoing is the growth that would have occurred had the funds remained in the scheme.
A point to consider – particularly for younger, ambitious DB scheme members who have not yet hit the TAA, but are very likely to in the future – is to fund a DC scheme while they can with full tax relief, so when the TAA kicks in on their DB scheme accrual they can use their DC pot to pay the charge. In this way the impact of the TAA charge may be significantly softened.