Pension allowances - magic required
It’s the time of year that we start reminding clients to make use of their allowances and use surplus cash to top up ISAs and pensions. ISA allowances are pretty straightforward - £20,000 a year, split how you want across the ISA range with the only caveat being a maximum of £4,000 for those youthful enough for the Lifetime ISA. Pension contributions can make money appear from thin air in the form of tax relief, but in contrast the allowances are a complex beast.
Clients may be subject to the standard annual allowance (AA), tapered annual allowance (TAA) or money purchase annual allowance (MPAA), and potentially have carry forward too. So advising how to make the most of allowances may require some wizardry.
Tax relief vs allowances
Confusion can arise between maximum permitted contributions and the annual allowances.
HMRC rules allow 100% of UK relevant earnings to be paid as personal contributions, and tax relief will be granted on the full amount, albeit there will be an annual allowance charge (AAC) on any excess. The AAC attempts to claw back the tax relief granted on the amount above the relevant annual allowance.
Of course, an employer can also make contributions which are not limited by earnings, but these use up whatever annual allowance is applicable to the member.
Back to our trio of allowances – those with annual income (not just earnings) below £150,000 who have not used the pension freedoms get the straightforward £40,000 AA this year and the ability to carry forward.
The oldest carry forward gets used first – and this year it’s the last time we need to deal with the quirky rules of 2015/16 when the tax year was split in two for AA purposes.
For the first period (6 April 2015 – 8 July 2015) there was an allowance of £80,000. From 9 July 2015 – 5 April 2016 there was no specific allowance, but you could carry forward a maximum of £40,000 from pre-8 July into this period. It is whatever is left over from this second part of the year that you can carry forward to use in 2018/19.
Those with high incomes (including investment income) over £150,000 are subject to the TAA. This tapers their allowance at the rate of £1 for every £2 of income over £150,000, down to a minimum of £10,000. The good news is the ability to carry forward is retained, so potentially someone with only a £10,000 allowance this year could still have £40,000 allowance from 2015/16 as well as their tapered amount from 2016/17 and 2017/18.
Finally, those who have triggered the MPAA have a £4,000 allowance in relation to money purchase benefits from the date the MPAA is triggered. It doesn’t reduce their ability to save into DB schemes (using the ‘alternative annual allowance’), and contributions can be made up to the full AA in the year the MPAA is triggered, as long as they are paid before the event. Triggering the MPAA does put a stop to carry forward, with the exception of DB accrual.
Don’t forget auto enrolment contributions increase in April to 8%, so those with earnings over £50,000 could be using over £3,500 of their MPAA with these contributions alone.
Finally, remember non-earners can make contributions of £3,600 gross – useful for non-working spouses and children.
The question “how much can I pay into my pension?” is far from simple. We’ve recently seen Mary Poppins return, a bit of magic and a pension simplification sequel wouldn’t go amiss either!