This is in effect a secondary test on all contributions and relevant benefit accrual after tax relief has been assessed on personal and/or employer contributions. This can be seen in Box 1.
Calculating accrual
For defined contribution arrangements, all contributions made by or on behalf of an individual - including employer contributions - are counted towards the annual allowance. Investment growth is not taken into account.
For active members of defined benefit schemes, all increases in the capital value of the pension and cash benefits are counted (with the exception of potential cash commutation) against the annual allowance.
This valuation basis is on a ratio of 16:1 and is calculated as:
Pension value = annual pensionable salary x (years accrued/accrual rate) x 16
The pension value at the start of the year is then uprated in line with CPI for the September preceding the tax year in which the valuation is taking place. To establish the annual pension contribution, subtract the uprated starting value from the value at the end of the year, which can be seen in Box 2.
Annual allowance charge
Any pension contribution in excess of the annual allowance is added to the individual’s taxable income for the year and taxed at their marginal rate via self-assessment. This can be seen in Box 3.
Employer contributions will count towards the individual’s annual allowance and so large employer contributions or significant defined benefit accrual may result in the employee being personally liable for an annual allowance charge at their own marginal rate of tax. The higher the salary increase and the lower the relevant inflation figure, the higher defined benefit accrual will be.
Eligibility for the annual allowance charge
The annual allowance now applies to the tax year in which benefits are taken. This was previously exempt and it allowed individuals to make very large contributions very close to their retirement date without attracting an annual allowance charge.
Pension savings in a particular arrangement will be assumed to be nil for the purposes of calculating any annual allowance charge in the year in which an individual:
- dies;
- retires on the grounds of severe ill-health; or
- is a deferred member of that arrangement.
Carry forward
The amount that can be carried forward is the balance of the relevant tax year’s annual allowance minus any contributions and accrual in that tax year; it is not limited where earnings were less than £50,000 in a previous tax year. However, the amount of tax relief received on contributions will still be limited by earnings in the current tax year - Box 4 is an example.
- An individual may carry forward any unused annual allowance from the three previous tax years.
- An individual is able to carry forward only if they were a member of a registered pension scheme in the tax year that is being carried forward. For these purposes ‘member’ includes deferred, retired and pension credit members.
- Carry forward is based on a deemed annual allowance of £50,000 in each year (£40,000 for tax years from 2014/15 onwards) even if the individual’s relevant UK earnings would have been insufficient to gain full tax relief in the appropriate carried forward year.
- The annual allowance from the current year is used first and then the unused annual allowance from the three preceding years, using the oldest year first.
- Any contribution using carry forward does not need to be made to the same registered pension scheme of which that individual was a member in the previous year.
- Excess contributions in the three transitional years of 2008/09, 2009/10 and 2010/11 do not reduce carry forward available from other years.
- To calculate carry forward available in 2011/12 to 2013/14, it is necessary to look back to 2008/09.
- Individuals do not need to report the use of carry forward from HM Revenue & Customs unless their contributions result in an annual allowance charge after carry forward is applied.
Transitional rules
It is not possible to carry forward a negative balance from the tax years 2008/09 to 2010/11. Where contributions in these transitional years exceed £50,000, the excess contributions will be assumed to be nil and will not count against the cumulative carry forward.
When calculating carry forward available in 2013/14, any excess over £50,000 will use up carry forward from the previous years. It is therefore necessary to obtain details of contributions from 2008/09 to establish how much carry forward is available in the current tax year.
The current tax year’s annual allowance must be used in full before carrying forward unused annual allowance, at which point the earliest tax year’s excess allowance will be used up first.
Therefore, individuals who have been taking full advantage of carry forward since its introduction may find that they are limited to the reduced annual allowance of £40,000 from 2014/15 onwards.
