PensionsJun 26 2018

Making allowances: Minimising excess contributions

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Making allowances: Minimising excess contributions

Pensions contributions sometimes amount to more than the member can reclaim tax relief on, and more than their annual allowance after carry forward. What happens next depends on the circumstances of the excess contribution.

First, it is important to distinguish between contributions in excess of a client’s UK relevant earnings and contributions in excess of the annual allowance.

Tax relief on personal contributions is limited by the client’s relevant UK earnings – which essentially are employed income, self-employed income and income from certain furnished holiday lets and patents. They are not income from items such as savings, dividends and buy-to-let properties. As a reminder, employer contributions aren’t tested against the individual’s relevant UK earnings, only the annual allowance.

Any contributions in excess of this level should not receive tax relief. It sometimes occurs that the client doesn’t earn as much as they expected, and therefore has paid excess personal contributions before they have realised there is an issue.

The member can request a “refund of excess contributions lump sum”, which is a refund of the contribution over their UK relevant earnings. The administrator will probably ask for evidence of the UK relevant earnings so they know what can be paid back. 

If the scheme administrator pays too much back it would be an unauthorised payment, meaning that there would be a tax charge. Needless to say, this should be avoided. The member should be sure that they have final correct details of their earnings before making the request to the scheme.

If the member has reclaimed any higher or additional-rate tax relief, they should contact HMRC to declare that a refund has been made because they will need to pay this back. If the member is doing self-assessment, it is likely this would be the point at which the overpayment of pension contributions would come to light. As a result, they can simply not make a claim for the relevant tax relief.

It is the member’s responsibility to ensure they don’t claim too much tax relief. If they do, HMRC can ask for the repayment directly. It is therefore advisable to ensure this doesn’t happen, and to try to monitor contributions throughout the year.

Due to the need to fully establish UK relevant earnings for the tax year, claims for refunds can only be done in subsequent years and up to six years later.

Exceeding annual allowance

Exceeding the annual allowance has never been easier, because members now have to deal with the standard annual allowance of £40,000, the tapered annual allowance – which could be anywhere between £10,000 and £40,000 – and the money purchase annual allowance that is now set at £4,000. 

The annual allowance tests the total gross pension input amount into all pension schemes. This may be made up of personal and employer contributions in a defined contribution (DC) scheme, or the increase in pension in a defined benefit (DB) scheme. 

In the latter schemes, the annual allowance test does not take account of what contributions have been paid, just accrual in the scheme.

Minimising any excess

The first thing to consider is carry forward, which allows members to bring forward any unused annual allowance from up to three previous tax years. But this doesn’t bring forward unused tax relief, so personal contributions still need to be covered by the member’s UK relevant earnings in the tax year in question.

There are rules that stipulate that once the current year’s annual allowance has been used up, then the oldest of the three previous years must be utilised. This process continues until either all available annual allowances have been expended, or the excess over the year in question has been reduced to zero. See Box One. 

If the excess can be extinguished by the use of carry forward, then there is no need to declare the excess or the use of carry forward to HMRC. But I would suggest ensuring that a record is kept, just in case.

Any contributions in excess of the annual allowance after the use of carry forward need to be declared on a self-assessment return. If the member doesn’t complete self-assessment and exceeds the annual allowance, they will need to apply for self-assessment. The details that form part of the self-assessment are relatively simple.

HMRC will not calculate the member’s carry forward or annual allowance excess – they will calculate the tax payable as a result based on the information provided. Nonetheless, it is best to try to estimate the tax due beforehand, especially if the member is going to ask the scheme to pay the charge on their behalf. 

To do this, the excess amount is added to the client’s income to determine the tax rate on the charge. If the amount spans two tax brackets, then some of the charge will be at one rate and the rest at the lower rate.

The member will need to complete questions 10, 11 and 12 in the pensions section, details of which are:

10. This is the excess amount. For example, if a member’s pension input amount for the year was £120,000, but they had a £25,000 carry forward and an annual allowance in this year of £40,000, the excess would be £55,000 and should be entered in box 10.

11. This is the amount of the annual allowance charge that the pension scheme is going to pay under the scheme pays rules (see below).

12. This is the scheme reference number of the scheme that is paying the annual allowance charge in question 11.

Questions 11 and 12 can be left blank if the member is going to pay the charge themselves.

Scheme pays

Scheme pays is a facility whereby the member can ask the scheme to pay the tax charge out of the scheme funds. If this is from a DC scheme, the amount will just be taken from their pension and paid to HMRC. If it is a DB scheme, some of the accrued pension will be commuted and paid to the scheme. This may reduce the pension now or be applied as a debit at retirement.

There are rules about how much the scheme can be forced to pay, although it can volunteer to pay the whole amount should it wish to be helpful.

Mandatory scheme pays is where the scheme has to honour the member’s request to pay the charge. This is only applicable where the contributions or accrual to the scheme exceed £40,000 and the total tax charge the client is required to pay is more than £2,000. This is a particular issue for those subject to the tapered annual allowance, because it may mean they have to pay the tax charge themselves – or at least the part applicable to the excess over the £10,000 and below the £40,000 bands. Schemes only have to pay the charge for the part over £40,000 that lies with them. 

The deadline to request mandatory scheme pays is 31 July following the tax year in which the charge occurs.

Voluntary scheme pays allows the scheme to pay any amount. The member cannot force this to take place, and their deadlines are aligned with self-assessment. The scheme will need time to process the request so it can impose its own deadlines for application.

Don’t forget the tax relief

The annual allowance charge assumes that all tax relief on the contributions has been claimed. If the tax relief isn’t claimed, the annual allowance charge will mean the member is out of pocket.

Higher or additional-rate tax relief should be claimed through self-assessment if applicable. Those that don’t complete a self-assessment and are subject to higher-rate tax can call HMRC with details of their pension contributions, and their tax code will be amended accordingly. HMRC should be notified immediately of any changes to contribution rates in the tax year so extra tax relief isn’t reclaimed which will then need to be paid back.

For those subject to additional-rate tax, their income will be such that they will be subject to self-assessment. As with a higher-rate taxpayer, they can get tax relief sooner by calling HMRC.

Pension contributions can generally be managed to avoid tax charges or having to request refunds. That said, as the annual allowance is just that – an allowance – exceeding it just removes tax relief and is therefore not the end of the world. 

In some cases, it is still beneficial to exceed the allowance if the contributions are from the employer and nothing would be given in exchange.

Claire Trott is head of pensions strategy at Technical Connection