How could annual allowance be improved?

How could annual allowance be improved?

Thankfully we saw no adverse changes to the annual allowance in the Budget at the end of October. Other commentators felt there would be major changes announced, but personally I didn’t expect a great deal of movement.

While I do always welcome a period of stability, a lack of activity isn’t necessarily a good thing – changes could have been made to improve the way pension contributions are tested.

What we can all probably agree on is things have got to the point where pensions are so complicated for the average pensions member that clients exceeding the annual allowance, as well as issues around declaring this and paying the appropriate taxes, all continue to be live issues in our industry. 

Multiple layers

The annual allowance was quite confusing for many when it was first introduced because it appears, at first sight, to be a limit on the amount of tax relief a person can claim. But it isn’t that simple. If the annual allowance is exceeded after carry forward, a tax charge is levied at the individual’s marginal rates of tax. 

It should always be remembered that any tax relief due on pension contributions that are paid personally should be claimed in the normal way. Personal tax relief can be claimed on contributions up to the member’s relevant UK earnings, and hence this is not technically limited by the annual allowance.

It is the total pension input amount that is tested against the annual allowance. For defined contribution schemes, this includes not only personal contributions and any applicable basic-rate tax relief, but also employer contributions. For defined benefit schemes, it is based on the increase in benefits within the tax year.

Should there only be a single annual allowance, there would still be two tests to worry about each year when trying to establish what can or should be paid to a pension scheme. In any case, we now have multiple annual allowances.

The money purchase annual allowance is applicable to those that have used the pension freedoms to access their pension funds and taken income. This would generally be via the uncrystallised funds pension lump sum,flexi-access drawdown, or a flexible annuity. Standard annuities, or income taken from most DB pension schemes, aren’t a trigger.

The MPAA reduces the annual allowance to £4,000 each year for DC scheme contributions. DB schemes are not impacted by this. There is no carry forward available once the allowance has been triggered.

The tapered annual allowance is the newest incarnation of the annual allowance and came into force in 2016-17. It is designed to reduce the annual allowance for what the government deems high earners, and to recoup tax relief further. 

Unlike the standard annual allowance and the MPAA, the tapered annual allowance is dependent on total earnings, including income that is not pensionable, such as rental income and dividends. When the net income – less any contributions paid personally to a pension scheme – is more than £110,000, we need to go to the next stage and the actual tapered annual allowance test must to be applied.