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The AA is the maximum amount of pension savings an individual can make each tax year with the benefit of tax relief. Pension savings are those made by the individual together with any made on their behalf. Pension savings above the AA may be made but a tax charge may apply when the AA is exceeded.
The standard AA is prescribed by legislation, and is currently £40,000. However, high earning individuals in a tax year have their AA reduced. This reduction is called the tapered annual allowance (TAA). The TAA applies to individuals with “Threshold Income” of over £110,000 and “Adjusted Income” of over £150,000.
“Threshold Income” is broadly determined as an individual’s net income for the year. This will include all taxable income sources such as salary, bonus, dividend income, interest from savings, etc less certain allowable reliefs. If Threshold Income exceeds £110,000 then “Adjusted Income” needs to be calculated in order to work out the amount of tapered annual allowance.
“Adjusted Income” is similar and again is based on an individual’s net income but adds in all employer pension contributions.
If the Adjusted Income exceeds £150,000 then the AA is reduced by £1 for every £2 of income above £150,000. The TAA can only be reduced to £10,000 which applies for those with an adjusted income of £210,000 or more.
Individuals who access their benefits under the flexible access rules trigger the money purchase annual allowance (MPAA) rules for the remainder of the tax year in which flexible access is first made and each subsequent tax year. Such individuals become subject to the MPAA for their money purchase pension savings, currently £4,000.
The AA refers only to an individual. That AA applies across all the schemes an individual belongs to, whether the individual is tapered or not.
Pension Savings Statements (PSSs) have to be issued to an individual if they breach the standard AA or the MPAA if they are known or believed to be subject to it. This confirms the Pension Input Amount (PIA) that has been made for that scheme. These statements have to be issued by 6 October after the end of the tax year, so statements in respect of the 2018/2019 tax year will already have been or are about to be issued. Some schemes may issue PSSs irrespective of whether this is an automatic requirement.
If a PSS has not been received, an individual may request a PSS from their scheme, and this must then be provided within 3 months of the date of request or by 6 October after the end of the relevant tax year if later.
Individuals are responsible for determining whether they are subject to an AA tax charge. In simple terms, the total of an individual’s PIAs is compared to their personal AA and if there is an excess, an AA tax charge may become payable. This can be mitigated by the use of any unused AA from the previous 3 tax years. However, if an individual is subject to the MPAA, money purchase pension input and other (alternative) pension may have to be determined separately. Unused AA (or MPAA) may not be used to offset a tax charge arising in respect of money purchase excess input. Any tax charge is determined at the individual’s marginal rate of tax.
Determining the amount of an AA tax charge is a complex matter. As such, individuals are recommended to seek appropriate tax advice.
Individuals are responsible for reporting an AA tax charge to HMRC via their self-assessment tax return and making the tax payment. However, they have the potential to use the “Scheme Pays” facility by requesting their pension scheme to pay tax on their behalf in return for a fair reduction in their benefits.
Scheme Pays falls into two categories: Mandatory and Voluntary. Mandatory is where the scheme must pay tax if certain conditions are met. Voluntary is where the scheme agrees to pay tax if the member so requests but subject to rules set by that scheme. In either case (and in some cases, AA tax may be covered by both), individuals provide details in their self-assessment tax return with the figure they expect the scheme to pay – the deadline for which is 31 January 2020 in respect of the 2018/2019 tax year.
Mandatory Scheme Pays has to be provided where the AA tax charge is more than £2,000, the PIA in the scheme exceeds the Standard AA and the individual elects for it to be paid this way. The scheme’s mandatory liability in this case is only for the tax on any input amount above the standard AA in the scheme – not for any amount between a TAA and the standard AA or any tax related to saving in any other scheme.
Voluntary Scheme Pays relates to schemes agreeing to pay a tax charge outside of the Mandatory Scheme Pays requirements. Although tax is paid by the scheme, the liability for the tax charge still remains with the member. Elections under Mandatory Scheme Pays in respect of a tax charge relating to the 2018/2019 tax year have to be made by 31 July 2020. Although recorded on the self-assessment tax form by 31 January 2020, no penalty is imposed even if the tax is not received by HMRC until after this date.
Elections under Voluntary Scheme Pays in respect of a tax charge relating to the 2018/2019 tax year should be made so that, if accepted by the scheme, the tax may be paid by 31 January 2020 to avoid any penalty imposition. Notwithstanding the above, schemes may prefer Mandatory and Voluntary (if being allowed) Scheme Pays requests to be made at the same time to assist with their administration processes.