Talbot and Muir

Annual Allowance

The Annual Allowance limits the amount by which an individual's pension savings can increase in each pension input period. The accrual of defined benefits is measured using a valuation factor of 16:1. In 2011/12 the annual allowance is £50,000.

 

Any contributions made to an individual's pension schemes that exceed their available allowance will incur an annual allowance tax charge set at their highest marginal rate of income tax.

 

It is important to be aware of the distinction between an allowable contribution and a tax relievable contribution. A contribution is allowable if it is within an individual's available annual allowance; the criteria by which a contribution is deemed tax relievable depend on the type of contribution:

 

·      A personal/employee contribution is tax relievable if it is within the higher of £3,600 or 100% of the individual's relevant UK earnings in the tax year of the contribution.

·      A company/employer contribution is tax relievable if it is deemed by HMRC to be "wholly and exclusively for the purposes of trade".

 

Only tax relievable contributions are tested against the annual allowance. Contributions made by an individual aged 75 or over are not tax relievable, and are therefore not tested.

 

 

What are Relevant UK Earnings?

 

·      Employment income such as salary, wages, bonus, overtime, commission providing it is chargeable to tax under Section 7(2) ITEPA 2003.

·      Income chargeable under Part 2 ITTOIA 2005, that is income derived from the carrying on or exercise of a trade, profession or vocation (whether individually or as a partner acting personally in a partnership).

·      Income arising from patent rights and treated as earned income under section 833 (5B) ICTA 1988.

·      General earnings from an overseas Crown employment which are subject to tax in accordance with section 28 of ITEPA 2003.

 

 

Pension Input Periods

 

The annual allowance does not simply apply to all pension contributions made in a certain tax year e.g. the total pension input amount for the 2011/12 tax year is not the total of contributions made between 6^th April 2011 and 5^th April 2012. Instead the level of contributions to be tested against the annual allowance is the total of all contributions made to pension schemes with a Pension Input Period (PIP) ending in a given tax year.

 

The first PIP for a pension scheme starts on the date that the first contribution is made to that scheme, and normally ends at the end of that tax year i.e. on 5^th April. If someone joins a pension scheme on 10^th April 2011, and makes their first pension contribution on 1^st May 2011, the first PIP starts on 1^st May 2011 and ends on 5^th April 2012. The next PIP starts on 6^th April 2012 and ends on 5^th April 2013, and thereafter subsequent PIPs will end on 5^th April each year.

 

It is possible, however, for the scheme member or the scheme administrator to nominate to alter the end of a scheme’s PIP. In the example above, the member could decide to end the first PIP of the pension scheme on 31^st December 2011. The next PIP would begin on 1^st January 2012 and end on 31^st December 2012, and so on. The scheme member can nominate to change their PIP whenever they like, provided that no PIP lasts longer than twelve months, and the nomination is made in advance of the end of the PIP in question e.g. a nomination cannot be made to alter a PIP that ends on 5^th April 2012 on or after that date.

 

Changing the input period in this way can affect which tax year’s annual allowance an individual’s contributions are tested against, and could mean that in any given tax year they could make contributions in excess of the annual allowance without incurring a penalty from HMRC.

 

In determining how much of the annual allowance someone has used, or still has available to them, they must add together all of the pension contributions they have made to pension schemes with a PIP ending in the tax year in question.

 

 

Carrying forward unused annual allowance

 

In view of the fact that the new annual allowance of £50,000 represents a sharp reduction from the previous allowance of £255,000, it will be allowed for an individual to carry forward their unused annual allowance from up to three previous tax years, based on an allowance of £50,000 having applied during that time. An individual can carry forward their allowance from previous years provided:

 

·       They were a member of any registered pension scheme in that year i.e. they do not have to have been an active member of any scheme, and they do not have to have been a member of the scheme to which they wish to contribute.

·       The allowance of £50,000 has not been used up in any subsequent year.

 

This would mean that if someone has been a member of a registered pension scheme for the last three tax years without having made any contributions, in an input period ending in 2011/12 they can personally contribute up to £200,000 without penalty (although whether tax relief is available depends on their earnings).

 

Note that whereas large pension contributions in an intervening year can reduce the amount carried forward from a previous tax year to the current tax year, this does not apply if the intervening year(s) is 2009/10 or 2010/11.