Case studies
Case studies for both tests
1. Joe - self employed
Joe is self-employed with taxable profits of £53,000 in the current tax year. What is his maximum pension contribution and can he use carry forward?
Tax relief
Joe is entitled to tax relief on a personal contribution up to 100% of his relevant earnings in the tax year the contribution is paid (as his relevant earnings are above £3,600). This means he can pay £42,400 net to a personal pension scheme operating Relief At Source (RAS). The pension provider will claim basic rate tax relief from HMRC, and add this to Joe’s pension, meaning a gross contribution of £53,000 is invested.
Annual allowance
Joe has the full standard AA of £60,000. If he pays a personal contribution of £53,000 gross then this uses £53,000 AA and leaves £7,000 unused AA which can be carried forward and used in a later tax year.
Joe’s AA for the current tax year is not limited to his relevant earnings. He actually has available AA but no more relevant earnings to make any additional tax relievable pension contribution in the current tax year.
It is only tax relief for Joe’s individual contribution that is limited by his relevant earnings.
Planning for next tax year
Moving on to the next tax year, let’s assume Joe then has taxable profits of £67,000. His maximum personal contribution will be 100% of his relevant earnings in that tax year, ie £67,000 gross.
Where total pension inputs in a tax year exceed the member’s AA, then Joe should look back to the previous three years to work out if he has any unused AA to carry forward. He’ll have that tax year’s allowance of £60,000 plus he’s got £7,000 that he hasn’t used, giving a total AA of £67,000.
If he pays a personal contribution of £67,000 gross, this will use £67,000 AA. Although pension inputs exceed the AA, there is no AA excess charge as carry forward can be used to fully absorb total pension input amounts (PIA).
2. Sky - member of employer’s GPP scheme
Sky has relevant earnings of £20,000. Her employer’s pension scheme is a group personal pension arrangement which operates RAS, and her employer pays £2,000 as a pension contribution.
Tax relief
Sky is eligible for tax relief on a personal contribution up to £20,000 gross.
Sky’s maximum personal contribution to this scheme would be a net contribution of £16,000, which would be grossed up to £20,000 in the pension when the provider claims 20% (£4,000) tax relief from HMRC. She’d still have to pay some tax but would have £4,000 added to her pension pot, and overall this would mean a net gain from HMRC.
Annual allowance
Sky has the full AA of £40,000. If she pays a personal contribution of £20,000 gross and her employer pays £2,000 then this uses £22,000 AA and leaves £18,000 unused AA which can be carried forward and used in a later tax year.
Sky’s AA for the current tax year is not limited to her relevant earnings. She actually has available AA but no more relevant earnings to make any additional tax relievable pension contribution in the current tax year.
It is only tax relief for Sky’s individual contribution that is limited by her relevant earnings.
3. Doug - active member of a Defined Benefits scheme
Doug is an active member of his employer’s defined benefit pension scheme. Doug pays a 3% employee contribution based on his pensionable salary of £37,500.
Working out the maximum individual pension contribution for a client who already contributes to their employer’s defined benefit scheme can be tricky. The usual two calculations will be required, checking tax relief limits then available annual allowance.
Defined benefits and the MPAA
A member with a defined benefit pension (either accruing benefits or receiving DB pension benefits) is broadly unaffected by the MPAA. You can read more about the MPAA in our technical centre. Taking a pension commencement lump sum and scheme pension from a defined benefits scheme does not trigger the MPAA for future pension savings.
If your client has flexibly accessed money purchase benefits and triggered the MPAA, any defined benefit pension input amounts are NOT tested against the MPAA. These are tested using the alternative annual allowance (the standard annual allowance, or tapered annual allowance where one applies, less defined contribution inputs paid up to £10,000 for the current tax year), including any available carry forward of unused annual allowance.
Tax relief
As always, the first consideration is tax relief and the usual limits apply - up to £3,600 gross pa, or 100% of relevant earnings in the tax year if greater. You must take in to account any personal contributions they already pay to any other pension scheme.
This means Doug already pays £1,125 to the Defined Benefits scheme therefore, to be eligible for tax relief, he can only pay up to a maximum of (£57,500 – £1,725) £55,775 gross to a personal pension plan.
Annual allowance
Next you should check for available annual allowance. Does your client have the standard annual allowance or are they subject to a tapered annual allowance? Have they triggered the money purchase annual allowance which applies to defined contribution savings? What are the pension input amounts for any other pension saving made in this tax year? For a Defined Benefit scheme it is the increase in pension entitlement for the year multiplied by 16 rather than the monetary contribution amount that is tested against the Annual Allowance. Full details of this calculation are set out in HMRC guidance
Now compare the proposed personal contribution amount with the available annual allowance. You’ll have two possible outcomes. Either the individual will have sufficient remaining annual allowance (including carry forward where eligible) to absorb the proposed new contribution amount or, they won’t.
We’ll say Doug’s defined benefit pension input amount (DBPIA) for the current tax year is estimated at approximately £11,000. It is not possible to get a definite DBPIA figure until the end of the pension input period/ tax year, when the pensionable salary at that date will be known.
If Doug has fully used his annual allowance for previous years, so has no unused AA to carry forward, his available annual allowance is £60,000 less the defined benefit pension input amount for the current tax year of £11,000 leaving £49,000.
Comparison
The remaining annual allowance is less than £55,775. This means Doug could pay up to £55,775 and receive tax relief on the whole amount. However, you know that his total pension savings would then exceed his available annual allowance and Doug would have to report the excess above his available AA and declare the related tax charge. An AA excess/ charge reduces the tax efficiency of making this level of personal contribution.
In this scenario it may be more appropriate to limit the individual pension contribution to £49,000 gross as this will receive tax relief without causing any annual allowance excess.
4. Maggie - business owner
Maggie owns her own business and is looking to make a large employer contribution to her personal pension in the current tax year. Employer pension contributions are unlimited so she’s planning on a contribution of £200,000, is this okay?
Again the two areas to consider are tax relief and annual allowance.
Tax Relief
As detailed in our ‘tax relief on employer contributions’ article, an employer pension contribution will receive tax relief based on whether or not the amount paid satisfies the definition of being an allowable deductible expense wholly & exclusively (W&E) for the purposes of the trade (expenses of management if paid by an investment company).
The company accountant is best placed to guide the employer on how much is reasonable. If HMRC were to challenge the contribution amount, then it is the accountant who would need to justify it.
The tax relief rules for employer pension contributions do not include any link to the client’s relevant earnings (this only applies to individual contributions paid by the member or paid on their behalf by a 3rd party e.g. as a gift from a parent etc). Neither is there any link to the client’s available annual allowance. So in a case for an employer who pays a pension contribution of £200,000 and this is deemed to meet the W&E rule, then it will receive corporation tax relief.
This is the end of the story for the employer. Maggie’s business will receive corporation tax relief in respect of the whole £200,000 contribution. What happens next does not change this position.
Annual Allowance
Sky has the full AA of £60,000. If she pays a personal contribution of £20,000 gross and her employer pays £2,000 then this uses £22,000 AA and leaves £38,000 unused AA which can be carried forward and used in a later tax year.
Maggie has been building up her business over the last 10 years and now wants to focus on pension planning. She started a pension plan for the first time in the current tax year. Her taxable income (salary and dividends) amounts to £60,000 so she is unaffected by the tapered annual allowance (as an employer contribution does not affect the Threshold Income measure for the Tapered AA, so she will not be over the £200,000 of Threshold Income) and at age 48 she’s too young (and healthy) to have flexibly accessed her pension benefits so is not subject to the money purchase annual allowance.
The standard annual allowance is £60,000. As Maggie was not a member of a registered pension scheme before this tax year she has no unused annual allowance to carry forward. This means she has an annual allowance excess of (£200,000 contribution - £60,000 allowance) £140,000. This is taxable on Maggie as an individual, even though the company made the contribution, it’s the member’s responsibility to report and arrange payment of the AA charge.
Maggie must report this excess in a self-assessment tax return. To calculate the relevant tax charge, the AA excess is added to other income to determine the tax rate which applies. Although the charge is to income tax, the amount is not income for tax purposes and therefore the member cannot offset any allowances, losses or relief against it. Similarly it will not lead to a loss of allowances, such as losing the personal allowance.
Using rest of UK rates the charge would be £65,140 x 40% and £74,860 at 45% a total of £59,743. Maggie can pay this herself or ask her pension scheme to pay the charge on her behalf by reducing the benefits in her pension. Either way the £200,000 pension contribution is effectively reduced to £140,257. There is still a net benefit so it’s not all bad, however, there may have been other options she would have considered had she been warned about the annual allowance excess before the contribution was paid.
Alternatively, some early planning a few years ago could have increased Maggie’s current options. It’s not uncommon to see clients in the same situation. Even if they don’t want to, or don’t have the means to, actively pay into pensions now, if they want the opportunity to pay large contributions in future, they need to plan correctly. If Maggie had paid a nominal amount in to a pension four tax years before the current one, she’d be able to carry forward unused annual allowance from then for each of the three previous tax years to reduce her current annual allowance excess.
Employer contributions are not limited to relevant earnings or annual allowance. Tax relief is based on the contribution satisfying the wholly & exclusively rule. Maggie’s business gained full corporation tax relief, but as the contribution exceeded Maggie’s available annual allowance, it is Maggie who must report and arrange payment of the AA excess charge.