The Complexities of Pension Contributions: Understanding the Annual Allowance
In a society with an ageing population, pensions are a key focus and often, a political hot potato. The government finds itself balancing encouraging people to save for their retirement via tax incentives whilst keeping the national budget in check.
One issue that has emerged is potential tax charges that can be unknowingly activated due to contributions exceeding your annual allowance.
What Exactly is the Annual Allowance?
In simple terms, the annual allowance is the upper limit on the amount that can be contributed to an individual’s pension scheme in a tax year whilst receiving tax relief. Since the 2023-24 tax year, this limit has been set at £60,000, encompassing all personal and employer contributions.
However, this allowance is reduced for individuals who fulfil two criteria – ‘threshold income’ and ‘adjusted income’. These terms dictate the income levels for reduction, currently set at £200,000 and £260,000 respectively.
Income Thresholds: A Peek into the Changes
In the 2020-21 tax year, the income threshold experienced a significant increase, partly to assist doctors in the NHS. However, this rise was not exclusive to those in the medical profession.
While this change was viewed as generous, it came with the caveat of a reduced minimum annual allowance. Moreover, it was too late for high earners who had used their ‘brought forward’ unused allowances, leading to an unexpected pension tax charge.
So, What Happens When the Annual Allowance is Exceeded?
If the annual allowance threshold is breached, a tax liability must be paid on the excess contribution at the marginal rate of the taxpayer. The individual can either pay this liability themselves or make a ‘scheme pays’ election to their pension provider. Regardless of the route taken, the pension savings tax charge must be included in your tax return.
Importantly, where a pension charge has not been reported to HMRC, they may open an enquiry or issue a notice, and charge interest and potentially a penalty if any errors are found.
How Can We Navigate This Minefield?
The first approach is for employers, who should ideally monitor this position using payroll information to alert any employee who could potentially be affected.
The second is for individuals to review their own pension contribution situation early in the tax year to anticipate their allowances when considering employer contributions. Seeking professional advice is highly recommended to ensure efficient communication with HMRC and mitigation of potential penalties.
Pensions are a vital part of wealth planning, aiming to optimise contributions for tax relief and enhance the pension pot. However, these benefits also come with drawbacks making professional advice indispensable.
If you need assistance with payroll or pension enquiries you can contact us on 01257 241111 or email info@studholme-bell.com
