Annual Allowance Regime
Background
In the 2010 emergency budget the Government announced its intention to revoke the previous Government’s legislation relating to “High Earners” but still intended to reduce tax relief on pensions by £4 billion. They announced a reduction to the existing Annual Allowance together with a number of other changes regarding the Annual Allowance Regime. Set out below is a summary of the changes that have occurred from April 2011:-
- Annual allowance reduced from £255,000 to £50,000. From April 2014 this reduced again to £40,000
- Previous year’s benefits to be revalued in line with the consumer price index (CPI)
- A factor of 16 to be applied to benefit accrual - previously 10
- Carry forward 3 years of unused Annual Allowance, to offset against any tax charge that might apply in the year of assessment
- Full tax relief up to the Annual Allowance, with marginal tax rate charge on any excess above the Annual Allowance
- Deferred members exempt from the Annual Allowance test, as the methods of revaluation are the same (i.e. CPI)
- Benefits in the year of death are exempt from any Annual Allowance assessment.
- Similar exemption also applies for serious ill health (although the HMRC definition of serious ill health is different from the LGPS).
- Members with “Enhanced Protection” are no longer exempt from the Annual Allowance
- No Annual Allowance exemption for Redundancy or the year the benefits come into payment
What is Annual Allowance?
In simple terms the “Annual Allowance” is the amount your pension savings are allowed to grow during a pension input period (PIP) before a tax charge may be applied. For the Local Government Pension Scheme (LGPS) the PIP is from 1 April to the following 31 March. From April 2011 the Annual Allowance was set at £50,000; however this reduced to £40,000 from April 2014.
If your annual pension savings increase by more than the Annual Allowance you may have to pay a tax charge on the excess growth over and above the level of the Annual Allowance. For the LGPS the Annual Allowance means the annual growth in your pension savings and not the amount you have paid in contributions. Details of how the annual growth in your pension savings is calculated are shown under “method of calculating whether a tax charge is due” below.
Tax charges on excess
The excess of your pension savings above the Annual Allowance counts as income. The amount of tax due depends on the total of your pension saving in excess of the Annual Allowance, as well as your total annual taxable pay. To assist you with calculating the tax charge due visit the HMRC website.
If your taxable pay exceeds £150,000 the proportion of the excess once added to your annual net pay that is above £150,000 is liable to the tax charge of 45%. The remaining excess would be subject to a 40% tax charge.
Method for calculating whether a tax charge is due
To identify whether a tax charge is due, a pension input amount (PIA) needs to be calculated. This is done by measuring the growth between the opening and closing balances in pension during the pension input period (PIP). The opening balance is revalued in line with the consumer price index (CPI).
In order to work out the capital value of your PIA the growth in your annual pension is multiplied by a factor of 16 and any growth in standard Lump Sum Retirement Grant is added to this (i.e. any option to take more lump sum by giving up annual pension is ignored). If the total figure is higher than the Annual Allowance then a tax charge may be due on the excess (see below re the “carry forward” option).
Carried Forward Allowance
Where a tax charge applies, the tax charge can be reduced or removed completely by using unused carry forward allowance. The same calculation to determine pension growth is carried out for the previous 3 years. For PIPs prior to April 2011 a notional Annual Allowance of £50,000 per year is used. Any unused allowance can be carried forward and added to the current year’s Annual Allowance to offset some, or possibly all, of the tax charge.
Reporting and paying the tax charge
You will need to report your pension growth and tax charges to Her Majesty’s Revenue and Customs (HMRC) and make payment of the tax charge through self-assessment in the January following the Pension Input Period. However the deadline for 2011/2012 and 2012/2013 was January 2014 as a year’s extension was granted for the first year of the new Annual Allowance Regime.
Scheme pays option
For tax charges over £2,000 you may have the option to pay the tax charge via the “Scheme pays” mechanism. This means that your pension administrator will pay the tax charge on your behalf. However, your pension benefits will be reduced accordingly, to reflect that the Scheme is paying your Annual Allowance tax charge for you. For members of the Local Government Pension Scheme (LGPS) the amount of reduction is based on factors and methodology provided by the Government Actuaries Department (GAD). It is possible to use the “Scheme pays” option each time you suffer an Annual Allowance tax charge, so you may have more than one reduction applied to your LGPS benefits to reflect this.
If you are interested in this option you should also read the factsheet on Scheme Pays before making your application to your pension administrator.
Further information
You can also find information on Annual Allowance and Scheme Pays, including a scheme member guide, on HMRC’s website.
Information regarding the LGPS including Annual Allowance can be found on the Local Pensions Partnership Adminstration website.
This information is provided solely for the purpose of considering pension growth in relation to Annual Allowance. The information in this letter is based on our understanding of HMRC, and the current LGPS legislation. The pension administration team are not lawyers, financial advisers or tax advisers and you may wish to take separate legal, financial and tax advice on this matter
Further guides
Disclaimer
Please note: this is intended as a broad guide to your benefits in the local Government Pension Scheme. It does not seek to cater for every different circumstance and no decisions should be taken based on its contents. You are strongly advised to consult our website and/or contact us for more detailed and individual information before taking any action in relation to your pension. Nothing on this page overrides the regulations which govern the LGPS and which are subject to amendment from time to time.
