Understanding Pension Saving Restrictions

Whilst generally saving as much as you can in your pension is a good idea, there are some limits which if breached will mean you will pay more in tax.

Lifetime Allowance

The Lifetime Allowance (LTA) was introduced into pension legislation on 6th April 2006 and is the maximum value of pension benefits an individual can accumulate in their working lifetime before being subject to a further tax charge, in addition to income tax, when taking pension benefits. This additional tax charge is known as the "LTA excess charge".

The LTA was originally set at £1,500,000 with incremental increases for the initial five years, reaching £1.8 million from 2010/11. It remained at this level until reductions were applied in 2012, 2014 and 2016 resulting in an LTA of £1 million from April 2016.

When the final reduction was implemented, it was announced that the LTA will increase annually in line with the Consumer Price Index (CPI) from April 2018 onwards.

It was announced in March 2021 that the LTA will remain at £1,073,100 until the 2025/26 tax year. 

Lifetime Allowance Excess Charge

Where benefits are accrued above the value of the LTA, an additional tax charge is levied known as the LTA excess charge. The rate applicable depends upon how this excess is paid to an individual. If the excess is taken as a lump sum the rate applicable is 55%, or 25% if benefits are taken as pension income. However, if taken as income it is also subject to income tax at your marginal rate, resulting in an effective overall rate of approximately 55% (assuming the individual is a higher rate tax payer).

If the Lifetime Allowance has been fully utilised, any benefits accessed after that point can be taken as a Lifetime Allowance excess lump sum. This means that the entire value of any benefits accrued over and above the LTA can be taken as a lump sum payment; however, this would be subject to a 55% tax charge.

Money Purchase Annual Allowance (MPAA)

The Annual Allowance is the amount that can be paid into your pension each year by you, your employer or any third party without you incurring a tax charge.

On 6^th April 2015, the Government introduced a lower level of Annual Allowance, called the Money Purchase Annual Allowance (MPAA), for anyone that 'flexibly' accesses pension income. It is designed to discourage people from using new flexible pension rules in order to avoid tax and potentially National Insurance (NI) contributions.

From 6^th April 2017, the MPAA reduced from £10,000 to £4,000 a year. So if the MPAA applies to you and if you contribute more to your pension than the MPAA, you will need to pay the relevant annual tax charge to HMRC via self-assessment.

The MPAA does not replace the current Annual Allowance rules (or reduce the normal Annual Allowance) unless you take your pension benefits from a Defined Contribution pension scheme using 'flexibility'.

How do I know if I'm accessing my pension income flexibly?

1. The HMRC defines what constitutes taking benefits 'flexibly', known as trigger events and a full definition can be found here: https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm05620
2. If you take benefits from a Defined Contribution pension scheme in the following ways, the MPAA is not triggered:
   • Buy an annuity that can't reduce the amount it pays
   • Only take tax-free cash and no income
   • Commencing a scheme pension from a Trust based Defined Contribution scheme
3. If you take benefits from a Defined Benefit scheme the MPAA is not triggered.

What happens if I trigger the MPAA by accessing my pension income flexibly?

1. The Annual Allowance will still be the primary allowance to consider, however, when a trigger event happens (see 1 above), the new MPAA rules will apply and continue to do so for each subsequent tax year.
2. The MPAA will only start to apply from the day after you have taken flexible benefits and so any previous pension savings are not affiliated.
3. If you take benefits from a Defined Contribution scheme flexibly while you are still working, you need to calculate how much you need to reduce your total pension contributions by, in order to be under the MPAA. Otherwise, you will need to pay HMRC a tax charge.

Pension Annual Allowance 2021/2022

The Annual Allowance changed for high earners with effect from April 2016. How do you work out if you're affected? And if you are, what action can you take?

The Annual Allowance:

The Annual Allowance is the highest amount you can save towards your pension each year tax-free. It applies to your contributions and your employer's, and to any other pensions you accrue benefits in.

If you go over the Annual Allowance you may have to pay tax on the excess, though you can 'carry forward' any 'unused' allowance from the previous three tax years.

For most people, the Annual Allowance is £40,000 for the 2021/22 tax year. However, a lower, 'tapered' Annual Allowance is applied with effect from 6 April 2021 if your 'adjusted income' is over £240,000.

Pensions and Self-Assessment for Scottish Based Employees

The Self-Assessment process enables individuals to declare to HMRC any additional tax due to be paid; or claim back any tax relief or overpaid tax. With regards to pensions, the self-assessment system is used:

• By intermediate, higher or additional rate tax payers to claim tax relief at their full rate on any contributions made directly to the pension provider where only basic rate tax relief has been received and/or
• To declare any tax due because of exceeding any of HMRC's allowances such as the Lifetime Allowance or Annual Allowance

Who can claim Tax Relief?

Any contributions paid to a pension receive tax relief. The rate of tax relief available is dependent upon the levels of taxable earnings an individual has in the applicable tax year. If you pay basic rate, higher or additional rate tax (20%, 40% or 45% respectively), this is the level of tax relief that is applicable. However, when contributions are paid directly to a pension scheme, either as an employee contribution from net pay or as a payment directly via a Direct Debit, the pension provider will apply tax relief at a rate equivalent to basic rate tax (currently 20%). If an individual pays a higher rate of tax then this additional rate tax can be claimed back via the Self-Assessment process.

Please note: If you are making contributions to your workplace pension by Salary Sacrifice or if you are contributing to a Final Salary Scheme or Occupational Scheme out of gross pay then these deductions are taken from your pay before the application of tax. Consequently, you are receiving tax relief at a rate equivalent to your highest rate of income tax and therefore no further tax relief can, or should, be claimed.

How many years relief can be reclaimed?

Whilst you can only use self-assessment to claim tax relief for the relevant year you are submitting the tax return for, higher or additional rate tax relief can still be claimed up to four years after the end of the relevant tax year the claim is being made for. This is confirmed by HMRC within the self-assessment claims manual and a link can be found here https://www.gov.uk/hmrc-internal-manuals/self-assessment-claims-manual/sacm3035. This is done by contacting your local Tax Office and their details can be found on your latest P60.

How is the additional tax relief calculated?

HMRC will add the value of the contributions made to your basic rate tax threshold. They will then work out how much total tax should have been paid on these contributions.

HMRC will then deduct the tax paid and if you have paid more you will receive the excess back. This will be used to offset any other tax liabilities or repaid to you either as a lump sum or by adjusting your tax code for the current year.

The content of this article does not constitute individual financial advice.