Beware a Pension Trap - The Annual Allowance Change
Whilst pension flexibility has perhaps never been greater, from recent experience, we are increasingly witnessing cases of individuals falling foul of the complex tax rules in relation to pension contributions.
Following the hideously complex changes to the pensions contributions rules in 2016, we are now reaching a point where a growing number of people may receive a nasty surprise from HMRC.
The amount of pension contributions an individual can make to a pension scheme, and qualify for tax relief, is determined by the Annual Allowance. Changes to the standard Annual Allowance have seen the threshold fall from £255,000 to £40,000 in the past decade. In addition, for the highest earners, this Annual Allowance falls to just £10,000.
It is this fall in Annual Allowance where care is needed; anyone with income over £110,000 per year should review their pension contributions. If the available Annual Allowance is exceeded, a tax charge may apply.
Identifying whether you may be impacted by the Annual Allowance tax charge is a science in itself. The nature of the pension scheme must be considered, alongside the level of any employer contributions, and whether the individual has already flexibly accessed any pension benefits. All of this must be reviewed against pension contributions made in the past three years.
The cuts in the annual allowance have particularly impacted the public sector, with doctors being on the front line of this. Indeed, the British Medical Association has claimed many high-earning medics are resorting to cutting hours or even leaving the profession as a result of the tax hits they are being forced to take to their pension pots.
Historically, putting large amounts into a pension fund was incredibly tax-friendly, and, combined with the ability to carry forward an unused allowance of up to £255,000 at one time, this meant that substantial pension funds could easily be accumulated.
However, it is now often the case that the NHS annual pension scheme accrual alone results in the £40,000 Annual Allowance limit being reached, even without any personal contributions; unfortunately, for NHS workers, there is no flexibility to reduce their contributions to mitigate the Annual Allowance tax charge.
For those who haven’t identified an Annual Allowance problem, it is worth noting that HMRC receive information directly from pension schemes and they are increasingly able to identify issues on your behalf
– where the limits are breached, there is a risk of interest and penalties for underpayment of tax liabilities.
Furthermore, once you’ve managed to calculate any tax due, the reporting of any Annual Allowance tax charge is not straightforward. The self-assessment tax return does not appear to have been designed to provide sufficient scope to report all relevant information and pay any tax due.
In summary, if you believe that you may be affected by these changes, it is essential that you obtain tax advice as soon as possible.
We would be happy to discuss your pension tax planning arrangements and please do not therefore hesitate to contact a member of our team on 0191 224 6760 (Newcastle) or 01423 740 761 (Harrogate).