The amount a person can save each year in a pension scheme before tax charges (known as the annual allowance) is £40,000. From April 2016, it will be tapered for those with annual incomes (adjusted to include their own and employers' pension contributions) over £150,000. For every £2 of adjusted income over £150,000, an individual's annual allowance is reduced by £1, down to a minimum of £10,000.
Tax relief on member contributions
A pension scheme member can claim tax relief on their pension contributions as long as, in each tax year, they contribute no more than 100% of their annual UK earnings.
Those members earning less than £3,600 a year can claim tax relief on their pension contributions up to that amount.
The tax charge
The government effectively limits the amount of tax relief on pension savings. This is done by imposing a tax charge on pension savings above the annual allowance.
A member's pension savings are not the same as their contributions. In a defined contribution scheme, pension savings include contributions paid in the year by employers as well as by members themselves. In a defined benefit scheme, pension savings are the increase in the value of the member's benefits in the year.
The tax charge applies to the pension savings in excess of the annual allowance. The amount of the charge is intended to reverse the tax relief on the excess savings. The tax rate will be 20%, 40% or 45% depending on the member's earnings.
Members may be able to avoid or limit the effect of one-off large payments to their pension scheme. They may offset excess pension savings against any unused annual allowance in the previous three years.
This three-year measure should help members who normally save less than £40,000 a year but who may receive a pension increase as part of a redundancy package or a one-off pensionable bonus.
When a tax charge amounts to less than £2,000 the member must pay it through their self-assessment tax return.
When a tax charge exceeds £2,000 the member can arrange for it to be paid out of their pension scheme. Trustees will need to adjust pension benefits to reflect the charge. Trustees cannot pass the additional administrative costs on to the member.
The £10k money purchase annual allowance
The £10k money purchase annual allowance is an allowance which, once triggered for a particular person, limits the annual level of contributions in respect of that person to any defined contribution arrangements going forward. It is generally triggered when an individual receives pension benefits from defined contribution savings other than through an annuity (for example, by taking money through a flexible drawdown fund). It operates in a similar way to the standard annual allowance (although excess pension savings cannot be offset against unused allowance in previous years).
In defined contribution schemes members may reduce contributions to ensure their savings remain below the annual allowance.
Some defined benefit schemes trustees have amended their rules to ensure that the value of the increase in each member's benefits in the year does not exceed the annual allowance.
Trustees will need to send a pension savings statement to all members who exceed the annual allowance. The statement must be sent by 6 October following the end of the tax year.
This statement will include all the information the member will need in order to determine whether they have exceeded the annual allowance and if they have any unclaimed allowance to carry forward.
All members have the right to request a statement regardless of whether they have exceeded their annual allowance. Trustees should ensure that there is a process in place to prepare and issue these statements.
Calculating pension savings
The period in which pension savings are measured is called the pension input period (PIP). PIPs are being aligned with tax years from 2015/16. Complex transitional provisions apply.