Employees who fall into the higher rate tax band, especially those with an income approaching or exceeding £100,000 per annum, should be paying close attention to their annual pension statement. This document, issued by occupational pension providers each year, details both employee and employer contributions. It’s an essential check to avoid unwanted surprises from HMRC pension rules.
What Is the HMRC Annual Allowance?
Since 2006, HMRC has applied an Annual Allowance to pension contributions. The HMRC annual allowance is currently £60,000 per tax year.
If the combined total of an individual’s pension contributions (including employee, employer, and any private contributions) goes above this allowance, it triggers a pension charge. This charge is based on taxable income, which can significantly increase your overall tax bill.]
Understanding Your Annual Pension Statement
Your annual pension statement shows the total pension contributions made during the tax year. How these contributions are measured depends on the type of pension scheme:
- Defined contribution scheme (DC): The amount is based on what you and your employer actually paid into your pension pot.
- Defined benefit scheme (DB): Instead of showing actual payments, the value is calculated by comparing the opening and closing value of your pension over the tax year.
A quick reminder: a defined contribution scheme builds savings based on what’s paid in, while a defined benefit scheme promises a set retirement income, usually linked to your salary and length of service.
In DB schemes, a promotion or large pay rise can sharply increase the closing value of the pension. This can lead to a high Pension Input Amount (PIA). If the PIA exceeds the HMRC annual allowance, it creates a Taxable Pension Input (TIA), which will be subject to a pension charge.
Pension Charges and Higher Rate Tax
When your TIA pushes you above the allowance, HMRC applies a pension charge. For higher earners, this may mean paying tax at the 45% rate.
The effect can be particularly harsh if you’ve had a significant salary increase and at the same time exceeded your annual allowance through pension contributions.
Carry Forward Rules
There is some relief available through “carry forward”. If you didn’t use the full HMRC annual allowance in the previous three tax years, you may be able to use the unused amounts to reduce your TIA.
However, the rules can be complicated:
- Following changes in the 2015/16 tax year, there were two input periods, making carry forward calculations trickier.
- Unused annual allowances older than three years are lost entirely.
The Tapered Annual Allowance for High Earners
Further complications arise for those with adjusted income over £260,000 and threshold income exceeding £200,000. In these cases, the standard £60,000 HMRC annual allowance is reduced (tapered).
- For every £2 of income over £260,000, your allowance reduces by £1.
- Anyone earning over £360,000 will see their allowance reduced to as little as £10,000.
This means that paying into a pension above this reduced allowance could result in heavy pension charges at the 45% rate of tax.
Why You Should Seek Advice
As you can see, the rules surrounding HMRC pension allowances are complex. From understanding your annual pension statement to working out whether you are at risk of a pension charge, this is a highly specialised area.
If you have any questions or need expert guidance, please contact us, or you can explore our tax services.
