2 - HMRC Regime Flashcards
What is the major legislation which defines the current treatment of pensions?
The A-day (6 April 2006) legislation replaced most of the existing rules (need some knowledge of transitional arrangements) and introduced annual and lifetime limits.
Which pension schemes are covered by HMRC rules?
A pension scheme MUST register with HMRC to be subject to the HMRC rules (i.e. get tax benefits).
It is then referred to as a registered pension scheme.
Who can make contributions to a pension scheme and how much can they contribute?
Contributions can be made by an individual, their employer or any third party.
There is no limit on the amount of contributions, however there are limits on the contributions eligible for tax relief.
Individual Contributions
What is the requirement for contributions to be eligible for tax relief?
The key requirement for individual contributions to a registered pension scheme to be eligible for tax relief is that they must be a relevant UK individual.
What is a relevant UK individual?
- Under 75 years old
AND one of the following:
- Has relevant UK earnings chargeable to income tax in that year; or
- Is resident in the UK at some point during the year; or
- Was resident in the UK when they became a member of the pension scheme AND at some point during the prior 5 tax years (max tax relief of £3,600 pa in this case)
What are relevant UK earnings?
Relevant UK earnings include any of the following:
- Employment income (eg salary, wages, overtime, commission)
- Trading income (sole trader or partner)
- Income arising from patent rights which is treated as earned income
- General earnings from an overseas crown employment which is treated as UK income
What is the maximum individual contribution that is eligible for tax relief?
This is the greater of £3,600 (pa) and the relevant UK earnings of the individual.
NOTE: This is the maximum amount that is eligible for tax relief.
- If this is greater than the annual allowance you may get some of that tax relief taken back off you.
- You can contribute more if you like (unlimited amount) but will not receive any tax relief above this eligible contribution.
Note: It is the earnings of the person whose pension scheme is being contributed to that determines the tax relievable amount. If a parent contributes to their childs pension, the relevant UK earnings of the child determines tax relief, not the parent.
How is tax relief awarded for pension contributions?
Which type of schemes are restricted in relief method?
Occupational schemes can use either:
- Net Pay Method; or
- Relief at Source Method
Personal scheme contributions are relieved using relief at source only.
How does the net pay method of tax relief work for occupational schemes?
Impact on NI contributions
The net pay method means contributions are taken from an employees gross pay, they then pay tax only on the remaining amount of salary.
National Insurance contributions are still calculated on the full gross amount so this does not reduce the amount of NI payable.
This is NOT the same as salary sacrifice, it is an individual contribution made to an occuptional scheme using the net pay method.
How does the relief at source method work for occupational schemes?
The pension provider claims basic tax relief (20%) from HMRC and the employee pays the remaining net (of basic tax) amount into the pension fund.
The employee can then claim a further tax refund (20% or 25%) back via self assessment if they are a higher/additional rate payer.
E.g. A higher rate tax payer putting £100 gross into their pension fund will pay £80 out of their net salary with the pension fund claiming £20 from HMRC. The employee can then claim a further £20 back from HMRC via self assessment.
How is higher/additional rate tax recovered via self assessment under the relief at source method?
Effectively your basic rate tax threshold (which is around £35k) is increased by the gross amount of your contribution.
E.g. for a gross contribution of £1k your basic rate band is £36k instead of £35k, so you pay 20% on the income between £35k and £36k instead of 40%, thus saving 20% on the £1k gross contribution.
The additional rate band is also shifted up so (if your earnings are high enough) you’d get another £1k at 40% instead of 45%, thus saving 25% of £1k in total.
How were contributions to retirement annuity contacts tax relieved prior to April 2006?
The relief on making a claim method was used.
The individual made contributions gross and reclaimed via self-assessment or tax code adjustment.
A pension provider who is still providing one of these schemes can continue to use this method or switch to relief at source.
What is adjusted net income and what impact does it have on tax relief for pension contributions?
Adjusted net income is the total of income from all sources (salary, dividends, interest etc.) less certain tax reliefs.
It is the figure used to determine how much personal allowance you are entitled to (£1 of personal allowance is withdrawn for every £2 over £100k).
The tax reliefs include gross pension contributions, so making a pension contribution can increase how much personal allowance you get if you’re in the £100k to c. £120k danger zone!
Impact of a £1k gross pension contribution if your adjusted net income is £110k.
The £1k gross contribution will reduce our adjusted net income from £110k to £109k.
This increases your personal allowance entitlement by £1k/£2 = £500.
That means you get an additional £500 taxed at zero, and £500 less in your tax calculation which would have been taxed at 40%. So you save an additional 40% * £500 = £200, or 20% of the £1k contribution.
This is ON TOP of the standard tax relief of 40% on your £1k contribution, so your total tax relief is 60%!
How are individual contributions for self employed people tax relieved?
Which tax installment receives pension relief?
There are no occupational schemes for the self employed, they get tax relief at source. So they pay gross of 20% basic tax and claim any additional amounts back.
Self employed tax bills are 50% of last years bill on 31st Jan then another 50% of last years bill on 31st July. The balancing payment on 31st Jan after the end of the tax year is for the difference between your current year bill and the prior year bill.
It is the final payment on 31st Jan after the end of the tax year where your pension contributions will be taken into account.
Along with the impact on personal allowance what other impact can a reduction in adjusted net income have?
Child tax benefit is also assessed on adjusted net income.
For every £100 over £50k (highest earning parent) 1% of the child tax credit paid is charged back as tax.
What is the impact on pension contribution tax relief of taking income from your company via dividends instead of salary?
Dividends aren’t included in relevant UK earnings so taking too much income as dividends can reduce the amount of pension tax relief you can claim.
What is salary sacrifice and what are the requirements?
Salary sacrifice is an official agreement between employer and employee to reduce earnings and make direct contributions to the employees pension instead.
There must be a written agreement in place before the salary sacrifice is taken, and the employees salary must not be reduced below the national minimum wage.
It’s a long term agreement (usually annual) and can’t be changed at will, although there is provision for changes on “lifestyle events” such as divorce.
What is the tax impact of salary sacrifice (with numbers)?
As salary is officially lower the gross income on which NI is assessed is lower, so both employer and employee pay lower NI contributions.
Depending on salary level employee NI can be 12% and employer NI 13.8% so the saving can be significant.
Impact of implementing salary sacrifice instead of net pay method
The salary sacrifice agreement will state what happens to the NI savings, either they are kept by the employee/employer, or used to increase the gross amount of the pension contribution.
If the gross contribution is kept the same then both employer and employee NI bills will be lower, the employee gets more take home pay but the same in their pension.
Alternatively the employee could get the same net pay but end up with a higher gross contribution than the net pay method. The employer might also agree to use their NI saving to boost the gross amount added to the pension.
Advantages and disadvantages to salary sacrifice
Advantages are the NI saving primarily (which can be expressed as either higher net pay or higher contributions for the same net pay).
Also the lower official salary can increase entitlement to working tax credit, increase personal allowance (if earning just above £100k) or decrease child tax credit charge (if earning £50k to £60k).
Disadvantages are that the lower official salary can have other effects such as reducing your official salary for death in service benefit, reducing the size of mortgage you can take out or affecting other state benefits.
What is recycling the PCLS?
What is the risk?
What are the rules?
Recycling your PCLS is when you receive a PCLS and add it back to your pension as a contribution, effectively claiming double relief.
If HRMC decide you’ve done it they’ll treat it as an unauthorised payment. This requires all of the following conditions:
- Total PCLS received in the last 12 months are over £7,500;
- The pension contribution is significantly greater than it otherwise would have been (defined as 30% over normal level);
- Contribution made by the individual OR somebody else (eg employer); and
- The recyling was preplanned.
What are employer contributions and how are they tax relieved?
Employer contributions are made direct by the employer and don’t come out of your salary or via a salary sacrifice scheme, so there is no employee tax and no NI due for anybody.
The employer treats them as an expense so they get tax relief against corporation tax (or against income tax if the employer is a sole trader/partnership).
Note: Employer contributions are not the same as individual contributions made by your employer (eg salary sacrifice, net pay method etc.)
HMRC rules for employer contributions to get tax relief
There is a basic rule that the cost must be wholly and exclusively for the purpose of trade (same as any other expenses).
This is rarely used, but the Local Inspector of Taxes could determine that a contribution was not eligible for tax relief, for example if a husband makes a contribution to his wifes pension.
General rule is that the pension contribution should make sense relative to the employees benefits package (which includes salary, bonuses, overtime, but NOT dividends).
What is the timing of the company tax relief for employer contributions?
Usually it’s in the same tax year as the contribution as with any expense.
However if a significant increase is seen (210% of prior year) and the excess (i.e. the 110%) is over £500k, it might be spread out.
- £500k to £1m : 2 accounting periods;
- £1m to £2m : 3 accounting periods;
- £2m+ : 4 accounting periods.
What is the annual allowance and how does it work?
Rules introduced in April 2016
The annual allowance is £40k.
Any pension input in excess of £40k in a given pension input period will be subject to tax (via self assessment) at the individuals marginal rate of tax.
Note: You still get the tax relief initially, your entitlement is still to the greater of £3,600 or your relevant UK income. BUT you get hit with a later tax charge via self assessment if you use over the annual allowance.
New rules (April 2016) withdraw £1 of the annual allowance for every £2 you earn above £150k.
What is the money purchase annual allowance?
The MPAA is a lower allowance figure (£4k) which is enforced in certain circumstances for money purchase schemes.
What is the pension input period?
This is the period of time (roughly annual) over which total pension input is assessed against the annual allowance.
Before July 2015 this was quite flexible, the only requirement was that exactly one PIP needed to end in each tax year but each could be shorter or longer than 12 months.
Now PIPs simply line up with the tax year (transitional arrangements were in place up to April 2016).
What is total pension input?
In what circumstances are contributions ignored in a given year?
This is the amount that is assessed against the annual allowance (or MPAA) to determine extra tax due at the end of the tax year.
The amount is based on contributions or accrued benefits, relating to DC and DB schemes respectively.
Specific exclusions in both cases include any contributions or accrued benefit in either the tax year of death or tax year in which benefits are taken due to severe ill-health (i.e. terminal illness, less than 12 months to live).
Inclusions and Exclusions in total pension input relating to money purchase schemes.
For money purchase total pension input includes the gross amount of all contributions made, including individual and employer contributions and the HMRC 20% contribution under the relief at source method.
Excluded from this are any contributions after age 75 and any investment income or returns on the pension fund assets.
How is total pension input calculated for DB schemes (and cash balance schemes)?
This is a calculation based on the increase in your benefit over the year.
First multiply your benefit at the start of the year by 16 (and add any guaranteed additional cash sum).
Then increase this by the CPI factor from the September before the tax year (to take into consideration a “free” amount of annual growth).
Then multiply the benefit at the end of the year by 16 (plus lump sum) and look at the increase from the last sum.
Note: The lump sum is for a guaranteed cash amount on top of the annual benefit, not a PCLS which would be taken out of the annual benefit “pot”.
How are deferred members of DB schemes treated for total pension input purposes?
Usually treated as having no TPI for the year.
What were the previous annual allowance amounts?
- 2010/11: £255k
- 2011/12: £50k
- 2012/13: £50k
- 2013/14: £50k
- 2014/15: £40k
- 2015/16: Transitional tax year
- 2016/17: £40k
Annual allowance details during the transitional tax year (2015/16)
Date of transition
The year was split into two due to the budget on 9 July 2015, effectively being split into two tax years.
Pre-transitional tax year: 6 April 2015 - 8 July 2015
Post-transitional tax year: 9 July 2015 - 5 April 2016
The annual allowance in the pre-transitional tax year was £80k.
In the post-transitional tax year it was the lower of £40k and the unused allowance from the pre-transitional tax year.
Effectively this just means you were limited to £40k in the second part of the year and £80k for the whole of the tax year.
How does annual allowance tapering work?
The annual allowance is gradually reduced when somebodys adjusted income is over £150k. They lose £1 of allowance for every £2 above £150k.
Note that those with a threshold income of below £110k are exempt from this tapering.
What is net income for annual allowance purposes?
It is NOT income after tax.
Rather it is income from all sources (salary, property, interest, dividends, trusts, pensions, …) less allowable deductions.
The only allowable deductions you need to know about are net pay method pension contributions and professional fees (eg CII fees).
What is threshold income for annual allowance purposes?
For threshold income start with net income (from all sources) then:
- DEDUCT any gross relief at source pension contributions, excluding employer contributions (note net pay relief are already deducted within net income);
- ADD BACK any salary sacrifice agreed after 9 July 2015;
- DEDUCT lump-sum death benefits that were taxed as pension income.
What is adjusted income for annual allowance purposes?
To calculate adjusted income start with net income and:
- ADD any employer pension contributions;
- ADD BACK any net pay relief method pension contributions (which would have been deducted within net income);
- DEDUCT any lump sum death benefits received that were taxed as part of pension income.
What is the difference between threshold income and adjusted income for annual allowance purposes?
The major difference is pension contributions. Threshold income has all pension contributions deducted whilst adjusted income includes them all.
Also threshold income has salary sacrifice amounts (if agreed after 9 July 2015) added back.
Both of them have lump sum death benefits deducted.
What are the lump sum death benefits in relation to annual allowance?
These lump sum death benefits are paid from somebodys pension when they die. If they die over age 75 the lump sum goes to their beneficiary and is taked based on the recipients marginal rate.
These amounts are deducted from both threshold income and adjusted income for he purposes of the annual allowance taper calculation.
How does carry forward of annual allowance work?
What is the requirement to be able to do this?
You can carry forward unused allowance from the last 3 tax years.
JUST affects the annual allowance, not carrying foward relevant UK income etc.
Use up your current year allowance first, then go back and use unused allowance from 3 years ago, then 2 years, then last year.
The requirement is that you must have been a member of a registered pension scheme in a given year to carry forward your allowance. You DON’T have to have made a contribution, could be a deferred member, drawing benefits or just made no contributions to an existing scheme.
How to calculate the unused annual allowance you can carry forward from the transitional tax year.
For the first part of the year (pre-transitional tax year) calculate the unused allowance (£80k less what you contributed) and CAP it at £40k.
Then deduct whatever you contributed in the second part of the year (post-transitional tax year).
E.G. if you contributed £38k before 8 July 15 and £20k afterwards, your unused allowance in pre-trans was £42k, but cap this at £40k.
Then take off your post-trans conts of £20k and you get £20k to carry forward.
What is the MPAA?
When does it apply?
MPAA is the money purchase annual allowance and is £4k.
It is a more restrictive annual allowance limit which will only ever apply to people who have begun flexible drawdown of their money purchase pension.
It is triggered by certain events, applies from the following day and for all future tax years.
Trigger events for MPAA
- DRAWING FUNDS from their own flexi-access drawdown fund (NOT designating funds OR drawing funds from a d/s/n drawdown fund);
- Taking an UFPLS (NOT a PCLS);
- Take more than permitted max for capped drawdown (pre 6/4/15 fund);
- Receive a stand-alone lump sum where lump sum protection exceeds £375k;
- Receive a lifetime annuity payment where the annual rate can be decreased in other than permitted circumstances (i.e. flexible annuity)
- Receve a scheme pension from a money purchase pension fund where the fund is paying out to fewer than 11 members.
How are people in flexible drawdown before 6 Apr 2015 treated for MPAA?
They won’t have had a trigger event after 6 Apr 2015 potentially, but since they were already in flexible drawdown they are subject to MPAA.
Consideration of member vs dependant/nominee/successor for MPAA.
MPAA triggers are based on members taking drawdowns or UFPLS from their own scheme.
If they receive a payment from their descendants flexible drawdown it does not trigger MPAA.
Likewise if they are descendants and receive somebody else’s UFPLS it will not trigger MPAA.
How does the MPAA work in conjunction with the annual allowance?
What is the “alternative allowance”?
Contributions to money purchase schemes are limited to the £4k limit first.
Any money purchase contribution above this amount will generate a tax charge.
The remainder of the £40k annual allowance (subject to tapering) is available for DB schemes.
The £36k difference is referred to as the alternative allowance, i.e. the amount available for DB schemes. However you actually get more than £36k if the MPAA isn’t fully utilised.
How does carry forward work with MPAA?
There is no carry forward of MPAA, however annual allowance can still be carried forward for DB purposes even after MPAA has been triggered.
MPAA calculation during the year it is triggered
The MPAA is in place from the day after the trigger event.
This means that money purchase contributions before the trigger event contribute to the annual allowance and only contributions after the trigger event contribute to the MPAA.
How does tapering affect the MPAA?
The MPAA is not affected by tapering.
The annual allowance is still fully susceptible to tapering but up to £4k is effectively protected from tapering for money purchase contributions.
How is the tax charge on any excess contributions (due to annual allowance or MPAA) calculated?
What is the tax rate?
First calculate the excess contributions.
Compare money purchase contributions against MPAA. If they are over £4k you have your first excess and then assess the remaining DB “contribution” against the £36k remaining “alternative allowance” for a potential second excess.
If they’re under £4k simply compare all contributions (MP and DB) to the £40k annual allowance.
Remember to reduce the £36k/£40k amounts for tapering.
Now apply tax on the total excess contributions by adding on top of taxable income. Described as taxed at your marginal tax rate, but can be split across two tax bands if you are close to the band.
How is the annual allowance tax charge paid?
Usually you would pay the tax charge due to exceeding the annual allowance via self assessment (tax charge = excess over annual allowance * marginal tax rate).
However if the charge is below £2k you can elect for the pension scheme to pay it if they agree (and the input into their scheme is below the annual allowance).
For money purchase schemes they simply take this value out of your fund. For DB schemes they reduce your income benefit by the amount of the tax charge divided by the commutation rate (e.g. tax charge of £120 and commutation charge of 12:1 means your benefit is reduced by £10pa).
What is the history of the lifetime allowance?
- 2006/07: £1.5m
- 2007/08: £1.6m
- 2008/09: £1.65m
- 2009/10: £1.75m
- 2010/11 and 2011/12: £1.8m
- 2012/13 and 2013/14: £1.5m
- 2014/15 and 2015/16: £1.25m
- 2016/17 and 2017/18: £1m
- To be indexed annually from April 2018 onwards
When is the lifetime allowance assessed?
The lifetime allowance gets assessed when there is a benefit crystallisation event (BCE).
There are a series of such events, which basically amount to the member becoming entitled to a pension benefit for the first time (or at age 75).
How are multiple BCEs assessed against the lifetime allowance?
How does this affect availability of PCLS?
An individual may have multiple “sets” of benefits which may crystallise separately.
On each BCE the value of the benefits is assessed against the lifetime allowance less any previously crystalised benefits.
Available PCLS is 25% of the benefit crystalised amount, so max of £250k currently.
If you have previously crystallised £500k of benefits (for example) without taking a PCLS however, you will only be able to crystalise a further £500k of benefits and thus only have £125k of PCLS available in.
