Chapter 2 (10 Questions) Flashcards
Relevant UK earnings (4)
Employment income
Income from a trade, profession or vocation
Earned Income from patent rights
Earnings from overseas Crown employment, subject to UK tax.
Relevant UK individual
Under the age of 75
AND
Has relevant UK earnings chargeable to income tax for that year
OR
Is resident in the UK at some time during that year
OR
Was resident in the UK both:
* at some time during the five tax years immediately before the year in which the contribution was
made. Relief in such circumstances is subject to a maximum of £3,600 per tax year; and
* when they became a member of the pension scheme
OR
They or their spouse have earnings for the tax year from an overseas Crown employment subject to UK tax.
Maximum individual contribution that will receive tax relief
The greater of £3,600 or 100% of relevant UK earnings each year.
Pension contributions can be made on someone else’s behalf, e.g. a child or spouse. In this case the eligibility for tax relief is based on the holder of the pension, not the person making the contributions.
Pension contributions made on someone else’s behalf (tax relief)
e.g. a child or spouse. In this case the eligibility for tax relief is based on the holder of the pension, not the person making the contributions.
How tax relief is awarded
- the net pay method; or
- the relief at source method
Relief at source method
NET OF BRT - Contributions are paid net of basic rate tax.
UP THE TAX BANDS - With self-assessment, the additional relief is awarded by adding the gross amount of the contribution to the employee’s basic rate tax band and higher rate tax band.
PERSONAL AND STAKEHOLDER - Contributions to personal and stakeholder pensions (including group arrangements) receive tax relief via the relief at source method
Adjusted net income
Total income from all sources (i.e. salary, interest, dividends etc.) less certain deductions. One of the deductions that reduces an individual’s adjusted net income is the gross value of a personally made pension contribution.
Timing of tax relief – self-employed earnings
- A payment on account on 31 January during the current tax year (i.e. on 31 January 2025 for 2024/25)
o This is 50% of the previous year’s tax liability. - A second payment on account on 31 July following the end of the tax year (i.e. on 31 July 2025 for 2024/25)
o This is also 50% of the previous year’s tax liability. - A balancing payment on 31 January following the end of the tax year (i.e. on 31 January 2026 for 2024/25)
o This is the difference between the year’s total tax liability and the two payments on account already made.
The following year’s first payment on account is made at the same time. Any higher and/or additional rate tax relief in respect of personal/ stakeholder contributions made in the current tax year received with the balancing payment
Salary v. dividends
Dividends do not fall within the definition of relevant UK earnings.
Dividend earners may find the amount of tax relief available is restricted.
Salary sacrifice
Under salary sacrifice, the employee agrees to a reduction in salary and the employer pays a pension contribution on their behalf.
Both will pay reduced NICs and the savings can be put into the pension scheme.
To satisfy HMRC, there must be a written agreement in place before the salary is reduced
must not take earnings below the national minimum wage.
Usually such an arrangement is irrevocable, only if a ‘lifestyle change’.
salary sacrifice will reduce the salary for all purposes, such as death in service cover, borrowing capacity and social security benefits.
Recycling the pension commencement lump sum
the Government sees this as an abuse of the rules.
Therefore, HMRC treat the entire PCLS as an unauthorised payment if:
* The individual receives a PCLS which, when added to any other PCLS drawn in the previous twelve-month period, exceeds £7,500.
* The PCLS means that the pension contribution paid on behalf of the individual is significantly greater than it would otherwise be.
* The additional contributions are made by the individual or by someone else, such as an employer.
* The recycling was pre-planned.
Employer contributions
No restriction on how many schemes or to the amount they can contribute.
Paid gross and is allowable as a business expense.
The tax relief is available so long as it passes the ‘wholly and exclusively’ test.
Tax relief usually given in the accounting period in which the contribution is paid. However, this is not the case where a loss is created that can be carried back or where a large single contribution is made that is subject to spreading for tax relief purposes (i.e. it exceeds 210% of the contribution paid in the previous chargeable period and the excess is £500,000 or more).
Spreading of tax relief on employers contributions
Excess (Spread)
£500,000 – £999,999 (2 accounting periods)
£1,000,000 – £1,999,999 (3 accounting periods)
£2,000,000 or more (4 accounting periods)
Annual allowance and money purchase annual allowance
The annual allowance is the maximum amount of ‘benefit’ or ‘total pension input’ that can build up from contributions (or accrue) during each pension input period, without incurring a tax charge. It is tapered for those with a threshold income over £200,000 and an adjusted income over £260,000.
For the 2024/25 pension input period it is £60,000.
The MPAA is triggered when certain events occur and reduces an individual’s annual allowance to £10,000 (2024/25) for defined contribution savings.
Pension input periods (PIPs)
The period over which the amount of pension input is measured for the annual allowance test. It runs in line with the tax year, i.e. between 6 April and 5 April each year.
Total pension input
The total pension input is the amount of contribution (or accrual) that is tested against the annual allowance.
Defined contribution schemes (Total Pensions Input)
AMOUNT PAID BY MEMBER AND EMPLOYER
EXCLUDED IS INVESTMENT RETURNS/INCOME AND MEMBER CONTRIBUTION 75+
The following elements are included in the total pension input:
* Any relievable pension contribution paid by the member or paid by someone else on their behalf.
* Any contribution paid for the member by their employer. The following elements are not included:
* contributions paid by the individual or someone other than the employer beyond age 75;
* investment income or returns.
Defined benefit and cash balance schemes (total pension input)
For active members, the total pension input is defined as the increase in the capital value of the individual’s rights over the PIP.
This is calculated as follows:
1. The value of the member’s pension benefits at the beginning of the PIP is calculated. The opening pension input value is then multiplied by 16. The total value is then increased (or revalued) by the increase in the CPI using the annual rate of increase for the September before the start of the tax year.
2. The value of the member’s pension benefits at the end of the PIP is then calculated. This is also multiplied by 16.
3. The difference between the two figures is the total pension input, which is tested against the annual allowance.
A deferred member of a defined benefit scheme is usually treated as having no pension input for a tax year.
Other exclusions from total pension input
These are contributions and defined benefit accrual in the tax year:
* in which the member dies;
* in which benefits are taken due to the member’s severe ill-health.
Annual allowance
This is the maximum amount of total pension input that can build up from contributions (or by accrual) in each pension input period without incurring tax at the member’s marginal rate. For 2024/25 it is £60,000.
Tapering the annual allowance
In 2024/25, the tapered annual allowance affects those with:
* threshold income (excluding pension contributions) over £200,000; and
* adjusted income (including own and employer’s pension contribution) over £260,000.
The annual allowance is reduced by £1 for every £2 of adjusted income above £260,000, with a maximum reduction in 2024/25 of £50,000.
It is first necessary to establish gross income from all sources. Then the threshold income can be calculated:
* threshold income = gross taxable income – gross member contributions + income given up as salary exchange – taxed lump-sum death benefits received.
* Only if the threshold income exceeds £200,000 is it necessary to calculate the adjusted income:
* adjusted income = gross taxable income + employer’s contributions – taxed lump-sum death benefits.
The tapered annual allowance is aimed at additional rate tax payers, who gain the most from pensions tax relief.
Taxable pension death benefits
Certain lump-sum death benefits are taxed as pension income at the recipient’s marginal rate of income tax for PAYE purposes. Most commonly, these will be lump-sum death benefits received by them from a pension holder who died aged 75 or older.
A recipient may also receive a taxable lump-sum death benefit following the death of the pension holder before aged 75. This would occur where:
* uncrystallised funds on death and valued in excess of the member’s (LSDBA).
* beneficiaries entitled to a defined benefits lump-sum death benefit valued in excess of the member’s LSDBA (NB: this can only be paid as a lump sum).
* beneficiaries entitled to an annuity protection lump-sum death benefit or a pension protection lump sum benefit valued in excess of the member’s LSDBA and the member’s scheme pension or lifetime annuity rights crystallised on or after 6 April 2024.
* The pension holder’s beneficiaries choose to take a lump sum that is valued in excess of the member’s LSDBA from the member’s drawdown fund and the member’s funds were crystallised into drawdown on or after 6 April 2024.
In these cases the excess over the member’s LSDBA paid to the recipient as a lump sum is taxable.
Carry forward of unused annual allowance
To carry forward unused annual allowance from a previous year, the individual must have been a member of a registered pension scheme at some point in the earlier tax year, though no pension input needs to have taken place. Note also, that the level of the member’s relevant UK earnings in that year is not an issue.
It is possible to carry forward unused annual allowance from the previous three tax years.
Therefore, the three tax years that we need to consider for a carry forward exercise in 2024/25 are 2021/22, 2022/23 and 2023/24.
In 2024/25 it works as follows:
* the annual allowance for the current year must be used up first (2024/25); then
* any unused annual allowance from the earliest carry forward year (2021/22); then
* for 2023/24 the unused annual allowance is calculated by deducting the pension input for that year from £60,000 (or the tapered annual allowance); then
* for 2021/22 and 2022/23, the unused annual allowance is calculated by deducting the pension input from £40,000 (or the tapered annual allowance).
Where pension input in one or more of the previous three tax years was in excess of the annual allowance for that year, it will be necessary to look back a further three years from the year in question to see what unused relief was available.
In this case, contributions made over three years ago fall out of the equation for the current tax year, but may have been used as part of a carry forward exercise in a previous year.
Money purchase annual allowance (MPAA)
The money purchase annual allowance is triggered when someone flexibly accesses their defined contribution pension savings. It is a reduced annual allowance for defined contribution savings (£10,000 p.a. for 2024/25).
Triggering the money purchase annual allowance (MPAA) rules
The MPAA is triggered when the member:
* first draws funds from a flexi-access drawdown fund;
* takes an UFPLS;
* converts a capped drawdown fund to a flexi-access drawdown fund and takes a withdrawal;
* takes more than the permitted maximum from a capped drawdown fund;
* receives a stand-alone lump sum when have primary protection and the lump-sum protection was greater than £375,000 on 5 April 2006;
* receives a payment from a lifetime annuity where the payment can be decreased in other than permitted circumstances;
* receives a scheme pension direct from a defined contribution arrangement with fewer than eleven other members; or
* receives payment of any of these from an overseas pension scheme that has benefited from tax relief.
It is only triggered when the member takes one of these; it is not triggered when a dependant, nominee or successor takes a flexible payment.
The MPAA in practice
When a member accesses their benefits flexibly they become subject to the MPAA for all subsequent defined contribution input. If input into the defined contribution scheme exceeds the MPAA there is an annual allowance tax charge to pay.
Alternative annual allowance
Where a member has £10,000 annual allowance for defined contribution, the alternative annual allowance is a maximum of £50,000. However, if the member’s tapered annual allowance is at the minimum of £10,000, then the alternative annual allowance for 2024/25 is zero.
Note: Carry forward does not apply to the alternative annual allowance, nor does it apply to the MPAA. It is never possible to have an MPAA greater than £10,000.
In the first year that the MPAA applies, only pension input amounts for defined contribution arrangements that are made after the date of the trigger event are measured against it.
Annual allowance and money purchase annual allowance charge in practice
Usually paid via self-assessment tax return.
can be paid by the scheme administrator if, for that tax year, the liability exceeds £2,000 and the total amount of the member’s pension savings in the scheme exceeds the annual allowance (£60,000). an appropriate reduction is made to the member’s benefits.
The annual allowance charge is payable at the individual’s marginal rate(s) of income tax (i.e. 20%, 40% and/or 45%). The excess over the annual allowance is added to their taxable income to establish the rate(s) of income tax that apply.
Lump sum allowance and lump sum and death benefit allowance
Abolition of the lifetime allowance (LTA)
Be aware In a newsletter issued on 4 April 2024 HMRC advised that some clients may wish to delay taking their pension benefits or transferring pension benefits until incorrect legislation relating to the abolition of the LTA had been fixed. The areas affected are where a member:
* has scheme-specific tax-free cash protection;
* wishes to transfer and holds enhanced protection;
* has enhanced protection or primary protection with protected lump-sum rights of more than £375,000;
* has the payment of a lump-sum death benefit pending for funds which crystallised prior to 6 April 2024;
* wishes to transfer from a drawdown to a QROPS; or
* wishes to transfer pre-6 April 2006 benefits to a QROPS.
On 6 April 2006, when the single tax and regulatory regime came into force, the lifetime allowance (LTA) was introduced. The purpose of the LTA was to limit the amount of savings that could be built up in a tax-advantaged environment.
Lump sum allowance and lump sum and death benefit allowance
Abolition of the lifetime allowance (LTA) 2
On 6 April 2006, the lifetime allowance (LTA) was introduced to limit the amount of savings that could be built up in a tax-advantaged environment.
Before 2023/24, a LTA tax charge was payable if the LTA was breached. The LTA tax charge was at the rate of:
* 55% where the excess above the LTA was taken as a lump sum; and
* 25% where the excess was taken as income.
The LTA tax charge was reduced to 0% as of 6 April 2023, although scheme administrators were still required to calculate the percentage of the member’s LTA used for all benefit crystallisation events that occurred in 2023/24.
The LTA regime ended as of 6 April 2024. no longer any limit on level of income that can be paid from a member’s pension benefits (i.e. no additional tax charges are applied). However, limits apply to the level of tax-free lump sum benefits during the member’s lifetime and following their death.
governed by three new allowances:
* lump sum allowance (LSA);
* lump sum and death benefit allowance (LSDBA); and
* overseas transfer allowance.
Levels of the LTA since its inception
The lifetime allowance was the aggregate limit that applied to all pension savings, including benefits built up prior to 6 April 2006 (A-Day).
The levels of the LTA since its inception were as follows:
* £1.5 million in 2006/07;
* £1.6 million in 2007/08;
* £1.65 million in 2008/09;
* £1.75 million in 2009/10;
* £1.8 million in 2010/11 and 2011/12;
* £1.5 million in 2012/13 and 2013/14;
* £1.25 million in 2014/15 and 2015/16;
* £1 million in 2016/17 and 2017/18;
* £1,030,000 in 2018/19;
* £1,055,000 in 2019/20; and
* £1,073,100 in 2021/22, 2022/23 and 2023/24.
Benefit crystallisation events
Prior to 6 April 2024, the value of benefits from a registered pension scheme coming into payment, whether in full or in part, had to be tested against the LTA in force at that point.
Any event that triggered a test against the member’s lifetime allowance was called a benefit crystallisation event (BCE).
There were 13 BCEs.
BCE 1: Drawdown pension
The market value of the fund
BCE 2: Entitlement to a scheme pension
Scheme pension × 20.
BCE 3: Excessive increase to scheme pension in payment
The additional increase × 20
BCE 4: Purchase of a lifetime annui Uncrystallised funds: The market value of the fund used to purchase the lifetime annuity.
Funds previously crystallised into drawdown: The market value of the drawdown fund used to buy the lifetime annuity less the market value of the fund designated to drawdown at the outset.
BCE 5: Defined benefit test at age 75
Scheme pension × 20 plus the amount of the lump sum.
BCE 5A: Test at age 75 for drawdown pension
Market value of the member’s drawdown pension at age 75 less the market value of that designated for drawdown at the outset
BCE 5B: Test at age 75 for uncrystallised defined contribution funds
The amount of any remaining unused funds
BCE 5C: Unused uncrystallised funds designated for drawdown following the member’s death
The market value of the assets designated as available for drawdown.
BCE 6: Relevant lump sums
The amount of the lump sum
BCE 7: Relevant lump-sum death benefits
The amount of the lump-sum death benefit
BCE 8: Transfers overseas
The amount of the transfer value
BCE 9: Prescribed event
The amount prescribed in the regulations
Using the factors: Benefits started on or after A-Day
Where all benefits started on or after A-Day, it was necessary to calculate the percentage of the LTA that was utilised in respect of each previous BCE.
Using the factors: Benefits started before A-Day
A standard 25:1 valuation factor was used for pre-A-Day income benefits.
Where the pre-A-Day income was in the form of a lifetime annuity or scheme pension the calculation was very straightforward. For example, if an annuity was purchased, £10,000 of annuity income was valued at £250,000. The factor was applied to the annual payment in force when the first BCE on or after A-Day occurred.
The higher factor was justified by HMRC on the grounds that no account was taken of any PCLS drawn before A-Day, and it was assumed that cash was normally taken up to the available maximum.
Different rules applied in respect of income withdrawals under a drawdown pension that started before A-Day, based on the maximum income that could be paid from the drawdown fund, but still valued using a factor of 25.
Relevant benefit crystallisation events (RBCEs)
A RBCE occurs when an individual becomes entitled to:
* A relevant lump sum; these are payments made in the member’s lifetime.
* A relevant lump-sum death benefit; these are payments made after the member has died.
At each RBCE the scheme administrator will determine if the lump sum payment needs to be assessed against the member’s available LSA and/or LSDBA so as to establish how much of the lump sum can be paid tax free.
Where multiple RBCEs occur on the same day the scheme member can decide the order they are deemed to be paid in. After death, members personal reps decide.
BCE 5D: Unused uncrystallised funds used to purchase an annuity following the member’s death
The market value of the assets used to purchase the annuity.
Relevant lump sums
Relevant lump sum payments are lump sum payments made during the member’s lifetime.
The following lump sum payments are not RBCEs and so do not count towards the LSA or LSDBA:
* Small pots payments.
* Trivial commutation lump sums.
* Winding up lump sums.
Relevant lump-sum death benefits
Relevant lump-sum death benefits are lump-sum payments made following the member’s death.
The following lump-sum death benefit payments are not RBCEs and so do not count towards the member’s LSDBA.
* Any lump sum payment where the member dies after reaching the age of 75.
* Any lump-sum death benefit where the member dies before the age of 75, that is paid more than two years after the scheme administrator was made aware of, or could reasonably be expected to know of, the member’s death.
* Charity lump-sum death benefits paid where the member dies before age 75 as long as there are no surviving dependants and the member nominated the charity.
* Trivial commutation lump-sum death benefits.
* Lump-sum death benefits paid from funds that crystallised before 6 April 2024.
Lump sum allowance (LSA)
The LSA limits the amount of tax-free lump sums a member can receive during their lifetime.
The standard LSA for 2024/25 is £268,275. This is equal to the maximum PCLS under the previous LTA regime, i.e. 25% × £1,073,100. There are no provisions in the legislation for increasing this allowance in future tax years.
Where the member’s remaining LSA is insufficient to cover the tax-free element of any RBCE, the excess over their available LSA can be paid as a pension commencement excess lump sum (PCELS) if scheme rules permit. A PCELS is taxed as the member’s pension income via PAYE.
Members who have transitional LTA protections will have an increased LSA based on the transitional protection they hold.
Reduction to the LSA for benefits taken pre-6 April 2024
Where a member has taken benefits prior to 6 April 2024 their LSA will be reduced. There are three different ways of calculating the member’s LSA:
* Standard transitional basis.
* Pre-commencement pensions basis.
* Transitional tax-free amount basis.
Standard transitional basis LSA
This method of reducing the LSA is used where members:
* had benefits tested under the previous LTA regime; and
* do not hold a transitional tax-free amount certificate (TTFAC).
The deduction applied to their LSA is 25% of their LTA used as at 5 April 2024.
Pre-commencement basis LSA
This method of reducing the LSA is used for members who:
* first took benefits prior to 6 April 2006 (so, before the introduction of the LTA regime); and
* did not have a BCE under the LTA regime (i.e. between 6 April 2006 and 5 April 2024).
Where a RBCE then occurs on or after 6 April 2024, the LSA will need to be reduced.
Reductions to the LSA for post-6 April 2024 RBCEs.
The LSA is reduced initially to take account of any benefits taken prior to 6 April 2024. Thereafter it is reduced by the tax-free amount of any RBCEs that occur on or after 6 April 2024
Lump sum and death benefit allowance (LSDBA)
The LSDBA is the overall limit on the lump sums that can be paid tax free in respect of an individual each time there is a RBCE.
In respect of relevant lump-sum death benefits, the LSDBA limits the amount of death benefits that can be paid from the member’s pension benefits in the form of tax-free lump sums.
Where a relevant lump-sum death benefit is paid it triggers a test against a member’s LSDBA if:
* the member was under age 75 when they died; and
* in most cases, the payment is made within two years of the scheme administrator becoming aware of the death.
Any relevant lump sum or relevant lump-sum death benefit paid in excess of the member’s LSDBA is taxed at the member’s or, in the event of their death, their beneficiaries’ pension income via PAYE.
The standard LSDBA is £1,073,100. There is no provision within the new rules to increase this figure in future tax years.
Anyone who has crystallised benefits prior to 6 April 2024 may have a reduced LSDBA. If the individual had used 100% of their LTA prior to 6 April 2024 they will have no LSDBA remaining unless they meet the conditions for a transitional tax-free amount certificate (TTFAC).
Reduction to the LSDBA for benefits taken pre-6 April 2024
Where a member has previously taken benefits under the LTA regime, their LSDBA will be reduced. The reduction will be applied at the point of their first RBCE after 5 April 2024.
As with the LSA, there are three different ways of calculating the reduction:
* Standard transitional basis.
* Pre-commencement pensions basis.
* Transitional tax-free amount basis.
Standard transitional basis LSDBA
This method of reducing the LSDBA is for individuals who:
* had benefits tested under the previous LTA regime; and
* do not hold a transitional tax-free amount certificate.
Pre-commencement pensions basis LSDBA
This method of reducing the LSDBA is used for members who:
* first took benefits prior to 6 April 2006 (so, before the introduction of the LTA regime); and
* did not have a BCE between 6 April 2006 and 5 April 2024 (i.e. did not crystallise any benefits under the LTA regime).
Where a RBCE then occurs on or after 6 April 2024, the LSDBA will need to be reduced.
The deduction applied is 25% of the aggregate value of the member’s pension in payment immediately prior to the first RBCE that occurs on or after 6 April 2024.
Reductions to the LSDBA for post-6 April 2024 RBCEs
The LSDBA is reduced initially to take account of any benefits taken prior to 6 April 2024. Thereafter it is reduced by the tax-free amount of any RCBEs taken on or after 6 April 2024.
Entitlement to a higher LSA and/or LSDBA
Let us now consider each of these scenarios and the impact on the member’s LSA or LSDBA.
The member was not a UK resident
Where an individual is working abroad, they will not receive tax relief on contributions to, or the accrual of benefits under, a registered scheme. Any resulting lump sum payments may count as RBCEs and impact on an individual’s LSA and LSDBA.
To account for this, an individual’s LSA and LSDBA can be enhanced for such a period of overseas service after 5
April 2006. The enhancement is achieved by applying a non- residence factor that is used to adjust the LSA and LSDBA.
The member had transferred benefits in from recognised overseas pension schemes
Overseas benefits transferred into a UK registered scheme will be tested against the LSDBA in the usual way when relevant lump sums are paid.
However, where the transfer occurred before 6 April 2024, the member can normally claim an increased LSDBA from HMRC if the transfer is made from a recognised overseas pension scheme (ROPS). The enhancement to the person’s LSDBA, based on the amount transferred, is known as a recognised overseas scheme factor.
This enhancement factor does not provide any additional tax- free cash for the member, so the LSA is unaffected.
Pension sharing – impact on allowances
When a couple is divorcing, there are three methods of dealing with pension entitlements built up by the couple prior to their divorce. One of these methods is pension sharing, whereby an ex-spouse becomes entitled to a share of their former spouse’s pension fund:
* the entitlement received by the ex-spouse is a pension credit; and
* the loss in entitlement suffered by the member of the pension scheme is a pension debit.
Pension credits – receiving pension rights as a result of pension sharing.
Any relevant lump sums taken from the extra benefits an ex-spouse receives in respect of a pension credit will count towards the ex-spouse’s LSDBA and, in some circumstances, their LSA.
Any part of a pension credit that came from a pension already in payment is called a disqualifying pension credit. No tax-free cash can be paid from a disqualifying pension credit and so there is no increase to the ex-spouse’s LSA.
However, in some circumstances the ex-spouse can claim an enhancement to their LSDBA – but only where the pension credit was received before 6 April 2024.
The treatment of the pension credit for LSDBA purposes depends on whether the pension credit rights were acquired:
* before 6 April 2006; or
* between 6 April 2006 and 5 April 2024 (and, if so, whether or not the member was already receiving the pension).
Where the pension credit rights were acquired before 6 April 2006, it was possible to claim an increase to the LTA based on a pension sharing order made before 6 April 2006. However, the claim had to be made before 6 April 2009.
Pension debits – giving up pension rights as a result of pension sharing
A pension debit doesn’t usually affect the member’s LSA or LSDBA, but it can for some with transitional protection as we will see in Transitional reliefs on page 61.
There will be no adjustment to the amount of LSA and/or LSDBA that has already been used up by funds that were crystallised before any pension debit. This means that any relevant lump sums that have been paid will still reduce the member’s available LSA and LSDBA.
PCLS as an unauthorised payment
The individual receives a PCLS which, when added to any other PCLS drawn in the
previous twelve-month period, exceeds £7,500.
*
The PCLS means that the pension contribution paid on behalf of the individual is
significantly greater than it would otherwise be.
– A ‘significant increase’ is taken to be ‘more than 30% of the contributions that might
otherwise have been expected’ and the cumulative sum of extra contributions exceeds
30% of the PCLS.
*
The additional contributions are made by the individual or by someone else, such as
an employer.
*
The recycling was pre-planned.
disadvantages to salary sacrifice
salary is reduced for all purposes: this may reduce benefits such as death in
service cover;
– however, a notional salary may be used by the employer, to ensure that benefits are
not reduced;
* the reduction in salary may reduce the employee’s borrowing capacity for mortgages and
other loans;
– however, changes in the mortgage rules mean lenders will assess a borrower’s
affordability, rather than using a multiple of salary. Since take-home pay is unreduced
(or may even be slightly increased), the salary sacrifice arrangement is likely to have
little impact on the amount that can be borrowed for a mortgage; and
* the salary reduction may cause a reduction or even a loss of other social security
benefits, such as maternity benefits.
advantages of salary sacrifice
*
if the employee was already paying a pension contribution take-home pay is usually the
same or even slightly higher;
*
if salary sacrifice is being used because of a new pension scheme, the reduction in
take-home pay will be less than the amount of the gross pension contribution;
*
National Insurance savings made by the employer and the employee may be paid into
the pension arrangement to increase the contribution at no additional cost;
*
as salary is reduced, the employee’s entitlement to Working Tax Credits may increase;
*
for those on higher earnings, salary sacrifice may be used to reinstate some or all of the
personal allowance (where earnings are initially in excess of £100,000); and
*
those who earn more than £60,000 p.a. can use salary sacrifice to reduce their earnings
to below £60,000 so that the High Income Child Benefit tax charge is not payable.
‘wholly and exclusively’ rules
One is where the contribution is for a
controlling director, or close friend or relative of a controlling director. It is usually accepted
that employer pension contributions are paid ‘wholly and exclusively’ for the purposes of
trade if the remuneration package is comparable with that paid to unconnected employees,
performing duties of similar value. The remuneration package includes employer pension
contributions as well as salary, bonuses, benefits in kind and so on. However, dividends are
not taken into account as part of the overall remuneration package.
An employer’s contribution will be spread over a period of years for tax relief purposes if:
- it exceeds 210% of the contribution paid in the previous chargeable period; and
- the amount of the excess (defined as the amount paid over and above 110% of the
contribution paid in the previous chargeable period) is £500,000 or more.
defined benefit (and cash balance) schemes, the total pension input
is defined as the increase in the capital value of the individual’s rights over the PIP
- The value of the member’s pension benefits at the beginning of the PIP is calculated. This is known as the
opening pension input value
The opening pension input value is then multiplied by 16.
(Some schemes include a separate lump sum in addition to the pension. In this scenario, you first
calculate the value of the pension by multiplying the member’s pension rights by a factor 16. The lump
sum is then added to this value (without being multiplied by a factor of 16)).
The total value is then increased (or revalued) by the increase in the CPI using the annual rate of increase
for the September before the start of the tax year. For the 2024/25 PIP this will be based on the CPI figure
for September 2023. - The value of the member’s pension benefits at the end of the PIP is then calculated. This is known as the
closing pension input value.
This is also multiplied by 16.
As in stage 1, any separate lump-sum entitlement is added to the value of the pension (without being
multiplied by a factor of 16). - The difference between the two figures is the total pension input, which is tested against the annual
allowance. The value of any death benefits provided by the scheme is ignored.
Other exclusions from total pension input
- contributions and defined benefit accrual in the tax year in which the member dies; and
- contributions and defined benefit accrual in the tax year in which benefits are taken due
to the member’s severe ill-health (where expectation of life is less than twelve months).
Tapering the annual allowance
In 2024/25, the tapered annual allowance affects those who have:
* threshold income (excluding pension contributions) over £200,000; and
* adjusted income (which includes their own and their employer’s pension contributions)
over £260,000.
Where these rules apply, the annual allowance is reduced by £1 for every £2 of adjusted
income above £260,000. The maximum reduction in 2024/25 is £50,000, so everyone will
have an annual allowance of at least £10,000 for the 2024/25 tax year.
Tax year
Threshold income
Adjusted income
Minimum tapered annual allowance
2016/17 – 2019/20
£110,000
£150,000
£10,000
2020/21 – 2022/23
£200,000
£240,000
£4,000
2024/25
£200,000
£260,000
£10,000
Threshold income
Gross taxable income
LESS
Gross member contributions (paid via net pay or relief at source or paid by a third party but not by the employer)
PLUS
Income given up as a result of a salary exchange or flexible remuneration exercise entered into on or after 9 July 2015
LESS
Any taxed lump sum death benefits received
(If greater than £200,000 then calculate adjusted income If less than (or equal to) £200,000 no tapering required and no need to calculate adjusted income)
Adjusted income
Gross taxable income
PLUS
Any employer’s contributions
LESS
Any taxed lump sum death benefits
(If greater than £260,000 the annual allowance is tapered.
If less than (or equal to) £260,000, no tapering required)
Taxable pension death benefits
Certain lump-sum death benefits are taxed as pension income at the recipient’s marginal
rate of income tax for PAYE purposes. Most commonly, these will be lump-sum death
benefits received by them from a pension holder who died aged 75 or older.
A recipient may also receive a taxable lump-sum death benefit following the death of the
pension holder before aged 75. This would occur where:
* The pension holder held uncrystallised funds on the date of their death and these are
valued in excess of the member’s lump sum and death benefit allowance (LSDBA).
* The pension holder’s beneficiaries are entitled to a defined benefits lump-sum death
benefit that is valued in excess of the member’s LSDBA (NB: this can only be paid as a
lump sum).
* The pension holder’s beneficiaries are entitled to an annuity protection lump-sum death
benefit or a pension protection lump sum benefit that is valued in excess of the member’s
LSDBA and the member’s scheme pension or lifetime annuity rights crystallised on or
after 6 April 2024.
* The pension holder’s beneficiaries choose to take a lump sum that is valued in excess of
the member’s LSDBA from the member’s drawdown fund and the member’s funds were
crystallised into drawdown on or after 6 April 2024.
In these cases the excess over the member’s LSDBA paid to the recipient as a lump sum
is taxable.
Carry forward of unused annual allowance
The reductions in the annual allowance since its introduction have caused more people to be subject to the annual allowance tax charge. For example, a member of a defined benefit scheme who has been promoted with a large salary increase could easily have pension input in excess of the annual allowance. This could be seen as a one-off ‘spike’ in pension accrual and it would be rather unfair for this to be subject to the annual allowance charge.
To protect against such spikes in pension accrual it is possible to carry forward unused annual allowance from the previous three tax years.
To carry forward unused annual allowance from a previous year an individual must have been a member of a registered pension scheme at some point in the earlier tax year. The definition of a ‘member’ includes:
- an active member;
- a pensioner member;
- a deferred member; or
- a pension credit member.
Note: this rule does not necessarily mean that any pension input (i.e. contributions or benefit accrual) need to have taken place in the relevant tax year.
Money purchase annual allowance (MPAA)
The money purchase annual allowance (MPAA) rules are designed to work with the annual
allowance rules to ensure that individuals cannot abuse the pension flexibilities. Where
the MPAA rules are triggered the member will have a reduced annual allowance imposed
for defined contribution savings. For 2024/25 the MPAA is £10,000 p.a., as it was in
2015/16 and 2016/17. Between 2017/18 and 2022/23 the MPAA was £4,000 p.a. and it
was increased back up to £10,000 from 2023/24.
Remember that if a client has not flexibly accessed their defined contribution pension
savings there will be no need to worry about the MPAA and the normal annual allowance
rules will apply.
Triggering the money purchase annual allowance (MPAA) rules
Certain events trigger the money purchase annual allowance (MPAA) rules. Once the
MPAA has been triggered it applies from the following day and will continue to apply in
all subsequent tax years.
The events that trigger the MPAA rules are where the member:
* first draws funds from a flexi-access drawdown fund (including in the form of a
short-term annuity);
* takes an UFPLS;
* notifies the scheme administrator of their intention to convert a pre-6 April 2015
capped drawdown fund to a flexi-access drawdown fund and then subsequently takes
a withdrawal from that fund (including in the form of a short-term annuity);
* takes more than the permitted maximum for capped drawdown from a pre-6 April 2015
drawdown pension fund;
* receives a stand-alone lump sum when entitled to primary protection where the lump-sum
protection was greater than £375,000 on 5 April 2006;
* receives a payment from a lifetime annuity where the annual rate of payment can be
decreased in other than permitted circumstances (i.e. payment is received from a flexible
annuity contract as introduced by the Taxation of Pensions Act 2014);
* receives a scheme pension paid directly from the funds of a defined contribution
arrangement where the arrangement is providing scheme pensions paid directly from the
funds of the defined contribution scheme to fewer than eleven other members (including
any dependants’ benefits being paid) at the time the first payment is made; or
* payment of one of the types of benefit
MPAA, do not trigger it.
- receives a PCLS;
- receives a trivial commutation lump sum;
- receives a small pots lump sum;
- receives a payment from a scheme pension from a defined benefit arrangement;
- receives a payment from a scheme pension paid directly from the funds of a defined
contribution arrangement where at least eleven other people (including dependants) are
receiving a scheme pension paid directly from scheme funds; - receives a scheme pension secured by way of an annuity from a defined contribution
scheme of any size; - is in receipt of a lifetime annuity where payments cannot go down except in prescribed
circumstances; - takes no more than the permitted maximum from a pre-6 April 2015 capped drawdown
pension fund; and - receives a payment from a dependant’s (or nominee’s or successor’s) flexi-access
drawdown fund.
MPAA there is an annual allowance tax charge to pay.
Default chargeable amount
total pension input into both
defined benefit and defined contribution schemes
LESS
(the annual allowance for the current tax year* plus any carry forward available)
input into defined benefit schemes less (the alternative annual allowance* plus any carry forward available)
PLUS
(input into defined contribution schemes less the money purchase annual allowance available)
Abolition of the lifetime allowance (LTA)
Before 2023/24, a LTA tax charge was payable if the LTA was breached. The LTA tax charge was at the rate of:
- 55% where the excess above the LTA was taken as a lump sum; and
- 25% where the excess was taken as income.
The LTA tax charge was reduced to 0% as of 6 April 2023, although scheme administrators were still required to calculate the percentage of the member’s LTA used for all benefit crystallisation events that occurred in 2023/24.
The LTA regime ended as of 6 April 2024.
These limits are governed by three new allowances:
* lump sum allowance (LSA);
* lump sum and death benefit allowance (LSDBA); and
* overseas transfer allowance.
Form of drawdown when the
RBCE occurs
Form of drawdown when the RBCE occurs
Form of drawdown prior to 6 April
2015 Calculation
Capped drawdown
* Capped drawdown
25 × 80% of the maximum annual amount that can be paid
as a capped drawdown pension immediately prior to the first post-6 April 2024 RBCE
Flexi-access drawdown
* Capped drawdown (which was converted to flexi-access drawdown on or after 6 April 2015)
25 × 80% of the maximum annual amount of capped drawdown pension that could have been paid at the point the member’s drawdown pension fund became a flexi-access drawdown fund
