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).
