TAPERED AND MONEY PURCHASE ANNUAL ALLOWANCES:

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1 TECHTALK This article originally appeared in JAN 18 edition of techtalk. Please visit for the latest issue. TAPERED AND MONEY PURCHASE ANNUAL ALLOWANCES: POST-BUDGET PLANNING OPPORTUNITIES There were no annual allowance changes in the Budget, but the tapered and money purchase annual allowances continue to affect pension planning. BERNADETTE LEWIS Bernadette joined the group in She has over 35 years experience in Financial Services with both intermediaries and providers. She has broad and deep technical experience across pensions, protection, tax and trusts. There were no annual allowance announcements in the Autumn 2017 Budget, but recent changes continue to affect pension planning. We summarise the main tapered annual allowance (TAA) and money purchase annual allowance (MPAA) rules. And consider some planning opportunities. ANNUAL ALLOWANCE LIMITS 2017/2018 & 2018/2019 Standard annual allowance: 40,000 TAPERED ANNUAL ALLOWANCE The TAA was introduced in 2016/2017. Carry forward is available, but carry forward from any tax years where the TAA applies is restricted to any unused TAA. Along with earnings increases, it s becoming more likely that affected clients will face annual allowance charges in 2017/2018 and 2018/2019, having already used up any carry forward. The TAA applies if: adjusted income is more than 150,000 and threshold income is more than 110,000. Tapered annual allowance: Money purchase annual allowance: 10,000 to 40,000 depending on adjusted income 4,000 If someone exceeds both limits, the 40,000 annual allowance reduces by 1 for every 2 of adjusted income over 150,000, to a minimum of 10,000 once adjusted income is 210,000 or more.

2 The MPAA was introduced in 2015/2016 at 10,000. It reduced to 4,000 with effect from 6th April ADJUSTED INCOME (KEY ELEMENTS) net taxable earnings including bonuses, benefits in kind etc* net taxable self-employed profits* other taxable income such as pensions, rent, interest, dividends* gross member contributions benefitting from net pay tax relief / relief on making a claim employer pension contributions for defined benefit schemes, the pension input amount minus employee contributions. THRESHOLD INCOME net taxable earnings, net taxable self-employed profits, other taxable income* add back any new salary sacrifice arranged in connection with pension contributions after 8th July 2015 deduct gross member contributions benefitting from tax relief at source. * Total of all components of net income at step 2 in the section 23 Income Tax Act 2007 calculation. For money purchase schemes, pension input from 2016/2017 onwards is the total of all contributions paid during the same tax year. For defined benefit (DB) schemes it s safest to obtain a pension savings statement from the administrator, but there can be significant delays. If it s necessary to rely on an estimate, clients should explain this on their self-assessment tax return. TAA CARRY FORWARD PLANNING OPPORTUNITY Some clients with adjusted income over 150,000 will still find that using carry forward to make a relief at source member contribution reduces their threshold income below 110,000 and takes them out of scope for the TAA. Sidonie s caught by the TAA for the first time in 2017/2018. Before any planning, her salary, adjusted and threshold income are all 180,000, making her TAA 25,000. However, she has 52,000 of carry forward available and makes a relief at source member pension contribution of 70,000 gross. This reduces her threshold income to 110,000. Sidonie benefits from the full 40,000 annual allowance for 2017/2018 and uses just 30,000 of carry forward. MONEY PURCHASE ANNUAL ALLOWANCE The MPAA was introduced in 2015/2016 at 10,000. It reduced to 4,000 with effect from 6th April 2017 as confirmed by Finance (No 2) Act The 4,000 limit applies to anyone who s already triggered the MPAA or who does so in future. The June 2017 General Election delayed the legislation implementing the reduction, which might have caught out some clients. MPAA TRIGGERS Usefully, setting up flexi-access drawdown and taking just the associated tax-free cash won t automatically trigger the MPAA. Nor will using the small pots rules. If someone does trigger the MPAA, their provider must notify them. The MPAA triggers are: taking an uncrystallised funds pension lump sum (UFPLS) taking income from member flexi-access drawdown converting member capped drawdown to flexi-access drawdown and taking income using member flexible drawdown before 6th April 2015 receiving income from a post-pension freedoms flexible annuity receiving income from a scheme pension set up from 6th April 2015 where the scheme has fewer than 12 members receiving some payments from overseas pension schemes receiving some stand-alone lump sums. Clients who were in flexible drawdown on 5th April 2015 automatically triggered the MPAA on 6th April Otherwise, the MPAA takes effect the day after a trigger event. It then applies to all their money purchase pensions for the rest of that tax year, and for every subsequent tax year. Once someone s triggered the MPAA, they face a tax charge if subsequent employer, member and/or third party contributions to all their money purchase pensions total more than 4,000 in a tax year. In addition, they can t use carry forward in respect of any money purchase pensions.

3 River is a member of a group personal pension (GPP) with an employer only contribution of 600 paid on the 15th monthly. He s a higher rate taxpayer, isn t affected by the TAA and has plenty of lifetime allowance headroom. River took a UFPLS on 1st August 2017 from an old money purchase scheme. He discovered his employer offered no cash alternative to pension contributions only after triggering the MPAA. River let the contributions continue. In addition to something being better than nothing, his pension fund grows free from tax, provides 25% tax free cash, and falls outside his inheritance tax (IHT) estate. River s pension input of 7,200 for 2017/2018 is within the standard 40,000 annual allowance. However, he triggered the MPAA on 2nd August His employer will pay 8 x 600 contributions between 15th August 2017 and 15th March 2018 totalling 4,800. That creates an excess of 800 over the 4,000 MPAA. River s liable for a 40% annual allowance charge of 320 for 2017/2018. So his net benefit from this year s employer contributions is 6,880. If his circumstances remain the same in 2018/2019, the excess of over the MPAA will be 3,200, generating a 1,280 annual allowance charge.

4 MPAA AND DB ACCRUAL Because the MPAA only applies to money purchase schemes, the normal annual allowance or TAA rules apply to any DB pension accrual. The member can also use carry forward in respect of their DB accrual. Dual active membership of money purchase and DB schemes is relatively unusual, but if required, see HMRC s Pension Tax Manual starting at PTM ANNUAL ALLOWANCE CHARGE A client faces an annual allowance charge if: the pension input amount for the tax year exceeds the standard annual allowance plus available carry forward the pension input amount for the tax year exceeds their personal TAA plus their available carry forward money purchase pension contributions that must be tested against the MPAA exceed 4,000 a client exceeds both the MPAA and either the standard annual allowance or the TAA (see HMRC s Pension Tax Manual starting at PTM056510). The annual allowance charge is at the taxpayer s marginal rate of income tax, making the excess contributions effectively non-tax relievable. The taxpayer declares their liability to the charge on their selfassessment tax return. Scheme pays might be an option, but it s only obligatory for a scheme if contributions to it exceed the standard annual allowance and the charge exceeds 2,000. TAA, MPAA AND AUTOMATIC ENROLMENT The fact that an employee is caught by the TAA or the MPAA doesn t change their employer s automatic enrolment duties. Contributions to automatic enrolment schemes established on a qualifying earnings basis should fall within these restricted annual allowances. However, many employers offer more generous contributions, certifying the scheme on a set 1, 2 or 3 basis. If automatic enrolment contributions cause an employee to exceed the TAA or MPAA, they can make their own choice to opt out, cease active membership, or possibly reduce their contributions below the scheme s automatic enrolment minimum. If so, they normally join the three-year automatic re-enrolment pool. However, some employers may be willing to switch affected employees to a qualifying earnings basis, or apply an entitlement check. To pass an entitlement check, the overall and employer contributions must be least as good as those required on a qualifying earnings basis. Ceasing active membership or opting out normally means the employee loses the benefit of an employer contribution. Their employer might agree to use its saving to pay additional salary plus the associated employer national insurance (NI) contributions. Hassan earns 275,000 a year, has a 10,000 TAA and used up all his carry forward in 2016/2017. His employer contributes 8% of earnings 22,000 a year to a GPP. Hassan s facing an annual allowance charge on the 12,000 excess in 2017/2018. Scheme pays isn t available. With a 22,000 pension contribution, there d be a 45% annual allowance charge on the 12,000 excess over the TAA. 12,000 would be invested in Hassan s pension and he d be liable for a 45% annual allowance charge of 5,400 payable via self-assessment. Ignoring investment growth and assuming the whole 12,000 falls within the lifetime allowance, Hassan might take 3,000 tax free cash from age 55 plus 9,000 taxable income. If he s still an additional rate taxpayer, he d pay a further 4,050 income tax. So the total tax on the excess contribution could be 9,450 giving a net effective benefit of 2,550. If the employer agrees to reduce Hassan s pension contribution to 10,000, it could use the remaining 12,000 to increase his salary by 10, after allowing for employer NI of 1, Hassan would pay tax at 45% and employee NI at 2%. The effective net benefit could be 5, The TAA or the MPAA doesn t change their employer s automatic enrolment duties.

5 HIGHER EARNERS FUNDING A SPOUSE OR COHABITEE S PENSION Tighter annual allowances plus lifetime allowance restrictions might make funding spouses, civil partners and cohabitees pensions more attractive. As these are third party contributions, the member benefits from tax relief of up to the greater of 100% of their relevant UK earnings or 3,600. Third party contributions are gifts for IHT purposes, but the interspouse or 3,000 annual exemptions are often available. HMRC can treat non-exempt third-party contributions paid directly to providers as chargeable lifetime transfers. Where this is a risk, gifting cash so the member can pay their own contributions creates potentially exempt transfers. For the over 55s, it s possible to make a money purchase pension contribution and immediately withdraw a higher amount. The MPAA reduction made this less attractive as a remuneration strategy. However, it can still work for third party contributions. Diana is 66. Her only taxable income in 2017/2018 is 6,360 basic state pension, so she has no relevant UK earnings. Her wife, Ingrid, has 33,000 taxable income and makes a 2,880 net pension contribution on Diana s behalf an exempt IHT transfer which the provider grosses up to 3,600. Diana can withdraw the whole fund immediately, taking 25% tax free, with the rest taxable: State pension: 6,360 Pension fund withdrawn (net of tax free cash): 2,700 Total taxable income: 9,060 The 2017/2018 personal allowance is 11,500, so Diana doesn t pay any tax. It also leaves her enough unused personal allowance to transfer 1,150 to Ingrid (a basic rate taxpayer) under the marriage allowance provisions. The contribution costs Ingrid 2,880 and creates an immediate 3,600 benefit for Diana. Similar planning can also work for the under 55s. Min is 45, with a 310,000 salary and significant money purchase pension savings. He s been advised to limit his own plus employer contributions to 10,000 for 2017/2018, given the 1 million lifetime allowance and the TAA. His cohabitee Louisa is 46. She works part-time earning 15,000 a year and pays 300 gross/ 240 net a year into an automatic enrolment GPP. Min gifts 11,760 cash to Louisa to ensure it s treated as a potentially exempt transfer. She makes a pension contribution, which the provider grosses up to 14,700, her maximum tax relievable amount. As Louisa is under 55, she can t draw on her pension fund yet, but Min can continue to help her top up her contributions to 100% of her relevant UK earnings each year. From age 55, even if Louisa s still working, she could draw the whole fund, taking 25% tax free cash with the rest taxable. This triggers the MPAA, restricting any future contributions. Alternatively, once she s retired she may be able to take withdrawals within her personal allowance, providing an ongoing tax free income. Note: Scottish resident taxpayers will have their own income tax rates and bands from 2018/2019 which may affect the tax outcomes in our examples. Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change. However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given. Scottish Widows Limited. Registered in England and Wales No Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number