Types of pension schemes
There are two broad types of
pension schemes from which an
individual may eventually be in
receipt of a pension:
•
Workplace pension schemes
•
Personal Pension schemes.
A Workplace pension scheme may
either be a defined benefit scheme
or a money purchase scheme.
A defined benefit scheme pays a
retirement income related to the
amount of your earnings, while a
money purchase scheme instead
reflects the amount invested and
the underlying investment fund
performance.
The number of defined benefit
pension schemes has declined in
recent years in part due to the
regulations imposed upon the
schemes and the cost of such
schemes to the employer.
All employers will soon need to
provide a workplace pension scheme
due to auto-enrolment legislation
and these are likely to be money
purchase schemes.
A Personal Pension scheme is a
privately funded pension plan but
can also be funded by an employer.
These are also money purchase
schemes. Self-employed individuals
can have a Personal Pension.
We set out below the tax reliefs
available to members of a money
purchase Workplace scheme or a
Personal Pension scheme.
It is important that professional
advice is sought on pension issues
relevant to your personal
circumstances.
What are the tax breaks and
controls on the tax breaks?
To benefit from tax privileges
all pension schemes must be
registered with HMRC. For a
Personal Pension scheme,
registration will be organised by
the pension provider.
A money purchase scheme allows
the member to obtain tax relief on
contributions into the scheme and
tax free growth of the fund. If an
employer contributes into the
scheme on behalf of an employee,
there is, generally no tax charge
on the member and the employer
will obtain a deduction from their
taxable profits.
When the ‘new’ pension regime was
introduced from 6 April 2006 no
limits were set on either the
maximum amount which could be
invested in a pension scheme in a
year or on the total value within
pension funds. However two
controls were put in place in 2006
to control the amount of tax
relief which was available to the
member and the tax free growth in
the fund.
Firstly, a lifetime limit was
established which set the maximum
figure for tax-relieved savings in
the fund(s) and has to be
considered when key events happen
such as when a pension is taken for the first time.
Secondly, an annual allowance
sets the maximum amount which can
be invested with tax relief into a
pension fund. The allowance
applies to the combined
contributions of an employee and
employer. Amounts in excess of
this allowance trigger a
charge.
There are other longer
established restrictions on
contributions from members of
money purchase schemes (see
below).
Key features of money purchase
pensions
•
Contributions are invested for
long-term growth up to the
selected retirement age.
•
At retirement which may be any
time from the age of 55 the
accumulated fund is generally
turned into retirement benefits
– an income and a tax-free
lump sum.
•
Personal contributions are
payable net of basic rate tax
relief, leaving the provider to
claim the tax back from
HMRC.
•
Higher and additional rate relief
is given as a reduction in the
taxpayer’s tax bill. This is
normally dealt with by claiming
tax relief through the self
assessment system.
•
Employer contributions are
payable gross direct to the
pension provider.
Persons eligible
All UK residents may have a money
purchase pension. This includes
non-taxpayers such as children and
non-earning adults. However, they
will only be entitled to tax
relief on gross contributions of
up to £3,600 per annum.
Relief for individuals’
contributions
An individual is entitled to make
contributions and receive tax
relief on the higher of £3,600 or
100% of earnings in any given tax
year. However tax relief will
generally be restricted for
contributions in excess of the
annual allowance.
Methods of giving tax
relief
Tax relief on contributions are
given at the individual’s marginal
rate of tax.
An individual may obtain tax
relief on contributions made to a
money purchase scheme in one of
two ways:
•
a net of basic rate tax
contribution is paid by the member
with higher rate relief claimed
through the self assessment
system
•
a net of basic rate tax
contribution is paid by an
employer to the scheme. The
contribution is deducted from net
pay of the employee. Higher rate
relief is claimed through the self
assessment system.
In both cases the basic rate is
claimed back from HMRC by the
pension provider.
A more effective route for an
employee may be to enter a salary
sacrifice arrangement with an
employer. The employer will make a
gross contribution to the pension
provider and the employee’s gross
salary is reduced. This will give
the employer full income tax
relief (by reducing PAYE) but also
reducing National Insurance
Contributions.
There are special rules if
contributions are made to a
retirement annuity contract.
(These are old schemes started
before the introduction of
personal pensions.)
The annual allowance
For 2017/18 onwards the annual
allowance is £40,000.
Any contributions in excess of
the £40,000 annual allowance are
potentially charged to tax on the
individual as their top slice of
income. Contributions include
contributions made by an
employer.
The stated purpose of the
charging regime is to discourage
pension saving in tax registered
pensions beyond the annual
allowance. Most individuals and
employers actively seek to reduce
pension saving below the annual
allowance, rather than fall within
the charging regime.
Individuals who are eligible to
take amounts out of their pension
funds under the flexibilities
introduced from 6 April 2015 but
who continue to make contributions
into their schemes may trigger
other restrictions in the
available annual allowance. This
is explained later in this
factsheet in ‘Money Purchase
Annual Allowance’.
Lower annual allowance for those
with ‘adjusted annual incomes’
over £150,000
From April 2016 a taper has been
introduced which restricts the
annual allowance available for
those with ‘adjusted annual
incomes’ over £150,000. Adjusted
income means, broadly, a person’s
net income and pension
contributions made by an employer.
For every £2 of adjusted income
over £150,000, an individual’s
annual allowance will be reduced
by £1, down to a minimum of
£10,000.
The rate of charge if annual
allowance is exceeded
The charge is levied on the
excess above the annual allowance
at the appropriate rate in respect
of the total pension savings.
There is no blanket exemption from
this charge in the year that
benefits are taken. There are,
however, exemptions from the
charge in the case of serious ill
health as well as death.
The appropriate rate will broadly
be the top rate of income tax that
you pay on your income.
Example
Anthony, who is employed,
has taxable income of
£120,000 in 2018/19. He
makes personal pension
contributions of £50,000
net in March 2019. He has
made similar contributions
in the previous three tax
years.
He will be entitled to a
maximum £40,000 annual
allowance for 2018/19. The
charge will be:
|
Gross pension
contribution
|
£62,500
|
|
Less annual
allowance
|
(£40,000)
|
|
Excess
|
£22,500 taxable
at 40% =
£9,000
|
Anthony will have had tax
relief on his pension
contributions of £25,000
(£62,500 x 40%) and now
effectively has £9,000
clawed back. The tax
adjustments will be made
as part of the self
assessment tax return
process.
|
Carry forward of unused annual
allowance
To allow for individuals who may
have a significant amount of
pension savings in a tax year but
smaller amounts in other tax
years, a carry forward of unused
annual allowance is
available.
The carry forward rules apply if
the individual’s pension
savings exceed the annual
allowance for the tax year. The
annual allowance for the current
tax year is used before any unused
allowance brought forward. The
earliest year unused allowance is
then used before a later
year.
Example
Assume it is March 2019.
Bob is a self employed
builder. In the previous
three years Bob has made
contributions of £30,000,
£10,000 and £30,000 to his
pension scheme. As he has
not used all of the
£40,000 annual allowance
in earlier years, he has
£50,000 unused annual
allowance that he can
carry forward to
2018/19.
Together with his current
year annual allowance of
£40,000, this means that
Bob can make a
contribution of £90,000 in
2018/19 without having to
pay any extra tax
charge.
|
Unused annual allowance carried
forward is the amount by which the
annual allowance for that tax year
exceeded the total pension savings
for that tax year.
This effectively means that the
unused annual allowance of up to
£40,000 can be carried forward for
the next three years. Importantly
no carry forward is available in
relation to a tax year preceding
the current year unless the
individual was a member of a
registered pension scheme at some
time during that tax year.
The lifetime limit
The lifetime limit sets the
maximum figure for tax-relieved
savings in the fund at £1,030,000
for 2018/19, increasing to
£1,055,000 for
2019/20.
If the value of the scheme(s)
exceeds the limit when benefits
are drawn there is a tax charge of
55% of the excess if taken as a
lump sum and 25% if taken as a
pension.
Accessing your pension –
freedom
Individuals have flexibility to
choose how to access their pension
funds from the age of 55. The
options include:
•
a tax free lump sum of 25% of
fund value
•
purchase of an annuity with the
remaining fund, or
•
income drawdown (see below for
options available regarding flexi
access accounts and lump sum
payments).
An annuity is taxable income in
the year of receipt. Similarly any
monies received from the income
drawdown fund are taxable income
in the year of receipt.
Flexi access accounts and lump
sums
Where a lump sum and annuity are
not taken access to the fund can
be achieved in one of two
ways:
•
allocation of a pension fund (or
part of a pension fund) into a
‘flexi-access drawdown
account’ from which any
amount can be taken over whatever
period the person decides
•
taking a single or series of lump
sums from a pension fund (known as
an ‘uncrystallised funds
pension lump sum’).
When an allocation of funds into
a flexi-access account is made the
member typically will take the
opportunity of taking a tax free
lump sum from the fund.
The person will then decide how
much or how little to take from
the flexi-access account. Any
amounts that are taken will count
as taxable income in the year of
receipt.
Access to some or all of a
pension fund without first
allocating to a flexi-access
account can be achieved by taking
an uncrystallised funds pension
lump sum.
The tax effect will be:
•
25% is tax free
•
the remainder is taxable as
income.
Money Purchase Annual Allowance
(MPAA)
The government is alive to the
possibility of people taking
advantage of the flexibilities by
‘recycling’ their
earned income into pensions and
then immediately taking out
amounts from their pension funds.
Without further controls being put
into place an individual would
obtain tax relief on the pension
contributions but only be taxed on
75% of the funds immediately
withdrawn.
The MPAA sets the maximum amount
of tax efficient contributions in
certain scenarios. The allowance
is currently set at £4,000 per
annum.
There is no carry forward of any
of the annual allowance to a later
year if it is not used in the
year.
The main scenarios in which the
reduced annual allowance is
triggered are if:
•
any income is taken from a
flexi-access drawdown account,
or
•
an uncrystallised funds pension
lump sum is received.
However just taking a tax-free
lump sum when funds are
transferred into a flexi-access
account will not trigger the MPAA
rule.
How we can help
This information sheet provides
general information on the making
of pension provision. Please
contact us for more detailed
advice if you are interested in
making provision for a
pension.
