The Annual Allowance (AA) is the amount by which the value of your pension benefits may increase in any one year without you having to pay a tax charge. This is in addition to any income tax you pay on your pension once it is in payment.
If the value of your pension savings in any one year (including pension savings outside of the LGPS) are in excess of the annual allowance limit, the excess will be taxed as income. The Government reduced the AA limit from £255,000 to £50,000 from 6 April 2011 and then reduced it again to £40,000 from 6 April 2014.
Further changes to the AA have been made for higher earners from 6 April 2016, which has resulted in special transitional rules for the 2015/16 tax year.
Pension Input Period: Annual Allowance
1 April 2011 to 31 March 2012: £50,000
1 April 2012 to 31 March 2013: £50,000
1 April 2013 to 31 March 2014: £50,000
1 April 2014 to 31 March 2015: £40,000
1 April 2015 to 5 April 2016: £80,000 (transitional rules apply)
6 April 2016 to 5 April 2021: £40,000 (unless tapering applies)
There is also a money purchase annual allowance (MPAA). Since 6 April 2017, if you flexibly access benefits under a money purchase arrangement, your MPAA will be £4,000. For more details on the MPAA, see the section below.
Am I likely to be affected by the Annual Allowance?
Most people will not be affected by the AA tax charge because the value of their pension saving will not increase in a year by more than £40,000, or, if it does they are likely to have unused allowance from previous years that can be carried forward.
You are most likely to be affected if:
- you have a lot of scheme membership and you receive a significant pay increase, and/or;
- you pay a high level of additional contributions, and/or;
- you are a higher earner, and/or;
- you transfer pension rights into the LGPS from a previous public sector pension scheme under the preferential club transfer rules and your salary (full time equivalent) upon joining the LGPS is somewhat higher than the salary you earned when you left the previous scheme, and/or;
- you combine a previous LGPS pension benefit that was built up in the final salary section of the LGPS with your current pension account and your salary (full time equivalent) has increased significantly since leaving and re-joining the scheme, and/or;
- you have accessed flexible benefits on or after 6 April 2015.
Your pension fund will inform you if your LGPS pension savings exceed the AA limit in any year by no later than 6 October of the following year.
How is the Annual Allowance calculated?
The increase in the value of your pension savings in the LGPS in a year is calculated by working out the value of your benefits immediately before the start of the ‘pension input period’, increasing the value by inflation and then comparing it with the value of your benefits at the end of the ‘pension input period’.
The ‘pension input period’ (PIP) is the period over which your pension growth is measured.
From 6 April 2016, PIPs for all pension schemes will be aligned with the tax year – 6 April to 5 April. Prior to the 2016/17 the PIP for the LGPS was 1 April to 31 March, except for the year 2015/16 when special transitional rules apply.
In the LGPS the value of your pension benefits is calculated by multiplying the amount of your annual pension by 16 and adding any lump sum you are automatically entitled to from the pension scheme plus any AVCs you or your employer has paid during the year.
If the difference in the value of pension benefits at the end of the PIP less the value of your pension benefits immediately before the start of PIP (adjusted for inflation), is more than the AA limit then you may be liable to pay a tax charge.
It is important to note that the assessment for the AA covers any pension benefits you may have where you have been an active member during the year, not just benefits in the LGPS. For example, if the increase in the value of your LGPS benefits was calculated as £30,000 in 2014/15 when the AA limit was £40,000, but you also had an increase in the value of other pension benefits of £15,000 in the same year, that would mean you had a total increase in pension benefits of £45,000. If you did not have any carry forward (see below for more information), you would be liable for a tax charge for the amount you exceeded the AA limit by, even though at face value you did not breach your AA limit in either scheme.
What is Carry Forward?
You would only be subject to an AA tax charge if the value of your total pension savings for a year increase by more than the AA limit for that year.
However, a three year carry forward rule allows you to carry forward unused AA from the previous three years. This means that even if the value of your pension savings increase by more than the AA limit in a year you may not be liable to the AA tax charge.
For example, if the value of your pension savings in 2014/15 increased by £50,000 (i.e. by £10,000 more than the AA limit), but in the three previous years had increased by £25,000, £28,000 and £30,000, then the amount by which each of these previous years fell short of the AA limit for those three years would more than offset the £10,000 excess pension saving in the current year. There would be no AA tax charge to pay in this case.
To carry forward unused AA from an earlier year you must have been a member of a tax registered pension scheme in that year.
Changes to Annual Allowance from 2016
The Finance (No 2) Act 2015 introduces two important changes to the AA with effect from 6 April 2016.
- An annual allowance taper for high earners from 6 April 2016
- To adjust the ‘pension input period’ during 2015/16 so that it becomes aligned with the tax year from 6 April 2016
Tapered Annual Allowance for higher earners
From the tax year 2016/17 the AA will be tapered for members who have a ‘Threshold Income’ in excess of £110,000, and ‘Adjusted Income’ in excess of £150,000. For every £2 that your Adjusted Income exceeds £150,000, your AA limit will be tapered down by £1 (to a minimum of £10,000).
Broadly your taxable income after the deduction of your pension contributions (including AVCs deducted under the net pay arrangement):
Broadly your threshold income plus pensions savings built up over the tax year:
Threshold income includes all sources of income that are taxable e.g. property income, savings income, dividend income, pension income, social security income (where taxable), state pension income etc.
Please note, you are not allowed to deduct from taxable income any amount of employment income given up for pension provision as a result of any salary sacrifice made on or after 9 July 2015.
How will the taper work?
From 6 April 2016, the taper will reduce the AA limit by £1 for £2 of adjusted income received over £150,000, until a minimum AA limit of £10,000 is reached. This means that from 6 April 2016 the AA for high earners will be as follows:
£150,000 or below
£210,000 or above
Aligning the ‘Pension Input Period’ with the tax year
The ‘pension input period’ (PIP) is the period over which your pension growth is measured. Up until 2014/15 the PIP in the LGPS ran from 1 April to 31 March. From 6 April 2016, PIPs for all pension schemes will be aligned with the tax year – 6 April to 5 April. Special transitional arrangements apply for 2015/16 meaning that there are 2 PIPs in 2015/16, as set out below:
Pre-alignment tax year: 1 April 2015 to 8 July 2015 - the revised AA limit during this period is £80,000
Post-alignment tax year: 9 July 2015 to 5 April 2016 - the AA limit for this period is the amount of the £80,000 not used up from the pre-alignment tax year (subject to a maximum of £40,000) together with any carry forward available from the three previous years.
If you have flexibly accessed any benefits in a money purchase pension arrangement on or after 6 April 2015 (see below) you should contact your pension fund for information about how the pre and post alignment tax years will work as it will be different to the above.
Money Purchase Annual Allowance and ‘Flexible Benefit’ access
If you have any benefits in a money purchase (defined contribution) pension arrangement which you have flexibly accessed on or after 6 April 2017 then the Money Purchase Annual Allowance (MPAA) rules may apply. However, the MPAA will only apply if your total contributions to a money purchase arrangement in a Pension Input Period exceed £4,000.
Generally, if your contributions to a money purchase scheme exceed £4,000 your defined benefit pension (LGPS) savings will be tested against a reduced AA and you will pay a tax charge in respect of your money purchase saving in excess of £4,000.
If you access flexible benefits your flexible access scheme will provide you with a flexible access statement; you should provide your LGPS pension fund with a copy of this statement.
Flexible access means taking a cash amount over the tax-free lump sum from a flexi access drawdown account, taking an uncrystallised funds pension lump sum (UFPLS), purchasing a flexible annuity, taking a scheme pension from a defined contribution scheme with fewer than 12 pensioner members or taking a stand-alone lump sum if you have primary but not enhanced protection.
How would I pay an Annual Allowance tax charge?
If you exceed the AA limit in any year you are responsible for reporting this to HMRC on your self-assessment tax return.
Your pension fund is obliged to notify you if your LGPS benefits (plus the amount of any Additional Voluntary Contributions (AVCs) you may have paid) exceed the AA limit in a year by no later than 6 October of the following tax year.
If you have an AA tax charge that is more than £2,000 and your pension savings in the LGPS alone have increased in the year by more than the AA limit you may be able to opt for the LGPS to pay some or all of the tax charge on your behalf. The tax charge would then be recovered from your pension benefits.
If you want the LGPS to pay some or all of an AA tax charge on your behalf, you must notify your pension fund no later than 31 July in the year following the end of the year to which the AA charge relates. However, the Leicestershire Pension Section suggests you notify them by the 30 November in the year following the breach, to avoid additional tax penalties that may be applied. However, if you are retiring (and draw all of your benefits from the LGPS) and you want the LGPS to pay some or all of the tax charge on your behalf from your benefits, you must tell your pension fund before you become entitled to those benefits.
This factsheet provides an overview of the AA rules and planned changes based on current understanding. It should not be treated as a complete and authoritative statement of the law. The rules governing AA can be complex and are subject to change; if you are unsure how to proceed you are advised to obtain independent financial advice. For help in choosing an independent financial advisor visit the Money Advice website