The Pension Annual Allowance Trap

The Pension Annual Allowance Trap

Latest HMRC figures show the annual allowance continues to help fill its depleted coffers.

Source: HMRC

The annual allowance is an important number in the pension world. It sets the maximum tax-efficient amount of total contributions in a tax year – from any source – that can be made to pension schemes for your benefit.

If the allowance is exceeded, then any tax relief you receive on the excess is effectively clawed back by the annual allowance charge. However, the tax status of the benefits bought with the unrelieved contributions remains unchanged, meaning potentially that 75% is taxable when withdrawn.

Until 2011, the annual allowance was set at a level that made it a somewhat academic topic – in 2010/11 it stood at £255,000. Then, in 2011/12, it was reduced to £50,000 – a cut of about 80%. The Chancellor’s aim was to lower the cost of tax relief at a time when the top rate of income tax was 50%.

Three years later, from 2014/15, there was another reduction, this time to £40,000. In 2016/17 the axe fell for a third time, but on this occasion, it was more a salami-slicing than a chop. The main allowance remained at £40,000, but it became subject to a taper that could bring it down to as little as £10,000 for high-income earners.

The effects of these changes are visible in the graph. In 2010/11, only 140 people reported a liability for the annual allowance charge on their tax returns. That jumped to 5,570 the following year and 18,870 in 2016/17.

At last count – three tax years ago – over 34,000 people were caught with total excess contributions of £817 million. The vast bulk of that excess would have been taxed at 40% or 45%, netting perhaps £350 million for the Treasury.

The Chancellor was forced to relax the rules for tapering in the 2020 Budget because potential tax bills were prompting NHS consultants and other senior public sector staff to take early retirement or limit their working hours. While the change should have reduced those paying the annual allowance charge in 2020/21, the problems it causes have not disappeared.

It remains wise to always take advice on contribution levels to ensure you don’t unwittingly breach the limits and present yourself with an unexpected tax charge.

We keep an eye on this at your portfolio reviews – let us know at your next one if you intend to make any additional contributions so we can run a check on the pension limits for you.

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Oaklands Wealth Management, founded by Helen Blackburn in 2004 advises clients around the Midlands on retirement planning, pensions & investments.

Her firm holds British Standard BS 8577 for client service & investment process.

Minimum investment is £500,000 (£650,000 for pension transfers).