How to boost a pension pot with unused annual allowances
The renewed enthusiasm for pensions created by the new benefit freedoms comes a warning that the Government are considering cutting back the reliefs on contributions and announcements could be made as early as the Autumn Statement at the end of November.
For this reason many individuals may be considering topping up their pensions under the current rules which are expected to remain in place until at least April 2016.
An individual is usually able to contribute up to their annual allowance in each tax year. The annual allowance is the limit of the total amount of contributions that can be paid to money purchase pension schemes and on which tax relief can be obtained.
The annual allowance is currently capped at £40,000 although a lower limit of £10,000 may apply if the individual has already commenced drawing a pension income. The annual allowance is the total of all contributions (both employer and individual) across all schemes of which the individual is a member. If the individual is also an active member of a defined benefit scheme the employer’s contribution is more difficult to calculate, although the scheme administrator will be able to advise.
Ordinarily if contributions exceed the annual allowance tax relief will not be granted and an annual allowance tax charge might apply. However, there are certain circumstances in which the contributions can exceed the annual allowance without penalties and this is known as “carry forward”.
The carry forward process allows an individual to make use of any unused annual allowances from the three previous tax years.
To qualify to use the carry forward rules an individual must first have been a member of a registered pension scheme in the year from which they wish to carry forward an allowance. Membership of a scheme is quite widely defined and can include being an active member where contributions have been paid, or where a scheme is dormant or even from a previous employment where benefits have been frozen or paid up.
Once a qualifying membership has been confirmed an individual is able to use unused allowances, starting with the first of the three previous years and moving forward each time a year’s allowance has been exhausted.
As an example, if a contribution in the current tax year of £90,000 was to be made the first £40,000 would use the current year’s annual allowance. The individual could then go back to use unused allowances from 2012/2013. In that year the annual allowance was £50,000, so if total contributions in that year had been only £15,000 then the unused £35,000 could be carried forward to the current tax year. This would then require the remaining £15,000 to be allocated against unused allowances from 2013/2014 where the annual allowance was £40,000, or if that years allowance had been fully used, to 2014/15.
It is important to remember that it is the contribution allowance that is being carried forward to the current tax year and therefore if personal contributions are being made they must be justified and within the individuals net relevant earnings for the current tax year. If individuals are looking to utilise employer contributions then their own earnings are not relevant but the contributions must be justifiable as genuine trading expenses.
Martin Tilley is director of technical services at Dentons Pension Management