Guidance on eight key areas you can share with clients prior to completing their self assessment tax returns.
Types of pension (1) The basic state pension is currently available to most UK individuals when they reach state pension age. The basic state pension depends on the number of years an individual has paid National Insurance or got National Insurance credits, eg while unemployed or claiming certain benefits. In order to receive the full basic state pension, an individual needs 30 years’ worth of National Insurance contributions or credits. See further guidance with regard to National Insurance contributions and the state pension.
Don’t forget that the State Pension Top Up is available until April 2017. It is for individuals who have already reached state pension age, or are reaching state pension age before 6 April 2016. They can secure an index-linked top up, increasing the weekly state pension for life by paying a lump-sum contribution.
Personal pension schemes provide a retirement fund for individuals, whether they are employees or self-employed. They are offered by financial organisations such as banks or insurance companies.
Occupational pension schemes are provided by employers to their employees. Where a pension scheme is registered with HMRC, there are tax advantages for the individual and the employer, where the employer also contributes to the scheme. Starting from 1 October 2012, a new requirement was introduced upon employers to provide eligible employees with automatic enrolment with a workplace pension plan. Further guidance on auto enrolment is available here.
Type of pension schemes (2) Money purchase schemes With a money purchase scheme, the money invested by an individual is used to purchase units in the fund, and the value of those units is dependent on the underlying investments made by the fund manager. There is no guarantee of pension benefits.
Defined contribution schemes With a defined contribution scheme, the benefits that an employee can take from the scheme are based on the employee’s salary and length of service.
Maximum contribution and ‘relevant earnings’ (3) Anybody (under the age of 75) can pay up to £3,600 per year into a pension scheme, regardless of the level of his earnings. The maximum contribution which can be made to a pension fund in any one tax year is 100% of an individual’s ‘relevant earnings’ for that year. ‘Relevant earnings’ include employment income (including benefits), trading income, furnished holiday lettings and patent income in relation to inventions.
Tax relief for pension contributions (4) Relief at source Applies to payments made into a pension scheme that are net of 20% basic rate tax. So, if an individual pays £800 into a pension scheme, HMRC will contribute £200 to bring the total contribution to £1,000. In contrast to Net Pay, contributions paid under Relief at Source do not reduce the individual's earnings before tax is calculated. The individual's earnings will be subject to deduction of tax in full.
If the individual is a higher rate taxpayer, extra tax relief is given by extending the basic rate band by the gross amount of the pension contribution. So, the new basic rate limit would be the current basic rate limit plus pension contribution times 100 divided by 80.
Net pay arrangements Applies to contributions to occupational pension schemes. Employees making contributions to an employer pension scheme will obtain tax relief via a net pay arrangement. Effectively, pay as you earn tax will be payable in respect of the gross pay less employee’s pension contribution. An employer’s contribution to an employee’s pension scheme is a tax-free benefit. However, if an employer pays pension contributions into the registered pension scheme of an employee’s family member, those contributions are a taxable benefit.
Annual allowance (5) The annual allowance represents the maximum amount of pension savings that can benefit from tax relief each year. It applies to both money purchase and defined contribution pension schemes, and it takes into account both the employee’s and employer’s pension contributions in the tax year.
The annual allowance for 2015/16 is £40,000. Any unused annual allowance can be carried forward and used to increase the annual allowance for that year by the unused annual allowance of the previous three tax years. Any unused annual allowance from previous years is utilised on a first in-first out basis. HMRC pension annual allowance calculator can be accessed here. The government have issued a consultation document Reducing the money purchase annual allowance
Unused annual allowance can be carried forward from a tax year only if the individual was a member of a registered pension scheme in that year, even if no contributions were made in that year.
Annual allowance charge (6) Annual allowance charge is the tax charged on the amount above the annual allowance. The rate of tax depends on the level of an individual’s taxable income and whether the excess contribution falls below the basic rate or higher rate band.
If the amount of the tax charge exceeds £2,000, an election can be made by 31 July following the anniversary of the end of the tax year to have the charge paid from the pension scheme.
There are three other situations where part or all of an individual’s pension savings will not be liable to the annual allowance charge for the tax year. These are: if the member dies, retires due to severe ill-health, or is a deferred member whose benefits do not increase beyond certain levels. Further guidance can be accessed here.
Lifetime allowance (7) Lifetime allowance charge is the tax charged on the capital value of the fund that exceeds the lifetime allowance. The lifetime allowance for 2016/17 is £1m. The tax charge is triggered when payments are made from the retirement fund (payment of a pension or a lump sum).
Where the payment from the fund exceeds the lifetime allowance (at the time of crystallisation) then the excess is charged at either 25% (if the fund is used to buy a pension), or 55% where the fund is used to make a lump sum payment.
The tax liability is on both the individual and the scheme administrator. However, in practice, the scheme administrator will deduct the tax and pay it to HMRC.
Lifetime allowance protection (8) If total pension savings exceed £1m on 5 April 2016, a taxpayer may be able to apply for protection under the Individual Protection 2016 and Fixed Protection 2016 schemes.
For those who had a total pension savings that exceeded £1.25m on 5 April 2014 (before the threshold reduced), they may be able to apply for protection under the Individual Protection 2014 and Fixed Protection 2014. The application has to be submitted by 5 April 2017.