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Annual allowance

Will I exceed my pensions annual allowance?

This is the amount your pension savings can increase in any one year before you become liable to an extra tax charge.

For most members the annual allowance for the tax year 2016/17 is £40,000.

Different rules will affect you if either of the following apply:

  • You have accessed pension benefits from another pension scheme flexibly under the new pension freedoms introduced by the government in April 2016. This triggers what is called the Money Purchase Annual Allowance rules and you must tell us if this applies to you. More information can be found at HMRC website
  • You earn more than £110000 and the value of your pension savings growth together with any other income exceeds £40000. The new Taper Annual allowance may then apply to you.

Usually, any pension benefits you have in all tax-registered pension arrangements you’ve paid contributions into during the tax year (or if your employer has paid contributions on your behalf) are included in calculating your pension savings in a year.

HMRC have an online calculator which you may find useful.

Because of some changes introduced by the Government in the July 2015 budget, for 2015/16 some transitional arrangements apply. For active members of the LGPS, in 2015/16 the year is split into two mini periods as follows:

Period 1 (the pre-alignment period): 01/04/2015 to 08/07/2015 = £80000

Period 2 (the post alignment period): 09/07/2015 to 05/04/2016 = £0 (see note below)

Note: Up to £40000 that you have not used from period 1 may carry forward into period 2.

We will write to you if:

  • Your WYPF or LPF benefits have grown in value by more than £80000 for the two periods; Or
  • Your WYPF or LPF benefits have grown by more than £40000 in period 2.

But if you have other pension benefits, then you need to add up all the values to check if you exceed the Annual allowance.

You will only have an annual allowance tax charge if the value of your pension savings for a tax year increases by more than the annual allowance level for that year. However, you may be able to carry forward unused annual allowance from the last three tax years. This means that even if the value of your pension savings increases by more than the annual allowance level in a year you may not be liable to the annual allowance tax charge.

For example, if the value of your pension savings in 2015/16 increases by £40000 in period 1 & £60000 in period 2, then this will be £20,000 more than the annual allowance level of £40,000 that would apply to the second period. But, if in the three previous years the increase had been £25,000 (2014/15), £38,000 (2013/14) and £42,000 (2012/13), then the total amount by which each of these previous years fell short of the annual allowance level applicable at the time (i.e. £15,000 + £12,000 + £8,000 = £35,000) would more than offset the £20,000 excess pension saving in 2015/16. There would be no annual allowance tax charge to pay in this case.

Please note:

  • To carry forward unused annual allowance from an earlier year you must have been a member of a tax registered pension scheme in that year.
  • Annual allowance thresholds since 2011/12 = £50000 up to 2013/14 reducing to £40000 in 2014/15.

Most people won’t be affected by the annual allowance tax charge because the value of their pension savings will not increase in a tax year by more than the annual allowance level or, if it does, they are likely to have unused allowance from previous tax years that they can carry forward.

How can I work out if I might be affected by the Annual Allowance?

Working out whether you’re affected by the annual allowance is quite complex, but this should help you work out your general position.

In general terms, 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 input period (1 April), increasing the value by inflation (as currently measured by the Consumer Prices Index), and comparing this with the value of your benefits at the end of the input period (i.e. the following 31 March). In a defined benefit scheme like the LGPS the value of your benefits is calculated by multiplying the amount of your pension by 16 and adding any lump sum you are automatically entitled to from the pension scheme.

If the difference between:

  • the value of your benefits immediately before the start of the input period (the opening value) and
  • the value of your benefits at the end of the input period (the closing value)
  • plus any contributions you paid into the scheme’s Additional Voluntary Contribution (AVC) arrangement in the year or that you and your employer have paid into the scheme’s Shared Cost AVC arrangement in the year

is more than the annual allowance level for the tax year, you may be liable to a tax charge.

The method of valuing benefits in other schemes may be different to the method used in the LGPS.

If you chose to transfer pension rights from another scheme into the LGPS, the value of the benefits relating to the transfer doesn’t count towards your pension savings in the LGPS in the year the transfer payment is received.

If your pension benefits in the LGPS are reduced following a Pension Sharing Order (issued as a result of a divorce or dissolution of a civil partnership) then, for the purposes of calculating the value of your pension savings in the LGPS, the reduction in your benefits is ignored in the year that the Pension Sharing Order is applied to your benefits.

If you retire because of permanent ill health and an independent registered medical practitioner certifies that you are suffering from ill health, which makes it unlikely that you will be able (except to an insignificant extent) to undertake gainful work (in any capacity) before you reach state pension age, there is no annual allowance tax charge on the ill health retirement benefits.

Members most likely to be affected by the annual allowance tax charge are those that have a lot of scheme membership and have had a significant pay increase, or who pay high levels of extra contributions, or who have been awarded extra pension in the LGPS by their employer.

We can tell you how much the value of your LGPS benefits, including any Additional Voluntary Contributions (AVCs) you may have, has increased during any input period.

Also, we’ll tell you if your LGPS pension savings are more than the annual allowance in any year, ignoring any carried-forward allowance from the previous three years, not later than 6 October following the end of the relevant tax year.

Example

Here’s an example showing the calculation of the increase in the value of pension savings for an employee who has been an active member of the LGPS throughout 2013/14

Working out the opening value of the member’s benefits for 2013/14

At 31 March 2013
Pensionable pay for the year to 31 March 2013 £60,000
Scheme membership 12 years (7 years before 31/03/2008 so counts at 80ths and 5 years from 01/04/2008 to 31/03/2014 so counts at 60ths)  
The Consumer Prices Index (CPI) for September 2012 2.2%
AVCs paid in 2013/14 £1,500.00
Opening value
Annual pension 7 / 80 x £60,000 £5,250.00
  5 / 60 x £60,000 £5,000.00
Total annual pension £10,250.00
Multiply by 16 £164,000.00
Add lump sum 7 x 3 / 80 x £60,000 £ 15,750.00
  £179,750.00
Increase by inflation as measured by CPI x 1.022
To give an opening value of £183,704.50

Do not add AVCs into the opening or closing values (these are added at the end)

Working out the closing value of the member’s benefits for 2013/14

At 31 March 2014
Pensionable pay for the year to 31 March 2014 £63,000
Scheme membership 13 years (7 years before 31/03/2008 so counts at 80ths and 6 years from 01/04/2008 to 31/03/2014 so counts at 60ths)  
Closing value
Annual pension 7 / 80 x £63,000 £5,512.50
  6 / 60 x £63,000 £6,300.00
Total annual pension £11,812.50
Multiply by 16 £189,000.00
Add lump sum 7 x 3 / 80 x £63,000 £16,537.50
To give an closing value of £205,537.50

Working out the increase in value during 2013/14

The increase in the member's benefits over the year to 31 March 2014 is £205,537.50 less £183,704.50 = £21,833.00 + £1500 AVCs = £23,333.00

As this is less than the annual allowance for 2013/14 of £50,000 there is no annual allowance charge in this example. The member has £26,667.00 unused annual allowance from 2013/14 to carry forward to 2014/15.

Two worked through examples of an annual allowance breach can be seen here.

What happens if my pension savings increase by more than the annual allowance?

You will be liable to a tax charge (at your marginal rate) on the amount that the increase in your pension savings for the tax year, less any unused allowance from the previous three years. If you exceed the annual allowance in any year you are responsible for reporting this to HMRC on your self-assessment tax return.

A tax charge resulting from a breach (if greater than £2,000) can be paid by the Pension Fund on your behalf providing that your pension savings in the LGPS alone breached the AA limit. The tax charge would then be recovered from your pension benefits in retirement. This is known as Scheme Pays.

If you intend to ask for scheme pays, you must contact WYPF no later than the 31st July in the year after the breach occurred, you must also do so before claiming your benefits if the breach occurs shortly before then.

For more information about the annual allowance please visit Her Majesty’s Revenue & Custom website: Annual-allowance