Pensions and Tax Liability

August 2019

This guidance contains important information for all members in the Teachers’ Pension Scheme (TPS) or the Local Government Pensions Scheme (LGPS), regardless of age or proximity to retirement.

This information is for the personal use of ASCL members only. 

Recent changes by the government to pensions, in particular the annual pension allowance, have meant that some ASCL members have found they are now facing an unexpected HMRC bill. In addition, changes to the lifetime allowance mean that some members could be on track to exceed this amount and therefore face unexpected costs in the future.

Individual circumstances should therefore be checked and specific professional advice taken. If you believe you may be affected, you are advised to consult a tax expert, such as an accountant.

This paper looks in detail at the following:

Section 1 Annual Allowance including Tapered Annual Allowance

Section 2 Lifetime Allowance Section

Section 3 Further Information Section

Section 4 Appendix 1 including scenarios and worked examples of Annual Allowance calculations based on 1/80th, 1/60th and 1/49th schemes, and the TPS CARE scheme

The example calculations provided at the end of this paper are designed to assist members. However, if you wish to take independent financial advice as part of a review of your current situation, ASCL has a partnership with the Lighthouse Group. Contact details are provided in Section 3.

Annual Allowance
The current tax regime allows an individual to increase the value of their pension each year up to a certain limit, currently £40,000. This is known as the Annual Allowance. If the pension increase goes beyond the Annual Allowance then the individual could be liable for tax on the excess.

Until 2010-11, pension pots could increase by as much as £255,000 in one year. However, this has been drastically reduced, so for tax year 2014-15, the Annual Allowance was £40,000. It will remain at £40,000 for the foreseeable future.

Many people are unlikely to be affected by this, especially as unused allowances in a three-year period can be brought forward (the three previous years’ allowances are based on the current allowance rate, not the previous higher allowance). However, a consistently high salary, a large one-off salary increase or an extraordinary payment into a pension through enhancement could cause the Annual Allowance to be exceeded.

For instance, a one off pay rise of more than £12,000 or regular pay rises greater than £3,500 over the last year, could result in a pension exceeding the annual limit.

Tapered Annual Allowance
The method chosen to reduce the Annual Allowance is the Tapered Annual Allowance. It reduces the individual’s normal Annual Allowance by £1 for every £2 of ‘adjusted income’ that the saver earns over £150,000, up to a maximum reduction of £30,000, leaving a minimum Annual Allowance of £10,000. Therefore, earners with an adjusted income of between £150,000 and £210,000 are affected by the taper from the 2016- 17 tax year. Those with an adjusted income of over £210,000 know that their Annual Allowance is only £10,000.

Due to the change in employer’s contribution from September 2019 all members with a salary greater than £115,000 are urged to seek advice regarding the Tapered Annual Allowance and their adjusted income.

The basis is derived from a formula that relies on the current Annual Allowance of £40,000, so the rate of reduction may vary for earners in the future if the Annual Allowance is changed. Those affected by the Money Purchase Annual Allowance face added complications.

For these purposes, ‘adjusted income’ is the total of all sources of taxable income falling in the tax year plus the value of any pension saving in that year. Employer contributions are counted as income for this purpose.

Individuals with a ‘threshold income’ of less than £110,000 are exempt.

ASCL encourages all members to check their Annual Allowance contribution to make sure they are within the limit.

If you are liable for tax, it is your responsibility to declare it in your annual tax return. A completed selfassessment tax return must be submitted by 31 January of the year following the notification of a liability, unless you have sufficient carry forward to cover any charge. You can opt for TPS to pay the tax from your pension, using the scheme pays form on the TPS website. The tax you pay is the equivalent to your current marginal rate (either 20, 40 or 45%).

For TPS and LGPS, the tax year is 6 April to 5 April.

Check this factsheet for more information from TPS on Tapered Annual Allowance.

Lifetime Allowance

The total value of an individual’s pension fund which may be held without a tax liability is called the lifetime allowance. This was reduced from £1.8 million to £1.5 million as from the 2011-12 tax year. It was further reduced to £1.25 million from 2014-15.

Following his 2015 Budget, the Chancellor reduced the lifetime allowance to £1 million with effect from April 2016. From April 2018, inflation is added to the lifetime allowance.

The current Lifetime Allowance is £1,055,000.

To determine your lifetime allowance (LA)
Figures for the current value and lump sum of your pension are required for this calculation and should be indicated on your annual pension statement.

The calculation is as follows:
LA = (current value of annual pension (as if taken at normal pensionable age) x 20) + lump sum if applicable

EXAMPLE
Headteacher A has a pension of £46,000 plus a lump sum of three times this amount. Lifetime allowance: (46,000 x 20) + (3 x 46,000) = £1,058,000
Note 1: In this example, the lifetime allowance is below the previous limit of £1.25 million but exceeds the new limit from April 2019.
Note 2: This calculation applies to total pensions held, not just those in TPS or LGPS.
Note 3: If you are in TPS and exceed your lifetime allowance, the scheme pays the tax (25% on the excess) and makes an appropriate reduction in your annual pension for life. There is no option but to have the scheme pay the tax via a pension reduction.

Applying for protection
If you are likely to exceed the new lifetime allowance you can apply for individual protection (IP16), provided you have not previously applied for any other types of protection.

Only protection for the change from £1.25 million to £1 million, introduced in April 2016, is currently still available if you had already breached the £1 million by 5 April 2016.

If you had a previous fixed protection it is not possible to commence a new pension scheme and any subsequent fund increases per year must be within the annual Consumer Price Index (CPI) increase to maintain the protection. This may ultimately lead to opting out of the scheme to avoid tax liability.

If you have joined the new LGPS or the new TPS then HMRC have declared the protection will cease. It is important, therefore, that you take advice if you have protection and are joining or have joined the new schemes.

Further information
The application form and accompanying notes are available on the HMRC website for 2016 applications. The relevant tax division can be contacted at: HM Revenue and Customs Pension Schemes Services, Fitzroy House, Castle Meadow Road, Nottingham NG2 1BD

HMRC Understanding Annual Allowance
HMRC Understanding Lifetime Allowance

Alternatively, lists of independent financial advisers based on postcode information are available here.

Pension schemes should inform members who are at risk of these tax liabilities, however, it is prudent to make individual checks.

Teachers’ Pensions now have a useful addition to their website, Tax and National Insurance, which is in the members section under the ‘Working Life’ and ‘Paying in’ tabs.

Lighthouse Group
Call 08000 858590 (with your ASCL membership number) for an appointment with a local representative.

This information is given in good faith and is based on regulations correct at the time of writing. ASCL cannot be held responsible for any losses resulting from the use of this information.

Appendix 1: Annual Allowance calculation
This method applies to the TPS and the LGPS
AA = Annual Allowance
PVB = Pension value at the beginning of the pension input period (PIP)
PVE = Pension value at the end of the PIP
CPI = Consumer Price Index for the previous September
AVC = Additional voluntary contributions

Calculating the PVB
  1. Determine the amount of your annual pension. (This is the amount of pension that you would be paid if you retired on 6 April at normal pension age without any extra benefits for ill health, and should be quoted on your pension statement.)
  2. Multiply this by 16.
  3. If your scheme also provides a separate lump sum in addition to your pension, add this to the amount in Step 2.
  4. Multiply the total in Step 3 by the CPI for the September during the tax year for which you are calculating Annual Allowance and add this to the total in Step 3.
CPIs
September 2012 (use for 2012-13) 2.2% September 2016 (use for 2016-17) 1.0%
September 2013 (use for 2013-14) 2.7% September 2017 (use for 2017-18) 3.0%
September 2014 (use for 2014-15) 1.2% September 2018 (use for 2018-19) 2.4%
September 2015 (use for 2015-16) 0.0%  

Calculating the PVE
The closing value is the notional ‘capital’ value of the expected benefits at the end of the tax year and is calculated in the same way as your PVB (but omitting the final step), as follows:
  1. Determine the amount of your annual pension on 5 April the following year.
  2. Multiply this by 16.
  3. If your scheme also provides a separate lump sum in addition to your pension, add the amount to amount in Step 2.
  4. If you pay into an AVC, add the contributions you have paid in the tax year
Examples for calculating the Annual Allowance and Annual Allowance tax charge
Scenario 1 - based on a 1/80th scheme
Fiona is a member of a scheme that gives her a pension of 1/80th pensionable pay for each year of being a scheme member. She receives a lump sum of three times her pension. At the start of the tax year, Fiona’s pensionable pay is £70,000 and she has 27 years 214 days service (27.586)

PVB
  1. Calculate annual pension entitlement at the start of the input period: (27.586)/80 x £70,000 = £24,138pa
  2. Multiply result by 16: £24,138 x 16 = £386,208
  3. Add lump sum: (3 x £24,138) + £386,208 = £458,622 (PVB)
  4. Increase amount for CPI. This calculation relates to tax year 2015-16 (0%): (£458,622 x 0%) = £0 + £458,622 = £458,622
PVE
At the end of the tax year, Fiona’s pensionable pay has increased by 10% to £77,000 and her pensionable service is now 28 years 214 days.
  1. Calculate annual rate of pension: (28.586)/80 x £77,000 = £27,514
  2. Multiply result by 16: £27,514 x 16 = £440,229
  3. Add lump sum: (3 x 27,514) + £440,229 = £522,771 (PVE) PVE – (PVB x CPI) = Annual Allowance £522,771 - £458,622 = £64,149
Fiona has gone over her allowance by £24,149. If she has unused allowance from previous years she will not have to pay tax. However, if she has already used up her allowance her tax charge will be her nominal rate (40%) of the excess.

Fiona’s tax charge will be £24,149 x 40% = £9,659.60

Scenario 2 based on a 1/60th scheme
Raj is a member of a scheme that gives him a pension of 1/60th pensionable pay for each year of being a scheme member. Although he can take a lump sum from his scheme, Raj can only do this by giving up (commuting) pension to provide the lump sum. At the start of the tax year, Raj’s pensionable pay is £50,000 and he has 15 years 214 days service.

PVB 
  1. Calculate annual pension entitlement at the start of the input period: (15.586)/60 x £50,000 = £12,989
  2. Multiply result by 16: £12,989 x 16 = £207,824
  3. Add any separate lump sum: Raj’s scheme does not give him a separate lump sum, so the total is still £207,824
  4. Increase amount for CPI. The calculation relates to tax year 2014-15
  5. £207,824 x 1.2% = £2111.980 (PVB)
PVE
At the end of the PIP, Raj’s pensionable pay has increased by 10% to £55,000 and his pensionable service is now 16 years 214 days.
  1. Calculate annual pension rate: (16.586)/60 x £55,000 = £15,204
  2. Multiply result by 16: £15,204 x 16 = £243,264
  3. Add any separate lump sum.
Raj’s scheme does not give him a separate lump sum, so the total is still £243,264

No adjustments need to be made to Raj’s closing value as he has not had any transfers in or out, pension debits or credits.

Raj’s pension saving for the year is the difference between his opening value and his closing value. PVE – (PVB x CPI) = Annual Allowance

£243,264 - £211,980 = £31,284

Raj does not exceed the £40,000 Annual Allowance.

To calculate the rate of the Annual Allowance tax charge
Excess pension savings can be charged to tax in whole or in part at 45%, 40% or 20% depending on your taxable income and the amount of excess pension savings. Calculate the applicable rate as follows:

Step 1: Establish your taxable income, after personal allowances, for the year (called ‘reduced net income’ in tax legislation). This is the amount on which you actually pay tax for the year.

Step 2: Calculate the proportion of your pension savings for the tax year liable to the charge. This is represented as: Pension savings for tax year = (total pension savings for the tax year) – (the Annual Allowance for that year) – (any unused Annual Allowance brought forward from earlier years)

Step 3: Add your reduced net income (from Step 1) and any excess pension savings (from Step 2). Pension savings will be taxed as follows:
  • over your higher rate limit will be taxed at 45%
  • over your basic rate limit but below your higher rate limit will be taxed at 40%
  • below your basic rate limit will be taxed at 20%
Step 4: If the total after Step 3 exceeds your higher rate limit, generally £150,000 (but may be more if your pension savings are paid net of basic rate tax) then see Step 5. Otherwise, see Step 7.

Step 5: From the amount of your excess pension savings in Step 2, deduct the amount brought into charge at 50% in Step 4.

Step 6: Work out the difference between your higher and basic rate limits.

Step 7: If the amount after Step 5 is less than the amount after Step 6, the amount at Step 5 is chargeable at 40%. Otherwise the amount chargeable at 40% is the difference between the higher and basic rate limits from Step 6.

Step 8: Any remaining amount of excess pension savings not brought into charge in Step 4 or Step 7 is then chargeable at 20%.

If you are filing your self-assessment tax return online, their system will calculate the amount of the tax charge for you.

Scenario 3 - calculating Annual Allowance tax charge
Frances has £30,000 pension savings on which she has to pay the Annual Allowance charge. Frances also has £140,000 income on which she must pay tax after accounting for her personal allowances (her ‘reduced net income’ or RNI).

Frances’s pension savings and reduced net income together is £170,000.

For the purpose of this example, Frances’s higher rate limit is £150,000 and her basic rate limit is £40,000.
Step 1: Frances has £140,000 taxable income (RNI).
Step 2: Frances has £30,000 pension saving on which she has to pay the Annual Allowance charge.
Step 3: Frances’s excess pension saving and RNI added together is £170,000.
Step 4: The total after Step 3 exceeds the higher rate limit of £150,000 by £20,000, therefore £20,000 of Frances’s excess pension savings is chargeable at 45%.
Step 5: Frances’s excess pension savings not chargeable at Step 4 £30,000 - £20,000 = £10,000.
Step 6: The difference between Frances’s higher and basic rate limits is £150,000 - £40,000 = £110,000.
Step 7: The amount after Step 5 (£10,000) is less than the amount after Step 6 (£110,000) so £10,000 is chargeable at 40%.
Step 8: There is no remaining amount of excess pension savings not brought into charge by Step 4 or Step 7. Frances’s tax charge is calculated as:
£20,000 at 45% = £9,000
£10,000 at 40% = £4,000
£0 at 20% = £0
Frances’s Annual Allowance tax charge is £13,000

Scenario 4 - based on a 1/49th scheme (LGPS CARE scheme)
Louise is a member of a scheme that gives her a pension of 1/49th pensionable pay in each year of being a scheme member.
2015-16      Louise’s pay is £73,000

Her pension increase for that year will rise by 1/49th of her salary: 1/49 x 73,000 = £1,490

To calculate her pension input for the year
£1,490 x 16 = £23,837

There is no automatic lump sum in the new schemes so there is no more to add on.

Louise is under her limit of £40,000 for the year.

Scenario 5 – based on the TPS CARE scheme
Michael transferred to the new scheme in April 2015. He has service in both the 1/80th scheme and the CARE scheme. To calculate his overall Pension Input for the tax year he would need to calculate the increase on both the CARE scheme and the 1/80th scheme pension.

In 2016-17 his pay was £93,000

His pension accrual for the year would be 1/57th of his salary: 1/57 x 93,000 = £1,632

To calculate his pension input for the year £1,632 x 16 = £26,105

There are no automatic lump sums in the new schemes so there is no more to add on.

Michael is under his limit of £40,000, however, if he’d had a pay rise for the year he would also need to check the increase in his 1/80th scheme pension as this is still linked to his current salary, although no future service is added.

Guidance produced by 
ASCL Pensions Specialist Stephen Casey

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