03 July 2015
Pay rises could push you over the tax relief limit and into trouble with HM Revenue & Customs (HMRC) so check your position, warns Stephen Casey.
Have you had a pay rise of more than £12,000 in the last two years? Have you had regular pay rises greater than £5,500 over the last two years? If you have said yes to either of these questions then you may well have exceeded your annual allowance (AA).
Unfortunately, most members are blissfully unaware of the annual allowance until a letter drops on the mat from their pension provider informing them that they have exceeded the maximum allowed over the last three years, along with details as to how they can reimburse HMRC for the excess tax relief they have enjoyed.
The current tax regime allows a person to increase the value of their pension in one year up to a certain limit – the annual allowance. If the increase in the value of the pension goes beyond the AA then the person is liable to tax on the excess. In the tax year 2014-15 the AA was set at £40,000 and will remain so for 2015-16.
Many people are unlikely to be affected by this, especially as unused allowances in a three-year period can be brought forward from the previous years. These three previous years’ allowances are based on the current allowance, not any previously higher allowance.
However, a consistently high salary or a one-off large salary increase may bring this regulation into effect, as may an extraordinary payment into a pension through enhancement or a significant salary rise.
Currently, depending on your service and salary, an increase of approximately £5,000 could trigger the annual allowance. If you haven’t used up your allowance from the previous two years this wouldn’t be a problem. But if you have, or if your pay rise is greater than £16,400, then you may be affected.
The tax is not based on how much you pay in during a pension input period (PIP), running from 1 April to 31 March, or how much your annual pension would be worth but on the increase in the value of your pension fund. The way that this is calculated is relatively straightforward and is explained below.
The increase in value of your pension savings in any one period is the difference between the notional value of your pension fund at the beginning and end of the period.
The value of your ‘pension fund’ is calculated as follows: (16 x annual pension) plus any lump sum.
Pension input is for the year 1 April 2014 to 31 March 2015.
1 April 2014 the member has a pension of £27,458pa and a lump sum of £82,374.
Their ‘pension fund’ at the beginning is worth: (16 x £27,458) + £82,374 = £512,702
At the end of the PIP their pension has increased, having an extra year’s service and a pay rise, and it now stands at £29,636pa and a lump sum of £88,908.
Their pension fund is now worth: (16 x £29,636) + £88,908 = £563,084
The ‘pot’ has nominally grown by £563,084 - £512,702 = £50,382.
However, the original worth is revalued due to inflation (1.2%), which means that the calculation is: £563,084 - £518,854 = £44,230
The annual allowance for 2014-15 is £40,000 and so the member has exceeded it by £4,230.
Don’t forget that you can also use up any unused allowance from the previous two years – although if you get regular pay increases or a large one-off increase then you may exceed all three years’ worth of allowance.
If you are liable for tax it is your responsibility to declare it in an annual tax return. You will need to complete a self-assessment tax return by January of the year following the notification of a liability, even if you have sufficient carry forward to cover any charge.
If you are a teacher then you can opt for the Teachers’
Pension Scheme to pay the tax but this is taken from your pension. You need to elect for the scheme to pay by 31 July following any relevant tax year. The tax you pay is the equivalent to your current marginal rate, which will be 20%, 40% or 45%.
It is important to remember that the allowance applies to your total pension assets, including additional voluntary contributions (AVCs) and any private pensions or pensions from previous employment; it is not just a limit on the Teachers’ or Local Government Pension Scheme (LGPS).
If you have additional pension pots then these must be added to the start and end of the pension input period. Consequently, pay rises less than those quoted earlier may trigger you exceeding the annual allowance.
If you would like further information on the annual allowance see our guidance paper on annual and lifetime allowances on the ASCL website.
Alternatively, there is a straightforward calculator on the members’ area of the Teachers’ Pensions website at www.teacherspensions.co.uk that indicates the likelihood of being liable for this tax.
Stephen Casey is ASCL Pensions Specialist