The annual allowance charge and Scheme Pays requests

Paul Squirrell takes a step-by-step approach to calculating client’s annual allowance charges.

The essential principle of the annual allowance is to limit the amount of ‘tax privileged’ pension savings an individual can accrue each tax year. If exceeded, a client may have to pay an annual allowance tax charge. The amount depends on the excess amount, how much the client has earned in the tax year and whether they have any unused allowances they can carry forward to reduce or potentially eliminate the charge. 

Broadly speaking, the charge is calculated by notionally adding the excess amount to the client’s taxable income for the year and is charged at their marginal rate (or rates if an income tax threshold is crossed). If a charge is due, then the next step is deciding how to pay it.

1. Direct payment to HMRC

In some circumstances, the client may have to pay the charge directly to HMRC, typically through self-assessment.

2. Scheme Pays

It may be possible for the client to pay some or all of the charge from their pension account. This is often a more palatable option and may also offer a pecuniary tax advantage (particularly if the lifetime allowance is a consideration). There are two types of Scheme Pays and, depending on the amount, how the charge arose and their circumstances, a client may have access to one, both or neither of them.

Mandatory Scheme Pays

If certain conditions are met, the pension scheme must fulfil requests to pay the charge from the pension and it will become jointly and severally liable with the client for some or all of the tax charge. However, this option is only available in limited circumstances:

  • When the charge is over £2,000* and;
  • The client has exceeded the standard annual allowance of £40,000 (for this purpose the tapered annual allowance and money purchase annual allowance are ignored).

* There is no minimum that the client can ask the scheme to pay but if this is less than £2,000 then they will need to confirm to the scheme that their total annual allowance tax charge liability is greater than £2,000.

It doesn’t apply when:

  • The client has exceeded the tapered annual allowance and/or the MPAA, but hasn’t exceeded the £40,000 standard annual allowance or;
  • They have an overall charge of £2,000 or more, but this is not based solely on the contributions to that scheme.

It partially applies when:

The client has exceeded the tapered annual allowance or the MPAA and the £40,000 standard annual allowance. In this situation, the scheme will only cover any charge on the excess over £40,000.

Voluntary Scheme Pays

Any pension scheme can offer Voluntary Scheme Payments but, unlike FundsNetwork, many do not. Where this facility is offered, there are no minimums and the scheme can pay any annual allowance tax charge, even if it isn’t in relation to that arrangement. However, the scheme will never become jointly and severally liable for the charge. As such, the reporting and payment deadlines for Voluntary Payments are different to Mandatory Payments.

Deadlines

Deadlines for Scheme Pays requests must be adhered to. If they are missed, then the option may not be available. The deadlines for FundsNetwork Pension Scheme Pays requests are shown below:

FundsNetwork Scheme Pays deadlines
Scheme type Tax year Deadline
Mandatory Scheme Pays 2017/18 31 July 2019
Voluntary Scheme Pays 2018/19 31 August 2019
Mandatory Scheme Pays 2018/19 31 July 2020

For Voluntary Scheme Pays, the date ensures there is enough time for the tax charge to be received by HMRC by the deadline for personal tax of 31 January, following the end of the tax year.

The annual allowance charge - Scheme Pays

Scheme Pays can be a complicated area. In this postcard, Paul Squirrell provide further details on calculating client’s annual allowance charges, including two case studies.

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Important information

This article provides information and is only intended to provide an overview of the current law in this area and does not constitute financial advice, tax advice or legal advice, or provide any recommendations.

This article represents a summary of our understanding of the law at the date of its last review (April 2019). Tax limits, benefits, allowances and rules are often subject to change and may change in future. Advisers and individuals should check that tax limits, allowances and rules have not changed. The value of benefits depends on individual circumstances. Withdrawals from a pension will not normally be possible until age 55.

Different options may have different effects for tax purposes, different implications for pension provision and different impacts on other assets and financial planning.

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