WHAT IS THE ANNUAL ALLOWANCE LIMIT IN A TAX YEAR WHERE BOTH A TAPERED ANNUAL ALLOWANCE AND THE MONEY PURCHASE ANNUAL ALLOWANCE APPLY?
7 August 2017
In this piece, Jacqueline Clezy, Technical Specialist at Prudential looks at the interaction of these rules.
The tapered annual allowance replaces the standard annual allowance for all pension savings in the tax year in which it applies.
The money purchase annual allowance (MPAA) does not replace the standard or tapered annual allowance. It simply limits the amount of money purchase (defined contribution) pension savings that will be eligible for tax relief. Any remaining standard or tapered annual allowance, which is called ‘alternative annual allowance’, can be set against non-money purchase pension savings.
A demonstration of the interaction of rules
So let’s say Ross flexibly accessed pension benefits in January 2016 and for tax year 2016/17, based on his usual salary and other incomes, he expected to have a tapered annual allowance of £32,000. This means that his annual allowance for all pension inputs would have been £32,000 instead of the standard amount of £40,000.
Ross was an active member of his employer’s defined benefit (equally, it could have been a career average) scheme. This is a non-contributory scheme, although Ross was eligible to contribute to the scheme’s money purchase AVC section.
Remember that although you cannot use ‘carry forward’ of unused annual allowance to increase the MPAA limit in any tax year, you can use available carry forward to increase your ‘alternative annual allowance’.
Ross chose to pay an individual contribution of £10,000. This used his full MPAA limit for 2016/17. His alternative annual allowance of (£32,000 – £10,000) £22,000 can be used to meet other non-money purchase pension saving, in this case, the defined benefit pension input amount.
If Ross had decided instead to pay only £5,000 to the AVC scheme, this would have left alternative annual allowance of (£32,000 – £5,000) £27,000 to meet the defined benefit pension input amount.
If Ross was unexpectedly made redundant on 31 March 2017 then he should have reviewed his tapered annual allowance calculation. However, in this scenario, he simply accepted his taxable redundancy settlement as an employer pension contribution. This increased his adjusted income to £210,000 making him subject to the minimum tapered annual allowance of £10,000. There would have been other options, as explained in our planning article, and this demonstrates the value of taking financial advice.
As Ross paid an AVC of £10,000, this would have used his full MPAA limit for 2016/17, and as his tapered annual allowance was also £10,000, there is £0 alternative annual allowance. He would need to look for unused annual allowances from the three earlier tax years, otherwise his total defined benefit pension input amount would be excess pension savings and subject to the annual allowance charge.
The Money Purchase Annual Allowance is for life, not just for one tax year
Once the MPAA is triggered it then applies every year for life, and the member will be subject to any change to the MPAA limit introduced by legislation. We now have confirmation there will be a further Finance Bill in 2017 reinstating the clause which will reduce the MPAA limit to £4,000 from 6 April 2017.
If you don’t use your MPAA limit in any one tax year, you cannot use this in a later tax year. In short, use it or lose it.
However, the tapered annual allowance will depend on the client’s level of taxable income in each tax year. It is possible to have a tapered annual allowance for one tax year, due to a spike in earnings or perhaps cashing in an investment which incurs a large bond gain etc, then revert back to the standard annual allowance in the next tax year. Remember though that carry forward from the earlier tax year will be based on unused tapered annual allowance where relevant.
One final point, if your client exceeds the tapered and/or money purchase annual allowance and intends to ask his scheme to pay the charge for him (by reducing his benefits), remember that the mandatory scheme pays conditions may not apply. The scheme may still agree to pay the charge on a voluntary basis but beware the shorter timescales that will apply – read more about this in our Oracle article.
• A tapered annual allowance replaces the standard annual allowance.
• The tapered annual allowance less the lower of;
o the money purchase pension input amounts, or
o the money purchase annual allowance is the alternative annual allowance.
• The alternative annual allowance can be increased using carry forward, the money purchase annual allowance cannot.
For more technical help by Prudential’s experts visit the PruAdviser website where you can find generic articles and analysis of legislation and consultations.