What limit applies to employer pension contributions?
20 September 2017
We are frequently asked “what is the maximum employer pension contribution that can be paid?”. Technically there is no limit, however, there are two areas to consider; tax relief and annual allowance.
As detailed in our article, ‘tax relief on employer contributions’, an employer pension contribution will receive tax relief based on whether or not the amount paid satisfies the definition of being an allowable deductible expense wholly and exclusively (W&E) for the purposes of the trade (expenses of management if paid by an investment company).
The company accountant is best placed to guide the employer on how much is reasonable. If HMRC were to challenge the contribution amount, then it is the accountant who would need to justify it.
The tax relief rules for employer pension contributions do not include any link to the client’s relevant earnings (this only applies to individual contributions paid by the member or paid on their behalf by a 3rd party e.g. as a gift from a parent etc). Neither is there any link to the client’s available annual allowance. So in a case for an employer who pays a pension contribution of £200,000 and this is deemed to meet the W&E rule, then it will receive corporation tax relief.
This is the end of the story for the employer.
If you are that lucky employee, we’ll name him Chandler, who is on the receiving end of this large employer pension contribution of £200,000 you may not be rubbing your hands in glee just yet. Remember all employer pension contributions are tested against the member’s annual allowance. Even if the full contribution does not qualify for corporation tax relief, it still uses up the member’s annual allowance.
Chandler has been working with his friends building up a business over the last 10 years and now wants to focus on pension planning. He’s started a pension plan for the first time in tax year 2017/18. His taxable income amounts to £50,000 so he is unaffected by the tapered annual allowance and at age 48 he’s too young (and healthy) to have flexibly accessed his pension benefits so is not subject to the money purchase annual allowance.
The standard annual allowance for 2017/18 is £40,000. As Chandler has not been a member of a registered pension scheme before this tax year he has no unused annual allowance to carry forward. This means he has an annual allowance excess of (£200,000 contribution – £40,000 allowance) £160,000.
Chandler must report this excess in a self-assessment tax return and either pay the relevant tax charge (the annual allowance excess is added to other income to determine the tax rate which applies, £100,000 x 40% and £60,000 at 45%) of £67,000 or ask his pension scheme to pay the charge on his behalf by reducing the benefits in his pension. So the £200,000 pension contribution is effectively reduced to £133,000. There is still a net benefit so it’s not all bad. However, there may have been other options he would have considered had he been warned about the annual allowance excess before the contribution was paid.
Alternatively, some early planning a few years ago could have increased Chandler’s current options. It’s not uncommon to see clients in the same situation. Even if they don’t want to, or don’t have the means to, actively pay into pensions now, if they want the opportunity to pay large contributions in future, they need to plan correctly. If Chandler had paid a nominal amount in to a pension back in 2014/15, he’d be able to carry forward unused annual allowance from 2014/15, 2015/16 and 2016/17 to reduce his annual allowance excess in 2017/18. We demonstrate this planning opportunity with a case study.
Knowledge is key
We help explain tax relief and annual allowance rules in the Prudential Technical Centre.