Technical: A reminder of the carry forward rules
1 March 2021
In the first of a new series of articles for Professional Paraplanner on tax, Jessica List, pension technical manager, Curtis Banks, provides a refresher of the carry forward rules and some important points for paraplanners to consider when working with clients on tax planning.
The last few weeks of a tax year see many clients thinking about maximising their tax efficient savings for the year. While the pandemic has led to many people reducing savings such as pension contributions this tax year, there are those fortunate enough to have kept their incomes and seen a reduction in their outgoings, leaving more spare cash available than normal. Some clients in that position may have preferred to keep the extra money readily available to bolster their emergency funds during the worst of the restrictions, but may now be thinking about how to make the most of their extra savings as things begin to improve.
When it comes to pension contributions and the annual allowance, it’s been years since there was a single allowance that simply applied to all individuals in a given tax year. Some clients may have a restricted allowance due to the tapering rules, or because they have triggered the money purchase annual allowance (MPAA). On the other hand, clients may also be able to increase their allowance for the year using carry forward. Here is a reminder of the key points of the carry forward rules for those who may wish to use them.
1. Carry forward increases the annual allowance, not tax relief
This first point isn’t exactly part of the carry forward rules themselves, but it is a very common area of confusion. This is because we often think of carry forward as a way for clients to make larger tax efficient contributions, which then leads to considering the limits based on a person’s relevant earnings. However, this is combining two separate issues.
The maximum amount someone can contribute while claiming tax relief in any given tax year is based on their relevant UK earnings for that tax year (or the ‘basic amount’ of £3,600 gross, if higher). This can’t be altered. How much someone can contribute in a tax year before facing an annual allowance charge is controlled by their annual allowance. This could be affected by the tapering rules, the MPAA, or carry forward – or any combination of those factors.
2. Up to three years’ worth of unused allowance is available
Carry forward allows clients to use up unused annual allowance from the three previous tax years. When working out how much carry forward is needed, you start from the earliest tax year and work forwards. This gives the best chance of using up allowance before it is no longer available and leaving more available to use in the future (assuming the client isn’t using up all of their carry forward in one go).
3. The current year’s allowance must be used first
When learning about carry forward, clients often ask if they can use up their unused allowance from three years ago, and then leave the current year’s annual allowance to use as carry forward in one of the following three years. Unfortunately this isn’t possible, as one of the conditions for carry forward is that the client has already used up their allowance for the current tax year first.
4. The client must have been a member of a pension scheme
It’s only possible for someone to use carry forward if they were a member of a registered pension scheme at some point during the tax year(s) from which they wish to use up unused allowance. This means it isn’t possible for someone to join their first pension scheme and instantly access four years’ worth of annual allowance. The individual can have been an active, deferred, or pensioner member of a registered pension scheme in that tax year, and they don’t have to have been a member of the scheme that they now wish to contribute to.
5. You might need to look back further than three years
Although clients can only use unused allowance from up to three years ago, if you are trying to work out how much carry forward a client has available, you might need to consider a longer time period to get a full picture. Let’s say your client has always been subject to the normal annual allowance, and is considering her available annual allowance and carry forward in 2020/21. Her contributions over the last three years were as follows:
From just looking at these tax years, it’s not possible to know how much carry forward the client has available today, because you don’t have the full picture for the annual allowance excess from 2018/19. It might have been taken care of using unused allowance from an earlier tax year – or it might have required some of the unused allowance that appears to be available from 2017/18.
If you do need to look back further to get a full view of a client’s carry forward history, there are a couple of important points to consider.
Firstly, 2015/16 was a nightmare of a year in annual allowance terms, with transitional rules to allow all pension input periods to be aligned to the tax year (so that contributions are tested against the annual allowance in the year during which they are actually made). If you need to go that far back you’ll need to remind yourself of those transitional rules, as carry forward was based on what was left at the end of the ‘post-alignment period’.
Secondly, carry forward wasn’t available from years during which someone was in flexible drawdown. Being in flexi-access drawdown is fine, but you’ll need to watch out for clients who may have been in flexible drawdown before 2015.
For most people, carry forward is a helpful tool that adds some flexibility at times when they’re in a position to make larger contributions than normal. However, it’s important to keep these conditions in mind to make sure clients aren’t unwittingly caught out.
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