To encourage retirement savings, government offers tax incentives when you contribute to a pension scheme.
What contributions apply for pensions relief?
Most contributions to a registered pension scheme qualify for tax relief and are referred to as qualifying contributions.
Qualifying contributions can be made by:
- a member (or other person on behalf of a member)
- an employer.
(Also Read ‘How to claim relief on Pension contributions‘).
A member of a registered pension scheme may make unlimited contributions to the scheme during a tax year, as long as the scheme rules allow it.
Other persons may also contribute to a registered pension scheme, as long as it’s for a member.For the purposes of tax, these contributions are treated as if the member made them. The effect of this is that the member gets any tax relief due on the contribution, rather than the person who contributed. Other persons can include the following: an individual,(e.g.a friend or family member), a corporate body (e.g. a company or some other legal entity or organisation).
To qualify for tax relief on contributions to a registered pension scheme, a member has to:
- be a relevant UK individual for that year -Generally, a relevant UK individual is someone resident here and who has relevant UK earnings chargeable to income tax, or who was in that position when they joined the scheme. Examples of relevant UK earnings are income from employment, or from a trade or profession.
- have paid tax relievable contributions (or had them paid for them) – A tax relievable contribution is a contribution paid by or on behalf of a member of the scheme except where the member is aged 75 years or older. (Contributions can be paid after a member has reached 75 but they’re not tax relievable).
- have not exceeded the annual limit for relief.
There’s an annual limit to the gross contributions for which a member can claim relief in any tax year. It’s limited to the greater of:
- the basic amount – currently £3,600
- the amount of the individual’s relevant UK earnings for the tax year.
Example: James relevant UK earnings are £35,000 for 2014/15. The most James can contribute and get tax relief for is £35,000. If he contributed less than £35,000 (gross) he’d get relief on his total contributions. He may be able to put more than £35,000 in if he wants, and the scheme allows, but he won’t get tax relief on the amount above £35,000.
If his relevant earnings were less than £3,600 he can still get relief for gross contributions up to £3,600, for example if another person made contributions on his behalf. (As you read earlier, a contribution paid by another person is regarded as a member contribution and counts towards the annual limit.)
Payments made by the member’s employer do not count towards the annual limit.
The member can’t carry unused relief backwards or forwards to other tax years and they can’t move contributions to other years.
An individual can pay into one or more registered occupational schemes (including a former employer’s registered scheme if the rules allow it) and any number of personal pension schemes at the same time. They get tax relief for all (aggregate) gross contributions in the tax year up to the annual limit.
A contribution to a pension scheme can only be refunded in certain circumstances.
One example is that If a member leaves pensionable service within 2 years of joining that service, they may be able to have a full refund. This is called a short service refund lump sum.
A member’s employer may make contributions to the member’s registered pension scheme.
An employer gets tax relief for a contribution if it:
- is made in order to provide benefits for its employees.
- meets the general rules on allowable deductions – is has to be wholly and exclusively for the purposes of the trade.
The Annual Allowance
As you’ have seen above, there’s no maximum amount that a member can add to their pension savings each year but an annual limit ensures that a member only gets tax relief on:
- either £3,600
- or the total of their relevant earnings,
whichever is the greater.
The annual allowance however is a separate consideration.
The annual allowance puts a limit on the amount by which a member’s pension savings can grow in the year. If the savings exceed this limit an annual allowance tax charge may arise.
|Tax Year||Annual Allowance|
To calculate whether a member’s pension savings have exceeded the annual allowance you must take into account the:
- pension input period
- pension input amount.
Pension input period (PIP)
A pension input period (PIP) is just as it sounds – the period over which the amount of the pension input in an arrangement is measured. The period can cover a year but it needn’t match the tax year. It can be less than a year.
The first period for an arrangement can’t be longer than 12 months but a subsequent period for an arrangement can. The first PIP normally starts when the first contribution is paid into the arrangement and it will normally end on the following 5 April (tax year), although a member or the administrator can choose to nominate an earlier or later end date. The first PIP cannot be longer than 12 months. The tax year in which the PIP ends determines which year the pension input amount applies to.
Tom starts paying into a personal pension scheme on 1 May 2013. He nominates the first PIP to end 30 April 2014. The first PIP therefore applies for 2014/15. If no further nomination is made the second PIP will be 1 May 2014 to 30 April 2015. The second PIP applies for 2015/16.
If he hadn’t made a nomination, the position would have been
- first PIP 1 May 2013 – 5 April 2014, applies for 2013/14
- second PIP 6 April 2014 – 5 April 2015, applies for 2014/15
- third PIP 6 April 2015 – 5 April 2016, applies for 2015/16.
Value of the pension input amount
The method used to value a member’s pension input amount depends on the type of arrangement. For example, in a money purchase arrangement the input amount is the
total of member and employer contributions paid during the PIP, whereas in a defined benefit arrangement it’s the increase in promised pension over the PIP.
Money purchase arrangement
The pension input amount in a money purchase arrangement is the total contributions paid.
During the pension input period ending in 2014/15
Sarah contributes £11,000
Her mother contributes £2,000
Her employer contributes £3,000
Total contributions £16,000
Sarah’s pension savings have grown by £16,000 so this is he value of her pension input amount in 2014/15.
Defined benefit arrangement
The method of valuing a member’s pension input amount in a defined benefit arrangement is based on the growth of the pension savings, but measuring the growth isn’t as straightforward as totalling the contributions.
To measure the growth in the member’s savings over a pension input period (and therefore the value of the pension input amount) you must calculate the difference in the opening and closing values of the member’s savings for that pension input period.
In short :
There’s no maximum amount that a member can add to their pension fund but the amount of pension input is tested against an annual allowance, e.g £40,000 for 2014/15. A tax charge applies to the part of the pension input amount that exceeds the annual allowance (the excess amount).
Pension Contributions over Annual Allowance
When a member’s pension input amount exceeds the annual allowance, plus any unused annual allowance that can be carried forward, they’re liable to pay an annual allowance charge. The excess is charged at the member’s marginal rate.
Exceptions to the annual allowance charge:
There are three situations where part or all of a member’s pension input amount isn’t liable to the annual allowance charge for the tax year. These are if the member
- retires due to severe ill-health
- is a deferred member whose benefits do not increase beyond certain levels.
The pension input amount is usually set at nil for the year the event takes place, but there are other considerations that we don’t cover in this manual. There’s more information in the RPSM.
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