At this time of year, questions from advisers on the annual allowance (AA) and the AA charge come into my team thick and fast.
For most people, the AA is of little concern as they're unlikely to ever be in a situation where their pension savings exceed the allowance of £40,000 in a single year. However, for a small minority of clients, and particularly those affected by the tapering of the AA, the whole issue around the AA charge can be something of a headache because they need to finalise their tax return and pay any resulting liability for the previous tax year before the end of January.
Where the individual identifies that they have an AA charge to pay, they need to complete the boxes in the ‘Pensions savings tax charges'
section of their online tax return, or the additional information pages SA101 in a paper return.
While the liability for the AA charges falls on the individual taxpayer, there are several ways the liability can be met.
They can pay the charge themselves, or alternatively, if they satisfy certain criteria, they can ask the scheme to pay the charge, meaning the scheme administrator becomes jointly and severally liable with the member for the charge.
For ‘scheme pays' to apply, the criteria are:
- Their AA charge liability for the tax year has exceeded £2,000 and
- Their pension input amount for the pension scheme for the same tax year has exceeded the AA amount of £40,000. (Note: that the tapered AA and/or money purchase annual allowance is ignored).
A final option, which could perhaps be construed as a hybrid of the previous two, is where the scenario doesn't satisfy the ‘scheme pays' rules, but the individual still asks the scheme to pay the charge on their behalf. If the scheme were to accept this request, it would be on a voluntary basis, though the liability remains with the individual.
There are potential pitfalls with this option, even where some of the liability falls under scheme pays with the remainder on a voluntary basis. It should be noted that whenever the scheme meets any of the charge, there must be an appropriate reduction in the person's pension benefits.
Let's consider an example
Gregor had a pension input amount for 2019/20 of £61,675 and had carry forward of unused AA of £25,228. He was impacted by the tapering of the AA to the extent his AA was just £10,000.
Conscious that he needs to settle his tax liability for 2019/20 he must ascertain what amount of the AA charge can be met on the mandatory basis and what proportion falls on him personally. Gregor is an additional rate taxpayer, with the whole of any AA charge being at a rate of 45%.
- The chargeable amount is £26,447 (£61,675 - [£10,000 + £25,228])
- Excess over the AA is £21,675 (£61,675 - £40,000)
- Potential scheme pays liability of £9,753 (£21,675 x 45%)
- Remaining liability £2,148
Although Gregor has until the 31 July 2021 to notify the scheme that he wishes to make use of scheme pays, he still has to account for the full charge in his tax return and pay the non-mandatory element by 31 January 2021, otherwise, he runs the risk of interest and penalties being applied.
I would suggest it's therefore prudent not to leave things until July, but rather for Gregor to ensure the SA is given sufficient notice to facilitate payment within the appropriate deadlines. For the portion of the charge covered by scheme pays, the SA then include this in their quarterly accounting for tax (AFT) tax return.
If the scheme also agreed to meet the residual liability of £2,148 on a voluntary basis, Gregor would be advised to check that this amount was actually paid by the SA before 31 January 2021. In situations where all the liability is to be met voluntarily, it is even more important that the individual ensures payment is made before the end of January.
Failure to do so could, again, result in interest charges and a penalty falling on the individual, bearing in mind the voluntary element of the liability remains solely with them.
Scheme pays or not scheme pays? That is a question where early planning and considerations of all the options may provide an appropriate answer.
Neil MacGillivray is head of technical support at James Hay