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Where the annual allowance has been exceeded, a scheme member can ask for the annual allowance charge to be paid from their pension fund using ‘Scheme Pays’.
However, there is a time limited window from 6 April to 31 July to notify a pension scheme that they wish to utilise this. This starts from the end of the tax year in which their annual allowance charge arises.
This means that the deadline for making a ‘Scheme Pays’ request to cover an annual allowance charge in respect of the 2021/22 tax year is 31 July 2023.
Conditions for Scheme Pays
For Scheme Pays to apply, both the following conditions must be met:
For the purposes of Scheme Pays, the tapered annual allowance and money purchase annual allowance limits are ignored. For example, if someone’s annual allowance charge is £5,000 by reference to the money purchase annual allowance, but would have been £3,000 by reference to the annual allowance, the maximum amount that they can require the scheme to pay is £3,000.
Where the conditions for Scheme Pays are not met, a scheme can still agree to pay the annual allowance charge for their member on a voluntary basis - albeit they are under no obligation to do so.
Otherwise, the individual will be required to pay the annual allowance charge liability themselves and account for this via Self-Assessment.
How much is the Annual Allowance Charge
The annual allowance charge aims to reduce the tax relief on pension savings above the annual allowance.
To determine the rate of the charge, an individual needs to work out the tax that would be charged if their excess pension savings were added to their taxable income.
This results in an annual allowance tax charge of 20% where the annual excess falls into nil or basic rate tax, 40% for higher rate tax and 45% for additional rate tax. For Scottish taxpayers (or where the excess straddles tax bands), the annual allowance charge will be at a slightly different rate to reflect the income tax position
Understanding available annual allowance can be complex and some people will find that they inadvertently exceed the limit. This is often the case with higher earners who may be using carry forward allowances or have been subject to the tapered annual allowance either now or in the past.
Unless the annual allowance excess also exceeds the members relevant UK earnings (thereby qualifying for a ‘refund of excess contributions lump sum’), a refund will not usually be possible and an annual allowance tax charge must be paid.
For these individuals, the 31 July deadline for Scheme Pays is fast approaching. If someone is subject to an annual allowance charge for the 2021/22 tax year (and meets the necessary conditions), they will need to notify their scheme administrator by that date for Scheme Pays to apply.
Finally, it’s worth remembering that if an annual allowance charge does arise and contributions were made to a Relief at Source scheme, the individual should still ensure they claim higher rate or additional rate tax relief on the contributions. If they don’t, they may find that have effectively paid tax on the contribution at a rate between 60% and 70%.
Please note this is for general information only and is based on LV=’s understanding of the relevant legislation and regulations and may be subject to change.
The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.
The use of this document is at your own risk, and the content should not be used for the provision of professional advice.
LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.