Annual allowance (AA) is set by the Treasury and is currently £40,000. The AA is the amount by which the value of your pension benefits may increase in any one year without you having to pay an excess tax charge. Your personal AA may be less than £40,000 if your taxable income exceeds HMRC limits or you’ve accessed flexible benefits.
Your pension savings over the tax year are calculated by subtracting the capital value of your pension at the start of the tax year (with an adjustment for inflation) from the capital value of your pension at the end of the tax year.
The capital value of your pension is calculated as 16 x your pension, plus any automatic lump sum.
In this example, we’re going to calculate a member’s pension savings over the 2018/19 tax year (standard annual allowance of £40,000).
The member’s pension benefits on 5 April 2019 are as follows:
- Pension = £20,000
- Lump sum = £52,000
Giving a value of (16 x £20,000) + £52,000 = £372,000
The member’s pension benefits on 5 April 2018 were:
- Pension = £16,500
- Lump sum = £45,000
Giving a value of (16 x £16,500) + £45,000 = £309,000
Therefore, the growth in the member’s pension savings for the 2018/19 tax year were = £372,000 – (£309,000 + 3% inflationary increase) = £53,730
As the growth in the member’s pension savings exceeds the 2018/19 annual allowance of £40,000 by £13,730, the member may be subject to a tax charge on the excess; however, if the member didn’t use up their annual allowance in the previous 3 tax years, then they can ‘carry forward’ this unused allowance to offset the excess, resulting in a lower tax charge, or possibly no tax charge, being applied.
In addition, although the standard annual allowance for the 2018/2019 tax year is £40,000, there is a ‘tapered’ allowance that may apply depending on whether you’ve exceeded the ‘threshold income’. For more information about how this works click the box below.
Capita will let you know if you’re reaching the AA and if you’re affected by a tax charge. You can also see our ‘High Earner Resource Hub’ if you think you may be affected.