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Annual Allowance

In April 2006 legislation came into force which fundamentally changed the rules governing the tax treatment of pension schemes and introduced the concept of an Annual Allowance – effectively a limit on the amount of pension contribution or accrual which could take place each year.  Initially set at £215,000 in 2006 this was reduced to £40,000 in April 2014.

Where the Annual Allowance is exceeded, the excess is subject to a tailored tax charge designed to recover the tax relief that the excess contribution (or accrual) is deemed to have received.

Where the full Annual Allowance is not used in  any given tax year, it is possible to carry forward the unused portion for a maximum of 3 years.

In the case of defined contribution money purchase schemes the contributions paid are simply tested against the Annual Allowance limit but clearly this is not practicable for defined benefit final salary arrangements like those typically found in the public sector.

Instead, the ‘opening value’ and ‘closing value’ of the pension entitlement is calculated at the beginning and end of the tax year in question. These values are then capitalised using a factor of 16:1 and the difference  measured.

Where the value of the contributions or accrual exceed the Annual Allowance the excess is subject to income tax at the members marginal rate. In certain circumstances the tax can be paid by the pension scheme.

Tapered Annual Allowance

If you are fortunate enough to earn more than £150,000 per annum then your Standard Annual Allowance of £40,000 will be reduced by £1 for every £2 of earnings above £150,000.

Consequently anyone earning £210,000 or more will have their Annual Allowance reduced to £10,000.

Money Purchase  Annual Allowance

Since 6 April 2015 a reduced Annual Allowance in respect of money purchase pension contributions, known as the money purchase annual allowance (MPAA), applies to individuals who have flexibly accessed their money purchase pension benefits.

HMRC introduced the MPAA to ensure that there are no potential recycling issues with individuals claiming further tax relief on any new contributions made having just taken their pension benefits under the  pensions flexibility rules.

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