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Pensions Annual Allowance – an easy mistake to make

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Many individuals pay into a pension scheme each year, whether through their employer, making their own contributions into a private scheme or a combination of both.  However, what most taxpayers don’t know is that there is both a life time limit and annual allowance.  Exceeding either of these comes with a significant tax charge, but the annual allowance is often the one that is missed. The annual allowance is the maximum amount that an individual can contribute to their pension and obtain tax relief.  This simply means that the money goes into their pension “tax free” because tax is paid normally when the money is taken out after retirement, depending on the earnings of the individual at that time. The annual allowance is currently £40,000 for individuals earning below £150,000.  This is a significant amount of course.  However, if earnings exceed this level the allowance is reduced by £1 for ever £2 that earnings exceed this limit.  This means that for an individual with earnings of £210,000, the limit is only £10,000. In fact, the law guarantees that the annual allowance will go no lower than £10,000.  In some circumstances, it is possible to roll unused allowances for the prior three years forward, as a temporary solution.  In the past this was a valuable method of escaping the problem, but individuals with consistently high contributions are running out of allowances. This is the situation that often causes a problem.  It is common that an individual at this level may be making pension contributions of 5% gross and their employer a similar amount.  On a salary of £210,000, this gives gross contributions of £21,000, exceeding the annual allowance but over 100%.  The individual will normally be forced to pay back the tax relief on everything over £10,000, resulting in an unexpected tax charge to the tune of £4,950.  This charge can be paid directly or from funds held in the pension. Stats for 2017-2018 show that in fact over 37,000 people in the UK had to pay a charge as a result of exceeding the annual allowance.  The amount of contributions in total over the limit amounted to £812m according to HMRC figures recently released.  Both of these numbers are significantly up from the year before, with only 18,500 being affected to the tune of £578m in that prior year. Many people do not immediately realise.  Pension companies are not often aware of the earnings of the individual concerned and since the limit could be as much as £40,000, they would not know to ‘warn’ their customers accordingly.  Employers are really the ones in a position to pass on this message to their higher paid employees.  However, it’s amazing how often employers do not have systems in place to do so, with the individuals concerned only finding out when they or their tax adviser submit their tax return. In fact, its common that individuals who prepare their own tax return do not even realise this is an issue even when preparing their return, causing a tax enquiry as a result. Individuals are advised to consider the contributions that both them and their employer are making on a regular basis in conjunction with their tax adviser.  Since tax relief is limited, many employers offer flexible benefits packages where the individual may be able to obtain a more preferential benefit at a similar tax cost. For more information on annual allowances or for assistance preparing your tax return, please contact Wisteria’s tax team. For more information on tax saving ideas for your business, contact Wisteria’s tax team on 020 8429 9245.

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