Annual Allowance
One of the benefits of your pension is that it is tax free up to a certain limit. This is known as your annual allowance. Once you exceed your annual allowance, there are some tax implications you will need to consider.
Contents
Changes to annual allowance 2023
Please be aware that the 2023 Spring Budget included plans to increase the annual allowance from £40,000 to £60,000 from 6 April 2023. If you receive a Pension Savings Statement from us in 2023, this will be for the 2022-2023 tax year when the £40,000 limit still applied.
What is annual allowance?
One of the perks of putting money into any kind of pension scheme is that it’s tax-free… up to a point. The only downside is that there is a limit on how much you can save before HMRC starts to take its share. This limit is called your annual allowance (AA).
LGPS pensions only
Your annual allowance is currently set at £40,000 for the majority of members. This is the maximum amount of money you can build up each year across all of your pension schemes – including salary deducted contributions, employer contributions and any additional private pensions you may have.
This is where it gets a little complicated. Rather than just adding up how much you and your employer pay into your company pension, your annual allowance contribution is calculated by working out the change in value of your pension benefits over the course of the year. This is done by:
- Multiplying the growth in the value of your pension by 16
- Adding on the value of any automatic lump sum you might be entitled to with your pension
- on any AVCs that you or your employer have paid in during the year
The same calculation is carried out at the beginning and the end of the financial year (April 6 – April 5) with an appropriate adjustment included for inflation. The difference between the two amounts is what goes towards your annual allowance.
For example, if your pension is worth £10,000.00 at the start of the year.Start of year
Pension (assuming 3.1% inflation): £10,000 x 1.031 = £10,310
x 16 = £164,960
+ Lump sum (assuming 3.1% inflation): £4,000 x 1.031 = £4,124
Total = £169,084
End of year
Pension: £12,000 x 16 = £192,000
+ lump sum = £4,500
+ AVCs = £5,000
Total = £201,500
The amount of used up annual allowance = end of year calculation – start of year calculation.
£201,500 – 169,084 = £32,416 (+ any private pension contributions).
If maths isn’t your thing, don’t worry – we always work out your contributions throughout the year and whenever you get close to (or over) your annual allowance limit, we write to you and let you know.
In some ways, it’s a nice problem to have, but if you do have more than £40,000 pension savings in a single year, you will have to pay an annual allowance Charge (AAC). This is worked out in the same way as your income tax, so anything over the £40,000 limit is effectively taxed as though it were additional salary.
The good news is that you are allowed to bring forward any unused allowances from the previous three tax years. So, if you do have one bumper year, it is possible to reduce your annual allowance charge or avoid it completely.
When you transfer to an LGPS, Police or Fire pension from a scheme which isn’t LGPS, Police or Fire, it can sometimes have an impact on your annual allowance – especially if you’ve had a salary increase along the way. But there shouldn’t be too many surprises. Here’s how we calculate your annual allowance in that first year:
- We don’t include the value of any transferred pension benefits
- We don’t include any actuarial adjustments
- We do include the effect of a salary increase
- We do include any increase in final salary benefits
Transfer from another LGPS, Police or Firefighters’ scheme
If you have transferred service from another LGPS, Police or Fire pension provider, HMRC will treat that pension accrual as the same arrangement and unused allowance and salary links will remain from your previous arrangement.
While the annual allowance for most people is £40,000, this limit is reduced (tapered) for high earners. So, if your ‘threshold income’ is greater than £200,000 or your ‘adjusted’ income is greater than £240,000., you don’t enjoy the same amount of tax relief on your pension.
Threshold income = Total Income – pension contributions – death benefits from other pension schemes
Adjusted income = Total income + pension growth/PIA not pension contributions – any death benefits
A tapered annual allowance works on a sliding scale, so the more you earn, the less tax relief you receive.
Tapered annual allowance
| Total adjustable income | Annual allowance |
| £240,000 | £40,000 |
| £250,000 | £35,000 |
| £260,000 | £30,000 |
| £270,000 | £25,000 |
| £280,000 | £20,000 |
| £290,000 | £15,000 |
| £300,000 | £10,000 |
If you’re forced to retire early on health grounds, you may be able to claim a full pension without any reductions (known as a tier 1 or tier 2 pension). These enhanced benefits can sometimes lead to annual allowance charges in your final year of employment – but there are exemptions if you meet HMRC’s severe ill health criteria. For more information, visit the Gov.uk website
If you’re forced to retire early on health grounds, you may be able to claim a full pension without any reductions (known as a tier 1 or tier 2 pension). These enhanced benefits can sometimes lead to annual allowance charges in your final year of employment – but there are exemptions if you meet HMRC’s severe ill health criteria. For more information, visit the Gov.uk website
Paying your tax bill
Parting with your hard-earned cash
You’re probably not be too thrilled about having to pay tax on your pension, but if you have received an annual allowance charge there’s no point making it more stressful than it needs to be. The following information will help you cut through the clutter when it comes to making the payment.
If you owe less than £2,000
If your annual allowance charge is less than £2,000, you should pay it directly to HMRC as part of a self-assessment tax return. The deadline for this is 31 January (the following year).
If you owe more than £2,000
If your annual allowance charge is more than £2,000, we can usually pay it on your behalf out of your pension fund. This is done through our Scheme Pays facility.
What is Scheme Pays?
Scheme Pays is a way of paying some or all of your annual allowance charges out of your pension savings. Rather than asking you to pay HMRC directly, we make the payment on your behalf and reduce your pension fund to cover the cost. This works in one of two ways:
As the name suggests, this is a compulsory payment method for anyone who meets ALL three of the following conditions:
- Your LGPS, Police or Fire pension savings are in excess of £40,000
- Your annual allowance tax charge from your LGPS, Police or Fire pension scheme is over £2,000
- Your Scheme Pays deduction applies exclusively to your LGPS, Police or Fire scheme
If you use the Mandatory Scheme Pays facility, you and your LGPS, Police or Fire pension fund are jointly liable for meeting HMRC’s payment deadline of 31 January (the year after the tax charge).
This is an optional payment method for anyone who wants to pay their annual allowance charge out of their pension savings, but doesn’t meet the criteria of the Mandatory Scheme Pays. It typically relates to people who are affected by the reduced (tapered) annual allowance.
If you use the Voluntary Scheme Pays facility, you are solely liable for meeting HMRC’s payment deadline of 31 January (the year after the tax charge).
If you want to use Scheme Pays, you will need to complete a form, which is available via our helpdesk, or by emailing us via our contact form. Just be aware that once you’ve signed and returned this form, you can’t change your mind.
Your annual allowance statement
Good news travels fast
If you receive a letter from us, which includes your annual allowance and Pensions Savings statement, it’s probably because you’re over your limit or very close. Please read the contents carefully, as it will outline exactly where you’re up to and what, if anything, you need to pay.
What to do next?
We understand that these types of letters can often leave you scratching your head. Unfortunately, as your pension administrators, we are not regulated to offer tax advice, which means we are limited in the support we can provide.
We can answer questions about the contributions listed on your statement or the Scheme Pays facility. We can also check your records if you think you have exceeded your annual allowance and haven’t received a letter. But if you do need advice on your personal tax situation, you must speak to a professional adviser.
If you have received an annual allowance letter from LPPA, please complete the actions below (if applicable) by the given the deadline dates. This will help to prevent late payment charges being imposed by HMRC if you have a tax charge to pay.
| Action | Deadline date |
| 1. Check if you are subject to the Tapered Annual Allowance. Details on how to do this can be found on the HMRC website | 14 November 2023 |
| 2. Calculate whether there’s a tax charge for you to pay by visiting HMRC | 14 November 2023 |
| 3. Decide whether you wish to use Scheme Pays. An estimate of the effect this option has on your pension benefits can be provided upon request. Please advise us (Local Pensions Partnership Administration) of the amount of tax you wish the scheme to pay. You can do this by completing the Member contact form on the ‘Contact us’ page of our website (lppapensions.co.uk). Or, if you prefer, post your details to the address at the bottom of this letter. | 14 November 2023 |
| 4. We provide you with your Scheme Pays quote | 30 November 2023 |
| 5. If you decide to go ahead with using Scheme Pays, you complete and return your Scheme Pays form accepting the quote from Local Pensions Partnership Administration (this can be returned by email). | 18 December 2023 |
| 6. We process your Scheme Pays deduction | 17 January 2024 |
| 7. You notify HMRC that you have a tax charge owing by completing your self-assessment tax return by the statutory deadline. Completing a self-assessment tax return can be found here | 31 January 2024 |
Please note: once we’ve received your acceptance form for Scheme Pays you won’t be able to withdraw your application. At this point we’ll adjust your benefits accordingly and the tax charge will be paid to HMRC on your behalf.
If your annual allowance letter advises that ‘this is an interim statement’, there is currently nothing further you need to do with regard to any pension savings built up in the Fire or Police scheme. Please wait for the final pension saving statement for the year 2022/23 that will be issued to you by 6 October 2024.
However, if you have built up savings in any other pension scheme, you may still need to go through the HMRC self-assessment process.
Where to get tax advice?
If you don’t have a financial adviser or a professional tax adviser, websites such as www.unbiased.co.uk may be able to help you find a suitable candidate. Personal recommendations are also worth considering. Alternatively, the links below include up-to-date information that you might find useful.
HM Revenue & Customs website
The Pensions Advisory Service (TPAS)
