Carry on Pensions: How Carrying Forward Unused Relief Could Result in a Tax Bill Instead of a Tax Rebate

Stocks and shares remain volatile, bond yields are stagnating, property prices are falling and interest from cash remains as low as ever. With so much uncertainty around, pension contributions remain an attractive prospect for savers with associated tax reliefs representing an immediate uplift of 20%, 40%, 45% or even 60%; a reward almost unattainable in any other mainstream investment or savings vehicle.

Pension tax relief was already considered low hanging fruit for the Chancellor of the Exchequer’s cost cutting and now, post Lifetime ISAs and Brexit, the end is potentially nigh. Quite rightly, savvy savers are therefore looking to ‘Carry Forward’ unused allowances from previous years to maximise tax relief whilst they still can, but are they entitled to it? David Smith, Director of Financial Planning at Tilney, considers the pitfalls and punishments of the allowance and how a little knowledge is proving to be a dangerous (and expensive) thing for many…

Carry Forward
“Carry forward is a very useful tool for both high earners and employers to make significant pension contributions in a single tax year. It is highly tax efficient in a number of scenarios, with Income tax relief of up to 60%, Inheritance Tax relief of up to 40% and potentially Corporation Tax relief of up to 20%, there is no savings vehicle like it.

“With only a standard annual allowance - that is the amount you can pay into a pension (or the deemed pension contribution amount) - of £40,000 per annum, Carry Forward potentially allows a contribution of up to £170,000 to be made during the current tax-year, less contributions (or deemed pension input) already made in the current and previous three tax years.

“As is ever the case though, it is not that simple. First of all, a commonly unknown requirement is that the individual must have possessed a registered pension scheme in the tax-year from which they intend to carry forward the unused allowance. Whilst this could be a standard Personal Pension, a workplace pension or a defined benefit scheme for example, an annuity does not necessarily fall into this bracket. Indeed, the purchase of this insurance contract often reflects the cessation of pension scheme membership. So, someone who took retirement benefits early and have since set up a new plan to utilise carry forward, might well be contributing more than is allowable.

“Savers must also be aware of a reduction to the annual allowance if they are high earners. Anyone with ‘adjusted income’ over £150,000 (essentially, income from all sources plus pension contributions) in a tax-year, could see their annual allowance reduce to £10,000 for the current tax-year, although previous years for carry forward could still potentially remain at £40,000 or £50,000. This is especially important to note if significant regular contributions are currently being made; a saver could breach the allowance without even knowing.

“Anyone who has accessed a new tranche of income from their pensions either this tax-year or last should be aware – they may only be entitled to £10,000 annual allowance this year and have no facility to carry forward whatsoever!

Contribution is key
“Perhaps the most complicated aspect of the annual allowance and carry forward is the determination of the deemed pension contribution within defined benefit pensions. Anyone with Local Government Pensions, NHS pensions etc. may be forgiven for assuming it is the amount they physically contribute that determines how much they have paid in. However, it is in fact the deemed increase in the value of benefits over the course of the scheme year that will be tested against the individual’s annual allowance.

"The situation is further complicated for those high earners who could be affected by the Tapered Annual Allowance. In this instance, not only do they have to calculate the annual allowance input but, they then need to deduct their own personal contributions into the scheme to establish the deemed cost of the employer contribution. This deemed employer contribution will then be added to their other income for the ‘adjusted income’ test. I would encourage members of defined benefit schemes who receive remuneration in excess of £100,000 or, those members who might receive an incremental award or large increase in salary, to seek specialist advice on this matter. Again, individuals could be incurring tax charges without even knowing.

But what is the tax charge?
“Should an individual ever breach their annual allowance, or cumulative carry forward (if available), they will be liable to pay a tax charge on the excess amount. This excess will be added to the individuals’ other income for that tax-year, with a tax charge of up to 45% of the excess potentially payable. From my experience this could be many tens of thousands of pounds; possibly more than what they would have been charged in income tax if they had received it as income in the first place. If the tax liability exceeds £2,000, the individual can request their pension scheme provider to pay the bill from their pension fund but various criteria must be met and the tax due would normally be paid through self-assessment. Compounding matters, any excess contribution now sits within the pension scheme, so 75% is potentially taxable upon withdrawal.

“All in all, what at first seems like a harmless calculation to determine a highly advantageous allowance is in fact an incredibly technical and obstacle-strewn process, which could ultimately result in additional tax being paid, instead of tax being saved. Therefore, should carry forward be of interest – get financial advice.”

To discuss this or any other financial planning topic please contact Gary Smith on 0191 269 9970/ david.smith@tilney.co.uk

-ENDS-

Important information

The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This press release is not advice to invest or to use our services. Past performance is not a guide to future performance. If you are in doubt as to the suitability of an investment please contact one of our advisers.

Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change. Please note we do not provide tax advice.