This second test (adjusted income) looks at total income, including the pension input amounts, which includes employer contributions – or deemed employer contributions for DB schemes. If this amount exceeds £150,000 then the standard annual allowance is reduced by £1 for every £2 in excess of £150,000. The minimum tapered annual allowance is set at £10,000.
Carry forward is available under the tapered annual allowance rules, but it is only based on the tapered amount each year, so this is key to ensure the calculations are accurate.
With all of the above, it can be very confusing for a member to establish the specific annual allowance that is relevant to them. In addition, we then need to establish the pension input amount, which is tested against their annual allowance. This could add another level of complexity.
DB vs DC
Another issue that raises questions is the way in which DB pension inputs are tested against the annual allowance, compared with the way DC pension input amounts are tested. With DB, the amount paid in has absolutely no relevance to the pension input amount and how much of the annual allowance it uses.
It should be noted that the amount of tax relief claimed does have a direct relationship to the amount contributed, which can make it even more confusing.
For example, take a member of a DB scheme who earns £60,000 at the beginning of the year and gets a £5,000 pay rise just before the end of the tax year. They have been a member of their pension scheme for 20 years at the start of the year, so 21 years by the end of the year. The contribution rates are roughly 10 per cent (£6,000) member and 15 per cent (£9,000) employer, although as it’s a DB scheme the employer contribution rate will vary in real life to ensure the scheme is fully funded.
If we calculated the pension input amount based on the above, it would be £36,320 using the consumer price index as of September 2018, at 2.4%. So we are assuming this is the pension input amount for this tax year 2018-19. If the CPI had been zero, the amount would have been £44,000, and had it been 5 per cent this figure would have been £28,000.
The lower the CPI, the greater chance of an annual allowance charge. This is because the pension input amount is calculated as the difference between the capital value of the benefits at the beginning of the year, increased by CPI, and the value of the benefits at the end of the year.
If we take the example here of CPI being zero, then the member will get a 40 per cent annual allowance charge on £4,000 if they have no available carry forward. They would have no control over this unless they wanted to opt out of the pension scheme, which isn’t usually good value even with an annual allowance charge. If this is happening every year, then financial advice should be sought to establish what the best option for the member might be.
