Although there is no limit on the amount that an individual can save in the form of contributions to pension schemes, there is a limit on the amount of pension savings that qualify for tax relief. This limit is known as the annual allowance.
From 6 April 2011 the annual allowance will be reduced from its current level of £255,000 to £50,000. However, relief will remain available at the individual’s marginal rate of tax. Under the current rules, any unused element of the annual allowance is wasted. However, under the new rules applying from 6 April 2011, any unused allowances can be carried forward for a maximum of three years.
This means that over a four-year period (assuming the allowance remains at £50,000) an individual can make tax-relieved contributions of up to £200,000 over that period. This means that it is possible to make tax-relieved pension contributions of more than £50,000 in any one year as long as there are sufficient unused allowances carried forward.
This is illustrated by the following example.
Example
Patrick makes contributions as follows in the three years from 2011/12 to 2014/15:
Year Contributions to registered pension schemes
2011/12 £15,000
2012/13 £20,000
2013/14 £5,000
Assuming an annual allowance of £50,000 in each year, Patrick has unused allowances as follows:
Year Annual Contributions Unused Unused Unused
allowance in year allowance allowances b/f allowances c/f
2011/12 £50,000 £15,000 £35,000 £0 £35,000
2012/13 £50,000 £20,000 £30,000 £35,000 £65,000
2013/14 £50,000 £5,000 £45,000 £65,000 £110,000
In 2014/15 Patrick can make tax relieved pension contributions to a registered pension scheme of up to £160,000 (£50,000 allowance for 2014/15 plus unused allowances for three previous three years of £110,000).
Where allowances are carried forward, the order in which allowances are used is as follows:
• Current year
• Previous years – earliest year first
This means that if in the above example Patrick were to make contributions in 2014/15 of less than the annual allowance, the unused allowances brought forward from 2011/12 of £35,000 would be lost. However, any unused allowance from 2014/15 would be available for carry forward for three years.
By contrast, if Patrick makes contributions to registered pension schemes of £90,000 in 2014/15, this would be covered as follows:
• £50,000 by the annual allowance for 2014/15;
• £35,000 by the unused allowances from 2011/12; and
• £5,000 from the unused allowances from 2012/13.
This would leave Patrick with unused allowance to carry forward to 2015/16 of £70,000 (the balance of £25,000 from 2011/12 and £45,000 from 2012/13).
Lifetime Allowance
The lifetime allowance places a cap on the value of pension benefits that can be received tax-free. If pension benefits exceed the lifetime allowance, a tax charge (known as the lifetime allowance charge) applies to the excess.
Practical Tip
The lifetime allowance is currently £1.8 million. The Government have announced that this is to be reduced to £1.5m from April 2012. However, those people who have already built up pension benefits in excess of £1.5m will have those protected to the level of the current lifetime allowance.
By Sarah Bradford
