Tony Granger outlines the pension contribution and fund taxation regime for business owners.
For some, it may become expensive to make pension contributions, as over-contributing can have taxation consequences. For many, the restrictions are confusing, and those who opted for ‘fixed protection’ will find their continued pension funding restricted.
Annual and lifetime allowances
There is an annual allowance on pension contributions applying to individuals, as well as a lifetime allowance applying to pension fund values from all registered funds combined.
The annual allowance limits the total of all contributions, including personal, employer and third-party contributions. It also limits the benefits built up in defined benefit schemes (such as final salary schemes).
The employee can receive contributions up to the maximum standard annual allowance (£40,000 for 2018/19) less annual allowance restrictions and payments to other pension schemes.
The annual allowance may be subject to tapering downwards according to earnings and the type of pension scheme invested into. It could be as low as £4,000 (i.e. for the money purchase annual allowance).
Tapered annual allowance applies if ‘adjusted income’ is more than £150,000 and ‘threshold income’ is more than £110,000 – both apply broadly to reduce the £40,000 standard annual allowance to a minimum annual allowance of £10,000.
Pension contribution checks must be made against the annual allowance (£40,000 maximum) and lifetime allowance (LTA; currently £1.03 million in 2018-19, increasing with inflation from April 2019).
If the annual allowance (including the carry forward allowance) is exceeded, an annual allowance tax charge is payable.
The annual allowance can be expanded by using carry forward allowances, which accumulate unused annual allowances from the past three years and can be added to the current year’s annual allowance. You must have had a registered pension scheme during that period to carry forward.
Money purchase annual allowance
Where a scheme member has flexibly accessed any of their pension scheme benefits, the annual contribution allowance falls to £4,000.
If you have both defined benefits and defined contribution (DC) arrangements and flexibly access the DC scheme, the alternative annual pension allowance is £36,000 (in 2018/19).
Employees who have opted for protection
If you protected your lifetime allowance (at a higher level than the current one), you are precluded from making any further pension fund contributions to new or current arrangements if you wish to retain your protections.
Maximum employer contributions
Employer contributions are not restricted into a registered pension scheme (regardless of salary levels). However, the contributions must satisfy the 'wholly and exclusively' requirement to receive tax relief. Employer contributions count towards the annual allowance of the employee. Where exceeded, employees can be liable to a charge on the excess.
Employee making own contributions
The employee must satisfy the relevant income rules for pension contribution purposes. For example, you cannot make a contribution of more than 100% of earned income in any one tax year.
Tax relief for the employer
Tax deductions as an expense are subject to the contribution being ‘wholly and exclusively’ for the purposes of the trade. Pension contributions are included in the profit and loss account of the employer, reducing profits.
Contributions must actually have been paid, and are generally treated as a deduction only in the accounting period in which they are paid unless the rules require spreading of the tax relief over different accounting periods on the basis of being exceptionally large.
Tax position of the employee
There is no need to have a salary at a relevant level to receive employer pension contributions.
If the annual allowance is exceeded, the excess is added to the member’s income and taxed at his or her marginal rate.
Tax charges
Tax is not payable on registered pension fund growth. Tax is payable when benefits are taken which exceed the tax-free allowances (e.g. 25% of the fund may be taken as tax-free cash). The potential tax rates for annual allowance and lifetime charges are:
(a) Annual allowance charge (i.e. where pension contributions exceed the annual allowance) – taxed at the marginal rate (20%, 40% and/or 45%).
(b) Lifetime allowance charge (i.e. where the value of registered pension scheme benefits exceeds the lifetime allowance) – 55% of the amount over the lifetime allowance if paid as a lump sum; 25% if the amount is not taken as a lump sum.
Practical Tips:
• Make annual allowance checks; a tapered annual allowance may affect higher earners, creating tax charges on excess contributions.
• Make lifetime allowance checks, and if you have protected funds, check your contribution position. If overfunded, consider alternative employee benefits.
