For Pensions Awareness Week – an example of the pension questions we receive, helping you better understand your pension.
I have received an Annual Allowance letter for the first time. I don’t understand why I have to pay tax on my pension or what has caused this. How much will the tax charge be?
Annual Allowance (AA) was introduced to limit the amount of pension savings in any one tax year that can attract tax privileges. This limit is currently £40,000 per tax year. If the contribution (input amount) to the Scheme member’s pension fund exceeds £40k then the member is liable to a tax charge on the excess contribution.
Although the armed forces pension is non-contributory a method to determine how much would have been contributed (input) was devised by HMRC based on the value of your pension. The Input amount is calculated by taking the annual pension value at the start of the tax year (6th April) multiplying it by 16 and adding any lump sum entitlements. The value is then calculated the same way at the end of the tax year (5th April). The value at the start of the tax year is inflated by the Consumer price Index (CPI) for that April. The input amount is the difference between the two.
If the AA limit is exceeded in any given year then unused allowance from previous years can be used to offset the excess. The rules allow only the previous 3 tax year’s unused allowance to be considered.
Glasgow have sent you the letter because you have exceeded the AA limit for the tax year. Your total input for that tax year was £97,668 and therefore you exceeded the limit of £40K by £57,668. However you have unused allowance from the 3 previous tax years which total £26,144 which can be offset against the breach of £57,668. Therefore £57,668 – £26,144 = £31,524. This is not the tax due but the breach upon which the tax charge is calculated and this will be at your marginal rate of tax ( in your case this is 40%) and therefore you can expect the tax charge to in the region of £12,609 (£31,524 x 40%).
You are a member of the 75 Scheme only. The pension value at the beginning of the tax year has been based entirely on an OF3 as at that point you had less than a year in the higher rank (OF4). The pension value at the end of the tax year however, is based on you having 18 months in the higher rank. So almost all of the increase towards the higher rank (2 years substantive required to achieve the full uplift). This causes a greater difference between the two values and consequently a higher pension input amount.
It is often a promotion and the accompanying spike in pension value that accompanies it that results in an Annual Allowance breach.
You can use the HMRC online AA calculator and the input amounts from the letter sent from Glasgow to determine the amount by which you have breached. You have the option to pay the tax charge directly to HMRC or you can choose Scheme Pays. Scheme Pays means that the Scheme will pay the tax charge on your behalf and when your pension comes into payment there will be a reduction to the annual pension for life and a one-off reduction to the lump sum too.
Wendy Bandeira, Senior Pension Adviser