RP case studies: Looking back to maximise pension tax allowances

Jess List explores a pension contribution case where a high earner finally gets the retirement planning bug and needs some tapered annual allowance advice

The ability to carry forward unused allowance from up to three previous tax years has given some breathing space to people affected by the tapered annual allowance.

However, looking back to the last three tax years still means looking back to the transitional rules from 2015/16.

The situation

Geraldine has earned £240,000 for many years but has never really engaged with pension saving. She has been contributing 5% of her salary as a combination of employer and personal contributions for as long as she can remember.

Prompted by a conversation with her parents about retirement and pensions, she has decided that she probably isn’t saving enough and would like to contribute more.

Geraldine is vaguely aware of the annual allowance: she remembers her parents saying that they kept an eye out to check how much they could contribute each year. Geraldine wants to pay in as much as she can. She arranges a meeting with Joey, a financial adviser, to discuss things further.

Joey has some bad news for Geraldine: because of the tapered annual allowance rules which were introduced on 6 April 2016, her annual allowance is much lower than it would have been previously. Joey explains that as Geraldine’s income excluding pension contributions is above £110,000 and her income including pension contributions is above £150,000, she is affected by these rules.

The tapering reduces the annual allowance by £1 for every £2 of income above £150,000, down to a minimum allowance of £10,000 for those whose income is above £210,000.

Geraldine falls into this category.

Joey then confirms that as Geraldine has been contributing 5% of her salary, £12,000, for years, she already inadvertently exceeded her tapered annual allowance over the last two tax years.

Geraldine is concerned about this until Joey confirms that it is possible to use unused allowance from up to three previous tax years in order to make larger contributions. Joey explains that when you carry forward unused allowance, you always have to start at the earliest of the three tax years.

Geraldine first overpaid in 2016/17 by £2,000. The earliest tax year she can carry forward from is 2013/14. As Geraldine contributed £12,000 in that tax year too and the annual allowance was much higher – £50,000 – there is more than enough to cover the overpayment.

Geraldine realises that if she had thought about this sooner, she could have made an even larger contribution in 2016/17 to use some more of the unused allowance from 2013/14.

However, as carry forward only allows her to go back three tax years, it is now too late and the rest of the unused allowance from that year is lost.

Joey confirms that the situation for 2017/18 is similar: Geraldine exceeded the tapered annual allowance for that year by £2,000, but she has plenty of unused allowance from 2014/15 to cover this. The rest of the unused allowance from that year is also lost.

This brings them to the current tax year, 2018/19. Starting from the earliest tax year first, Geraldine can carry forward unused allowance from 2015/16, 2016/17 and 2017/18; however, she already used her full allowance in 2016/17 and 2017/18. This only leaves 2015/16.

Joey then explains that 2015/16 was a strange year for annual allowance purposes, due to an exercise to align everyone’s pension input periods (the period of time over which pension savings are measured and tested) to the tax year.

This involved splitting the tax year into two and introducing some transitional measures for testing against the annual allowance.

In order to work out how Geraldine’s contributions in 2015/16 were tested against the allowance and how much she has available to carry forward, Joey needs to know exactly when the contributions were paid. Geraldine checks her records and finds that her contributions are paid on the 15th of each month.

Joey knows that 2015/16 was split into the ‘pre-alignment’ and ‘post-alignment’ periods.

The pre-alignment period ran from 6 April 2015 to 8 July 2015. Therefore Geraldine made £3,000 of contributions in that time. The annual allowance for the pre-alignment period was £80,000. For those not affected by the money purchase annual allowance (MPAA), the annual allowance for the post-alignment period was nil, plus up to £40,000 of unused allowance from the pre-alignment period. This means Geraldine’s allowance for the post-alignment period was £40,000. She made £9,000 of contributions in that time, leaving her with £31,000 of allowance to carry forward and use in 2018/19.

The results

Joey confirms that Geraldine can make £41,000 of contributions in total in 2018/19 without exceeding her total available annual allowance. From next year, if her income and the tapered annual allowance rules remain the same, Geraldine’s total allowance will be £10,000 each year, as she will have fully used the allowance in each of the years she might otherwise have been able to carry forward from.

Joey knows this is less than Geraldine would have liked – after all, it’s lower than the amount she was already contributing.

Joey explains to Geraldine that the annual allowance (including variations such as the taper) does not limit how much she can contribute to her pension: it only limits the amount of tax relief she can benefit from.

If her contributions exceed her annual allowance, she will pay an annual allowance charge which in effect takes back the tax relief she is assumed to have received on the excess.

While tax relief is a big incentive for pension saving, the rest of the contribution will still benefit from the other tax advantages of a pension wrapper, such as tax-free investment growth and a potentially advantageous inheritance tax position.

Joey will also explore other options for Geraldine to boost her retirement, and arranges to meet with her again.

Jessica List is pension technical manager at Curtis Banks Group