Claire Trott: Decisions to make on annual allowance charge

Due to the tapered annual allowance, many people are subject to an annual allowance charge, which can be a significant outlay, writes Claire Trott. Here she discusses client options which need careful consideration...

Hopefully, most clients will have received their pension savings statements for the tax year 19/20 and will have been able to calculate if they have an annual allowance charge.

Due to the tapered annual allowance many people are subject to an annual allowance charge, which can be a significant sum of money. Thankfully when we are looking at the year ahead, we should see fewer people impacted down to the increase in the threshold and adjusted income figures for 20/21 onwards.

For those who don’t meet the mandatory scheme pays rules, they may well have to find these funds themselves or use, if available, the voluntary scheme pays option. Care needs to be taken to understand how it works and the implications it will have on retirement benefits.

Mandatory scheme pays basics

An individual can elect to notify their scheme administrator that they require the scheme to pay some or all of their annual allowance charge liability in return for an appropriate reduction in their pension benefits within the scheme; the following two conditions must be met:

  1. their annual allowance charge liability for the tax year has exceeded £2,000; and
  1. their pension input amount (PIA) for the pension scheme for the same tax year has exceeded the annual allowance amount in section 228 Finance Act 2004; currently £40,000

If the conditions are met then once a member has notified their scheme administrator that they want the scheme to pay all or part of their annual allowance charge, the scheme administrator will become jointly and severally liable to the annual allowance charge together with the member.

The maximum amount that a member can ask their scheme administrator to pay under mandatory scheme pays is based upon the PIA under the scheme that exceeds the annual allowance. There is no minimum amount that the member can ask their scheme administrator to pay but, if this is less than £2,000, then they will need to confirm to their scheme that their annual allowance liability for the year is more than £2,000.

The member does not have to ask their scheme administrator to pay the maximum amount that they are entitled to request. Alternatively, they can ask the scheme to pay part of the amount and then the member would pay the difference direct to HM Revenue & Customs (HMRC).

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It is still possible to request that mandatory scheme pays is applied even if the scheme has transferred in the interim. The ceding scheme won’t be able to pay the charge because it won’t hold any of the client’s assets, but the requirement to pay can be passed onto the new scheme administrator.

Voluntary scheme pays basics

Voluntary scheme pays is just as it says, if mandatory scheme pays doesn’t apply or doesn’t cover the whole payment due to the MPAA or tapered annual allowance, the scheme can pay the charge on a voluntary basis. This type of scheme pays doesn’t make the scheme jointly liable for the payment; it is still the responsibility of the member to ensure it is paid.

This was originally most common in money purchase schemes where the deduction of the charge is usually the simplest and has the least impact on the administrator. However, we are seeing this becoming more widely available in recent years from defined benefit pension schemes as well.

Deadlines to note

For those that are using voluntary scheme pays then it is worth noting the deadline for HMRC to receive the funds is the same that applies for self-assessment (31 January following the tax year in which the charge arose).

For mandatory scheme pays the deadlines are more lenient. The scheme needs to be notified of the client’s intent to use scheme pays before 31 July following the end of the tax year in which the charge arose. That said, it will still need to be declared on the self-assessment form, so the figures will still need to be calculated by then.

A word of warning, I have experienced schemes who don’t appear to agree with the client’s request for mandatory scheme pays, trying to use carry forward as an excuse. The scheme has no right to calculate the available carry forward in order to decide if mandatory scheme pays applies – it is irrelevant here.

The amount of the deduction

The scheme must make sure that the adjustment made to the member’s entitlement to benefits is just and reasonable, having regard to normal actuarial practice. HMRC would expect a scheme to be able to demonstrate that the adjustment made was just and reasonable.

Where the adjustment is not just and reasonable (or no adjustment is made at all), the payment of the annual allowance charge on behalf of the member by the pension scheme would be an unauthorised member payment.

I am unaware of any challenges to the adjustments made to pension benefits following the application of scheme pays, but in theory, it could happen.

Claire Trott is head of pensions strategy at St. James’s Place Group

Read all of Claire’s columns for PA, here