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You can, if you wish, pay up to 100% of your taxable earnings in any tax year (or £3,600 if greater) into any number of concurrent pension arrangements of your choice.
However, there are limits on the total amount of contributions you can make into all of your various pension arrangements and get tax relief. There are also limits on the pension savings you can build up before they become subject to a tax charge. This is in addition to any tax due under the PAYE system on pension payments. If these limits are exceeded, a tax charge may be due.
There are two main allowances for pension savings – an Annual Allowance (AA) and a Lifetime Allowance (LTA). These allowances limit how much tax relief you can get.
Annual Allowance (AA)
The annual allowance is set by HMRC. It is the maximum your pension can increase by in a tax year before you receive a tax charge. Each taxpayer has an annual allowance which may be allocated to his or her pension ‘pot’ without incurring liability to tax. Put another way, the annual allowance is the maximum amount of tax exempt pension savings, from all registered pension arrangements, that can be built up in one tax year. Tax is usually paid if savings in the individual’s pension increase by more than the Annual Allowance which is currently £40,000 a year (for 2020/2021 tax year).
All your benefits in the fund, and any Additional Voluntary Contributions (AVCs) and contributions to personal pensions or stakeholder arrangements, are added together each year to work out your pension input amount (PIA). This is tested against the annual allowance for each tax year.
This annual allowance has been gradually reduced over the last 6 years from £255,000 to the current £40,000 level. In a defined benefit scheme, such as the Firefighters Pension Schemes (FPS), the “value” of the amount of pension and lump sum which is built up across the tax year is estimated.
Any increase in the value of a:
- pension and lump sum above the Annual Allowance is subject to the Annual Allowance tax charge. Annual Allowance tax charge will be at the individual’s highest rate of tax
- pension over the year is multiplied by a factor of 16, meaning that a middle or high earning employee who receives a significant promotion or pay rise has the potential to be affected by this tax liability
Changes to the annual allowance, known as “tapering”, see the annual allowance reduce as low as £4,000 for high earning individuals, from April 2020.
Annual allowance limits
Pension input period
1 April 2011 to 31 March 2012
1 April 2012 to 31 March 2013
1 April 2013 to 31 March 2014
1 April 2014 to 31 March 2015
1 April 2015 to 5 April 2016
£80,000 (transitional rules apply)
6 April 2016 to 5 April 2017
£40,000 (unless tapering applies)
6 April 2017 to 5 April 2018
£40,000 (unless tapering applies)
6 April 2018 to 5 April 2019
£40,000 (unless tapering applies)
6 April 2019 to 5 April 2020
£40,000 (unless tapering applies)
6 April 2020 to 5 April 2021
£40,000 (unless tapering applies)
How is the annual allowance worked out?
Your pensions growth is measured over the ‘pension input period’ (PIP). From 6 April 2016, PIPs for all pension schemes were brought in line with the tax year – 6 April to 5 April.
How is an annual allowance tax charge triggered?
You will have a tax charge if your pensions input amount (PIA) in a tax year exceeds the annual allowance for that year, plus any unused annual allowance you may have carried forward from the previous three years.
You may have more than one PIA if you are paying into more than one pension scheme. Please take advice from a tax specialist if you think this applies to you.
Will you tell me if I exceed my annual allowance?
You will be sent a pensions savings statement if your savings in the Firefighters Pension Fund exceed the annual allowance limit for that year. You need this statement to work out if you must pay a tax charge. If you need to pay a charge, there are different ways to do this.
If you have pension benefits elsewhere, you must take these into account. It is your responsibility to pay the right amount of tax and you may need to take independent financial advice to make sure you understand your tax position.
What should I do if I get a pensions savings statement?
- Step one – Think about any pensions savings you have made outside of the East Sussex Fire and Rescue Firefighters Pension Fund to work out your total pension savings over the tax year.
- Step two – Think about any pensions savings you have made outside of the East Sussex Fire and Rescue Firefighters Pension Fund to work out your total pension savings over the previous three years.
- Step three – Work out if you have any unused allowance from the previous three years to see if you have any carry forward.
- Step four – Using your carry forward, work out if you have triggered an annual allowance tax charge (the HMRC annual allowance calculator can help).
- Step five – If you have triggered a tax charge, think about how you want to pay it. You can do this through a self-assessment tax return, ‘mandatory scheme pays (MSP)’ or a combination of both. In some cases you can also use ‘voluntary scheme pays (VSP)’ if you do not meet the criteria for MSP or you do not make your nomination in time.
- Step six– fill out your self-assessment tax return by the deadline of 31 January. Make sure to mention your tax charge and how you will pay it.
- Step seven – If you have chosen scheme pays, fill in the option form by the deadline of 31 July
How will the tax be collected?
Scheme Pays is a mechanism that allows an individual to ask the pension scheme administrator to pay any tax charge due to HMRC in relation to an excess of pensions savings above the Annual Allowance. In return there is a reduction pension benefits.
A scheme pays pension facility works by having the pension scheme pay the member’s tax charge initially from the pension fund, with the debt repaid by the member as a permanent debit applied to their pension once it comes into payment.
It is not the responsibility of the Fire and Rescue Authority (FRA) or the Administrator on behalf of the FRA to calculate the tax charge due. The member should inform the FRA of the amount of tax charge that they wish the FRA to settle.
Mandatory scheme pays (MSP)
If you have breached the standard annual allowance, you may use ‘mandatory scheme pays’ if the following points are met:
- The annual allowance tax charge exceeds £2,000 in the pension scheme that the scheme pays election is made;
- The individual is subject to the standard annual allowance (currently £40k);
- The relevant time limit for making an election has been met;
- This relates to a single scheme and to the immediately preceding tax year.
If you make an election requiring us to pay the annual allowance charge, both the scheme and yourself become jointly liable for the tax charge. The scheme administrator must pay the tax, but you must report the amount of the tax that will be paid on your self-assessment tax return.
The individual does not need to seek the consent of the Fire & Rescue Authority before they make their election, but they must confirm their decision in writing within the prescribed time limits. In particular, before they take any scheme pension benefits. If the conditions are met, then the scheme becomes jointly and severally liable (with the member) for the annual allowance charge and must pay this to HMRC within a given timescale. They must also make a consequential adjustment to the member’s pension savings or their benefits under the pension scheme. The pension scheme will meet the immediate tax charge due and apply a permanent pension debit to the pension. If this occurs again in subsequent years, further debits will apply.
Mandatory Scheme Pays will, therefore, cover the majority of cases where a tax charge is due as a result of the member’s AA limit being breached in the Fire pension schemes
Voluntary scheme pays (VSP)
If you do not meet the requirements for mandatory scheme pays to apply, or you do not make your nomination in time, you can ask us to pay the annual allowance tax charge on a voluntary basis. We are willing to take voluntary scheme pays elections where you incur a charge that is less than £2,000 and/or due to a tapered annual allowance.
Unlike mandatory scheme pays, we would not have joint and several liability for the tax charge, the liability would remain with you. If the tax charge is also made up of pension savings built up elsewhere, you will have to pay the tax charge directly to HMRC yourself or make alternative arrangements.
If your scheme pays election is in excess of the maximum mandatory amount you must tell us the value of your tapered annual allowance.
It is important to note that for any voluntary scheme pays elections, the part of the tax charge over and above what could be met through a mandatory scheme pays election, remains the sole responsibility of you as the member. As such, any delay in payment beyond the 31 January, coincident with the fiscal period covered by this annual return, will attract late payment interest and charges. We take no responsibility and assume no liability for any such interest or charges. They cannot be settled by us as part of a voluntary scheme pays election.
What is the deadline for a scheme pays election to be made?
The deadline is 31 July of the year after the annual allowance charge occurred. For the tax year 2017/2018 we must receive your election on, or before, 31 July 2019. Any elections received after this date will be rejected. For the tax year 2019/2020, we must receive your election no later than 31 July 2021.
For 2019/2020 voluntary elections, late payment and interest charges will accrue from 31 January 2021 until HMRC receives payment. Where possible we will make payment the quarter after we receive all required information. It is therefore important that voluntary scheme pays elections are received by us by 30 November 2020.
In order to meet HMRCs Scheme Pays deadlines, members should estimate their liability for an annual allowance charge based on available information. Members who have been provided with a provisional statement should use the information contained in their statement for tax purposes.
The tapered annual allowance
The standard annual allowance is £40,000. From the 2016/2017 tax year, if your income exceeds certain limits, your annual allowance for pension savings in that tax year will be reduced. You could be subject to a gradual tapering of annual allowance if your total income (including savings and investment income), which is subject to tax, is more than £200,000 in any tax year. The maximum reduction is £36,000, leaving a minimum annual allowance of £4,000 in a tax year.
Taking benefits under pension freedom rules
The money purchase annual allowance (MPAA) applies if you have taken pension benefits flexibly under ‘pension freedom rules’ on, or after, 6 April 2015, you will be subject to the MPAA from that point. The MPAA for the 2018/2019 tax year is £4,000. If you are subject to the MPAA, you will get a tax charge on contributions to money purchase pensions which exceed this limit in any tax year. This is based on both contributions made by you or on your behalf. If you exceed the MPAA, your annual allowance for other types of tax-relief pension savings, such as defined benefits, is reduced by £4,000 to £36,000.
If you are subject to both the MPAA and the tapered annual allowance, your MPAA will stay at £4,000. However, if in any year you exceed the MPAA, your allowance for other types of pensions savings (normally £30,000) will be reduced on a tapered basis, potentially removing the whole £30,000. The tapered annual allowance will be personal to you and your financial circumstances.
For further information about reducing the MPAA, visit the gov.uk website.
Annual allowance calculator
HMRC have an annual allowance calculator to help you work out how much annual allowance you have used, and how much you can contribute to your pension schemes without facing an annual allowance charge.
Use the annual allowance calculator to check:
- How much annual allowance you’ve used
- If you have an annual allowance charge to pay
- If you’ve any unused annual allowance to carry forward
Where can I get independent financial advice?
If you would like independent financial advice, you must consult an independent financial adviser. You can find a registered adviser near you through the Unbiased website.
You are responsible for the costs of the advice.
Mandatory Scheme Pay (MSP) takes precedence and needs to be considered first and ruled out (under the regulations) before Voluntary Scheme Pay (VSP) can apply. You cannot opt for VSP if you meet the criteria for MSP.
Lifetime Allowance (LTA)
The lifetime allowance is the total capital value of all your pension arrangements, not including your state pension, pension credit, or any partner’s or dependant pension you may be entitled to, which you can build up without triggering a tax charge.
The pension administrators will let you know the value of your Firefighters Pension Scheme (FPS) benefits on retirement and ask you about any other pensions you may have in payment, so they can work out if they need to deduct a recovery tax charge. Also, under HM Revenue & Customs (HMRC) rules, if you recycle your lump sum back into a pension arrangement, there'll be a tax charge.
The lifetime allowance covers any pension benefits you may have in all tax-registered pension arrangements, not just the benefits you have in the East Sussex Fire and Rescue Firefighters Pension Fund
What's the limit?
The standard lifetime allowance was raised from £1 million to £1.03 million from 6 April 2018 for the 2018/2019 tax year and raised again since then. Although the allowance may seem a large amount, you may be affected if you've a lot of service and receive a high salary, or have other large pension arrangements.
How is the lifetime allowance worked out?
For pensions that start to be drawn on or after 6 April 2006, the capital value of those pension benefits is worked out by multiplying your annual pension by 20 and adding any lump sum you draw from the pension scheme.
For pensions already in payment before 6 April 2006, the capital value is worked out by multiplying the current annual rate, including any pensions increase, by 25. Any lump sum already paid is ignored in the valuation.
When any FPS benefit, or any other pension arrangement you may have, is put into payment you use up some of your lifetime allowance. So, even if your pensions are small and individually will not be more than the lifetime allowance, you should keep a record of any pensions you receive. If you have a pension in payment before 6 April 2006, this will be treated as having used up part of your lifetime allowance.
If your FPS benefits are more than your lifetime allowance limit you will have to pay tax on the excess. If your excess benefits are paid as a pension the charge will be 25%, with income tax deducted on the ongoing pension payments; if the excess benefits are taken as a lump sum they will be taxed once only at 55%.
You can choose to pay the tax charge immediately by a reduction to your lump sum or you can ask the scheme to pay the charge for you in return for a permanent reduction to your pension – this is called a lifetime allowance debit.
If you exceed your lifetime allowance, you may have to pay a lifetime allowance tax charge when your benefits are paid to you. If the value of your benefits is higher than the available lifetime allowance, you can choose how to take your benefits and the tax charges that apply.
Lifetime allowance protection
When looking at how to calculate the pension lifetime allowance you need to consider all types of pensions you have including personal pensions, pensions arranged via your employer and final salary pensions including public sector schemes like the NHS and Local Government pensions. The only pension that is not included in how to calculate the pension lifetime allowance is the State Pension.
If your total pension ‘pot’ is over the pension lifetime allowance then nothing happens immediately. But at the point you make a withdrawal from any of your pensions, whether it is starting a final salary pension (like FPS) or withdrawing money using pension drawdown from a money purchase or defined contribution pension scheme, a lifetime allowance test will be applied.
Only the pension you have used to provide you with a pension income will be tested at this point. The value of this pension will be proportioned against the lifetime allowance.
However should you perhaps start to receive an income from a final salary pension as well as your pension drawdown and its value for lifetime allowance purposes is calculated to be £1 million, then you would have used 110% of your pension lifetime allowance and you will, therefore, face a lifetime allowance tax charge on top of the normal Income Tax charge you pay for withdrawing from a pension.
The rate of lifetime allowance charge you pay will depend on whether you take the money out of the pension as income (tax charge 25%) or a lump sum (tax charge 55%). Certain schemes like the FPS give their members a right to take pension and lump sum benefits below the normal minimum pension age. Where a member of the FPS takes a pension or lump sum benefits before the normal minimum pension age, the individual’s lifetime allowance is not reduced.
When the government announced the lifetime allowance limit would be reduced from £1.25 million to £1 million from 6 April 2016, protections were introduced if you were in excess of the £1 million allowance at 5 April 2016, or if you're expected to exceed this level when your benefits are taken.
To use the protections you'll need to apply directly to HMRC before taking your benefits, otherwise, they'll be assessed against the lifetime allowance limit.
Individual Protection 2014 (IP2014) and Individual Protection 2016 (IP2016) are two types of protection that are available if your pension benefits had a value of more than £1.25 million on 5 April 2014 (for IP2014) or more than £1 million on 5 April 2016 (for IP2016).
Another type of lifetime allowance protection is Fixed Protection 2016 (FP2016). Please note that this does not apply if you remained a member of the FPS after 5 April 2016, as benefits would have built up, causing the protection to be lost. If you have fixed protection, your LTA will be £1.25 million but you will not be able to accrue any future pension savings. This means that if you are in a final salary pension scheme you will have to become a deferred member by 6 April 2016. If you applied for this protection, you must tell HMRC the protection was lost from 6 April 2016.
HMRC have an online lifetime allowance calculator for pension scheme members to apply to protect their pension savings from the lifetime allowance tax charge. This service replaces the paper process for applying for Fixed Protection 2016 (FP2016) and Individual Protection 2016 (IP2016) and replaces the online form for applying for Individual Protection 2014 (IP2014).
You can apply online for pension protection through the Government Gateway. You must inform East Sussex Fire and Rescue Firefighters Pensions Administrator of your protection registration number. To apply for protection visit the gov.uk website.
For more information on Tax charge debits (scheme pays) please access GAD guidance on calculating tax charge debits for Mandatory (MSP) and Voluntary Scheme Pays (VSP) in each of the 1992, 2006 and 2015 schemes.
This is a complex area and if you believe that you will be affected by the above you should speak to your financial adviser.