Annual Allowance

What are the pension annual allowance rules from 2011?
Although the basic annual allowance framework remains in place, there are some important changes to the rules from tax year 2011/12 onwards:

• The annual allowance from tax year 2011/12 is £50,000 (significantly lower than the previous £255,000). This is initially a fixed amount, but may increase over the longer term.
• For tax year 2011/12 only, special transitional rules allow pension input amounts of up to £255,000 in some circumstances without any annual allowance tax charge.
• Unused annual allowance from the previous three tax years can be carried forward to offset excess provision in the current tax year.
• The value of defined benefit increases is calculated using a factor of 16:1 (rather than the previous 10:1 basis) for testing against the annual allowance. To help balance this, the opening benefit value is increased in line with CPI before the year's pension input is valued.
• A variable annual allowance tax charge of up to 50% applies to pension provision above the annual allowance.
• There are only exemptions from the annual allowance test on death, serious ill-health or severe ill-health.

Carry forward and tax relief
Where unused annual allowance is being carried forward, the usual tax relief rules still apply to any contributions made.

• Tax relief on employer contributions is subject to the usual wholly and exclusively test; and
• Tax relief on personal contributions is limited to 100% of the individual's relevant UK earnings for the current tax year (or £3,600 if greater).

It's possibly easiest to understand how the carry forward calculations work by looking at a couple of examples.


What is the pension annual allowance tax charge from 2011?
From tax year 2011/12, if someone's total pension input amount for a tax year is more than the annual allowance, they'll normally face a variable annual allowance tax charge of up to 50%.

• For personal contributions, the tax charge cancels out some (or all) of the individual's tax relief on the excess contribution;
• For employer contributions, the tax charge is effectively a type of benefit in kind tax on excessive employer pension provision.

The precise tax rate levied on an individual, known as the appropriate rate, depends on the rate(s) of income tax they'd pay if the excess amount was included in their reduced net income for the tax year and treated as the top slice of that income. The appropriate rate is:

• 50% on any of the excess amount that falls into the additional 50% income tax bracket;
• 40% on any of the excess amount that falls into the higher 40% income tax bracket; and
• 20% on any of the excess amount that falls into the basic 20% income tax bracket.

An individual's reduced net income is, broadly, their gross income subject to income tax from all sources, less their gross pension contributions, allowable trade losses, gifts to charities in the form of shares, securities and real property (not gifts made under gift aid), personal allowances and blind person's allowance.
The tax charge is normally collected through the self-assessment process, but it's possible for it to be paid from pension benefits in some circumstances for tax years 2011/12 onwards.