Paying the Tax Charge When You Exceed the Pension Annual Allowance

Published / Last Updated on 03/07/2022

The Pensions Annual Allowance

The maximum you and your employer can currently pay into a pension scheme (or the equivalent accrual i.e., increased yearly pension income entitlement for a defined benefit scheme = 16 X the increased pension income less inflation adjustment) each year is the lower of your salary of your income or £40,000 pa.

For example, if you earn £20,000 pa, the maximum that can be paid into your pension each year is £20,000.  If you earn £100,000 pa, the maximum that can be paid into a pension each year is £40,000 pa.  You can go back up to three years if you pay more than this, but you can only to use up unused pension contribution relief from those years.

Annual Allowance Reduced

  1. Your annual allowance £40,000 may be reduced if your adjusted annual income exceeds £240,000.  For every £2 your adjusted income goes over £240,000, your annual allowance for the current tax year (£40,000) reduces by £1.  The minimum reduced annual allowance you can have in the current tax year is £4,000 pa.  This is known as the Tapered Annual Allowance.
  2. Your annual allowance will be reduced if you have accessed a pension via pension flexible drawdown and taken not just some or all of the pension commencement lump sum but also the taxable part (flexible drawdown) of the pension, even if just £1.  Your annual allowance is reduced to £4,000 pa.  This is known as the Money Purchase Annual Allowance (MPAA).

If you do not have any ‘carry forward.  of unused relief left and between you and your employer more than £40,000 (or any reduced annual allowance) is paid into a pension, you face a pension tax charge.  You have exceeded your annual allowance. 

The Excess Annual Allowance Tax Charge is the equivalent of refunding the tax relief that you and your employer received when paid in that you were not entitled to.

Paying the Excess Annual Allowance Tax Charge

There are two options to pay the charge:

  1. Pay HMRC directly, usually through self assessment.
  2. Scheme Pays (the charge is paid from/by your pension scheme).

There are two types of ‘scheme pays’

  • Mandatory Scheme Pays and Voluntary Scheme Pays.

MANDATORY SCHEME PAYS

This is where your pension scheme is legally required to pay the tax charge if you request it but is subject to qualification.

  1. The total tax charge must exceed £2,000.
  2. You must have exceeded the £40,000 pa contribution (Tapered Annual Allowance and Money Purchase Annual Allowance are ignored).
  3. The scheme can then pay the tax charge from your accrued pension benefits.
  4. You can if you wish choose to split the payment between yourself and your pension scheme.  The scheme can pay less than £2,000 but the bill must be £2,000 or more in total.
  5. Both you and your pension scheme are jointly and severally liable for the tax bill.
  6. The tax bill under Mandatory Scheme Pays must be paid by 31st July after the relevant tax year end in April.

Mandatory scheme pays’ does not apply

  1. If the total tax charge is less than £2,000
  2. The pension contributions in the year exceed any tapered annual allowance or money purchase annual allowance but do not exceed £40,000 pa.
  3. If the total tax charge is less than £2,000 and over £40,000 has been paid into the pension, your scheme can only pay the tax charge attributable to those contributions over £40,000.

VOLUNTARY SCHEME PAYS

  1. Some but not all pension schemes may offer a voluntary scheme pays solution.
  2. If your pension scheme has rules written into the scheme that it has a voluntary scheme pays anyway rather than those schemes that do not and only pay if they are forced by the mandatory rules, then your scheme is not jointly and severally liable for any tax charge.  You are solely responsible for the tax charge.
  3. The tax bill under Voluntary Scheme Pays must be paid by 31st August after the relevant tax year end in April.

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