Pension Annual Allowance: Taper, Carry Forward and Scheme Pays

A tax charge that routinely lands on people who made no decision at all. In a defined benefit scheme the “input” is a notional figure the member does not control, and a promotion alone can produce a five-figure liability.

A Charge That Lands on People Who Did Nothing Wrong

The annual allowance limits the pension input that can be made in a tax year with tax relief. Exceed it and the excess is charged to income tax at the individual’s marginal rate. Unlike most tax charges, this one routinely arises for people who made no active decision at all, because the allowance tapers with income, and because in a defined benefit scheme the “input” is a notional figure the member does not control.

The Taper

For individuals with income above the threshold, the annual allowance is reduced by reference to adjusted income, down to a floor. Two definitions do the work and they are routinely confused:

• Threshold income: broadly net income less certain reliefs, with adjustments to prevent salary sacrifice being used to sidestep the taper. If threshold income is below the limit, the taper does not apply at all regardless of adjusted income.
• Adjusted income: broadly net income plus the value of pension inputs, including employer contributions and the DB pension input amount.

Because adjusted income includes the pension input, and the pension input drives the charge, the calculation is circular in feel and error-prone in practice. Miscalculating threshold income is the single most common cause of an incorrect return in this area, in both directions.

Carry Forward

Unused allowance from the three previous tax years can be carried forward, provided the individual was a member of a registered pension scheme in those years. Points that matter:

• The current year’s allowance is used first, then the earliest of the three carry-forward years.
• Membership in the earlier year is required, but contributions in that year are not.
• Carry forward frequently eliminates a charge HMRC has assessed, and it is regularly overlooked by the taxpayer, the scheme and sometimes by HMRC.

The Money Purchase Annual Allowance

Once benefits have been flexibly accessed, a much lower money purchase annual allowance applies to money purchase contributions, and carry forward is not available against it. Individuals who took a flexible drawdown payment years earlier and then returned to work and rejoined a scheme are a standard source of unexpected charges. The scheme is required to notify the member when the MPAA is triggered, but the notification is frequently not acted on.

Scheme Pays

Where the charge exceeds a threshold and the input in that scheme exceeded the standard allowance, the member can require the scheme to pay the charge in exchange for a reduction in benefits: mandatory scheme pays. Many schemes also offer voluntary scheme pays on wider terms.

• The election is subject to a deadline, and missing it can leave the member personally liable for a charge they cannot fund.
• Mandatory and voluntary scheme pays have different deadlines and different consequences if the figures are later revised.
• The reduction in benefits is actuarially calculated and is not always the cheaper option. It should be modelled, not assumed.

Where the Disputes Arise

• Late or incorrect pension savings statements from the scheme, leaving the member unable to complete the return correctly. This is central to any reasonable excuse argument.
• Threshold income miscalculated, often through the treatment of salary sacrifice, bonus timing or property income.
• Carry forward not claimed, producing a charge that should never have arisen.
• MPAA triggered and unnoticed.
• Discovery assessments for earlier years, where the officer’s awareness from the return is the battleground: see Langham v Veltema and Charlton.
• Penalties. Where the member relied on scheme information that was wrong or absent, Perrin reasonable excuse is a real argument, and the behaviour is at worst careless.

Practitioner Application

1. Compute threshold income first. If it is below the limit, the taper is irrelevant and a great deal of work falls away.
2. Always check three years of carry forward before accepting any charge.
3. Request pension savings statements early, and document the request, a scheme’s failure to supply is evidence, not an excuse to be improvised later.
4. Check for an MPAA trigger in any client who has accessed benefits flexibly.
5. Diarise the scheme pays deadline separately from the filing deadline.
6. On an HMRC charge, rebuild the input amounts from scratch. Errors in the scheme’s figures are not rare, and the charge is only as good as the input calculation behind it.

Frequently Asked Questions