Pension Earning Cap - How it Works

highgiant

Hi All,

I'm newish to the area of pensions and I'm trying to understand how the pension earning cap works. I'm finding it difficult to find information on the HMRC or Pension regulator website so any links to material on the earning cap or direction on this that people here can provide would be appreciated.

At a very high level, I understand the value of the pension earning cap for the 2016 tax year will be £150,600 but I'm trying to understand how that actually works on a period by period basis or if I had joined during the tax year.

o On a period by period basis. - E.g. if Monthly paid then in April I imagine the allowed pensionable salary I can earn is capped on a basis of the annual earning cap / 12. If not then if I had large payments earlier in the year I could run out of my cap before the end of the tax year.

o A mid year joiner - Am i still entitled to the full annual threshold or does a pro rata apply based on the number of periods I've been there. I expect I still have the full pensionable salary cap and that it would be based cumulatively e.g. assuming monthly paid if I joined in May it would be the annual earning cap / 12 * 2 (for 2 months)

Am I completely off here? Again any direction on this appreciated.

LXdaddy

I'm not clear what you are talking about. What leads you to believe that "the value of the pension earning cap for the 2016 tax year will be £150,600"


I've not seen a maximum for what a pension scheme can pay out.


There IS a lifetime allowance which limits the value that you can have in your pension schemes (reduced to £1,000,000 this year)


There are also points on the income scale at which various benefits or allowances get reduced (£150,000 is one of those)


I've not heard the term "pension earning cap".

PensionTech

It depends how your scheme rules are defined. Some schemes define "Pensionable Salary" (or similar) on a certain date every year, say 1 April, which might be based on the last 12 months' basic salary (which will usually be pro-rated up to an annual equivalent if you joined in the last 12 months). Each year's Pensionable Salary may then be capped to whatever the (notional) cap is in force when the figure is defined, and your Final Pensionable Salary actually used to calculate your benefits might be an average of the last three capped Pensionable Salaries. Or the individual Pensionable Salaries might be uncapped, but the Final Pensionable Salary might itself be capped. Or any number of other possibilities depending on how your scheme rules work. The cap doesn't get pro-rated down for your length of service - indeed that's irrelevant, since your salary and your service are considered separately in pension calculations.

You won't find much information about this online because the Earnings Cap was a feature of the pre-2006 pensions regime, and is now only used by schemes that had it written into their rules prior to that date. It doesn't even strictly exist any more; all capping is done on the basis of the notional figure that would be the current Earnings Cap had it remained in force.

Your scheme administrator (presuming that you are asking in respect of a pension scheme in which you have benefits, rather than one you're working on) should be able to give you detailed information about exactly how the Earnings Cap affects your benefits - but if you have any more specific questions or more information about the scheme in question, we can try to give you more info here too.

xylophone

http://www.civilservicepensionscheme.org.uk/employers/employer-pension-notices/epn449/

may be of interest as an example.

http://adviser.royallondon.com/pensions/technical-central/rates-and-factors/earnings-cap/

highgiant

thanks all for the responses so far.

I may be using incorrect terminology apologies if so. When I was referring to the earnings cap I was talking about it in terms of an employee making contributions in to the fund and get tax relief on.

There is a limit on the amount of earnings that can be pensioned. This limit of earnings reduces the amount of pensionable earnings on which pension contributions are paid. Any contributions made from salary in excess of this cap would not be entitled to any relief.

This impacts where an employee may be contributing to my pension based on a % of my earnings.

I'll review the links posted above now. Thanks again.

PensionTech

Right - I think you may be talking about the Annual Allowance Taper.

The Earnings Cap restricts the benefits payable to you. It may or may not have an effect on the contributions you pay to the scheme; if you earn £200,000 but your pensionable pay is capped to £150,600, depending (again) on how your scheme rules are constructed, you may pay x% of the capped pay or your full pay. If you make additional contributions, the benefits these purchase will depend on your scheme - they may buy additional final salary pension, or they may go into an invested money purchase fund to sit alongside your final salary pension. They will however still be relieved of tax. The Earnings Cap does not affect what is and isn't relieved of tax. Under the pre-2006 regime, there was a cap on the maximum contributions you could pay, but I believe that operated as a strict barrier - i.e. you cannot pay more than 15% at all, otherwise the scheme risks its approval status - rather than a tax threshold - i.e. you can pay more than 15% but you won't get tax relief on the extra. However, 2006 is before my time so my knowledge on this is limited.

The limit on tax relief is a post-2006 policy called the Annual Allowance. This restricts the amount of pension contributions you and your employer can make (or, in the case of final salary schemes, the increase in the "value" of your pension benefits) to £40,000 in any individual tax year. If you earn more than £150,000 - and this includes pension contributions or growth, so in practice you could be affected if you earn £110,000 upwards and also have a really great pension - then the £40,000 allowance gets tapered back gradually (by £1 for every additional £2 over the £150,000 threshold that you earn) until it reaches a minimum of £10,000. So this means that someone earning £180,000 would be able to contribute a maximum of £25,000 to his pension (i.e. the standard £40,000 allowance, minus the difference between £180,000 and £150,000 divided by two). Any contributions over that limit will not be relieved of tax. In practice, if you go over the tax-free limit, the contributions themselves will still be relieved up-front but you will retrospectively incur a tax charge which may be payable directly or may be deducted from your pension benefits, depending on the amount in question. You can, however, use unused allowance from the previous three tax years to mitigate any excess paid in this year - although I don't know how that works for the taper.

The taper is based on your total earnings in a tax year and the limits don't get proportionately reduced if you have only been working for part of a tax year. So if you earn the annual rate of £200k but have only been employed for 6 months in a tax year, and have no earnings for the other 6 months, then congratulations - your earnings for the tax year are £100k and you don't get caught by the taper. Next year you would not be so lucky.

Confused? Me too. The taper is a mess and should never have been introduced. But all of this is important if you earn enough to be affected.