The £40,000 annual allowance, and the £1M cap

noClue

Hi guys,

Would be great if I can get some help

My pension is TPS, I can increase my contribution by either "Additional Pension" or "Faster Accrual". I did some research, and am still deciding which is the best way to do it. My feeling is that the calculation is not that straight forward for TPS pension.

Now assuming I have decided what to do on that and have done that. Using made up number in the following example. Let's say that the yearly contributions are 4,000 from me and 8,000 from employer. (It's based on a pre-tax salary of 40,000). That makes a total of 12,000 contribution per year. My take home salary is 27,000.

Assuming I do not have other income apart from my salary. (Does interest count as income? Just asking.) Given the annual allowance of £40000, does that mean I can still contribute (40,000-12,000 28,000 from my salary of 36,000 (after TPS contribution but before tax)?

If so, assuming my living does not depend on my salary (the reason why I asked the interest question above), what kind of private pension should I be looking for?

Also, what is that £1M limit on the pension? Does that mean if the private pension pot reaches 1M contribition in total, you can not contribute tax free any more?

Thanks for your help!

------------------Answer here---------------------------------

Q: My client is an active member of his employer’s defined benefit pension scheme. He also wants to make a personal pension contribution. How do I calculate the maximum personal contribution allowed for tax relief? He has a pensionable salary of £37,500 and pays 3% employee contribution.

A: Calculation one – tax relief

The client already pays £1,125 to the DB scheme therefore, to be eligible for tax relief, he can only pay up to a maximum of (£37,500 - £1,125) £36,375 gross to a personal pension plan.

Calculation two – annual allowance

His DB pension input amount for the current pension input period is estimated at approximately £11,000. He has fully used his annual allowance for previous years so has no carry forward available.

Therefore, available annual allowance is £40,000 less the DB pension input amount for the current tax year of £11,000 leaving £29,000.

Comparison

The remaining annual allowance is £29,000 ie less than £36,375. This means your client could pay up to £36,375 and receive tax relief on the whole amount. However, you know that his total pension savings would then exceed his available annual allowance (he has no carry forward) and he would have to report the excess of £7,375 (36,375 - 29,000) and declare the related tax charge. An AA excess/ charge reduces the tax efficiency of making this level of personal contribution.

In this scenario it may be more appropriate to limit the individual pension contribution to £29,000 gross as this will receive tax relief without causing any annual allowance excess.

As always, there will be exceptions to the rule. There may still be a net overall benefit for an individual to pay a personal contribution that actually causes them to have an annual allowance excess. This would be the case if the individual wanted to pay a larger pension contribution to get them out of the child benefit or personal allowance tax traps, or to reduce their threshold income to avoid a tapered annual allowance etc.

zagfles

TPS (assuming you mean teachers) is a defined benefits (DB) scheme, so contributions are irrelavant for the pension input amount calculation. Look on your statements for PIAs for previous tax years. Working it out is complicated, google "pia db scheme" if you really want the details. But the annual allowance can be usually be carried forwards from previous years if you have some spare.

Note there's also a tax relief limit of 100% gross of your "relevant earnings" into a pension. Interest and other "unearned" income doesn't count. 

The LTA (bit over £1M limit) is complicated but basically you pay high rates of tax when you take the pension out if you exceed it. For DB schemes the annual income is multiplied by 20 eg if you have a DB pension of £20k a year that counts as £400k towards the LTA.

noClue

Yes it is Teachers' Pension.

I googled and indeed it seems very complicated just looking at some examples! I actually couldn't find PIA figures in the statements?!

The reason I asked this is because I have some spare money and everyone is telling me "MAX OUT PENSION" because that is the most tax efficient way to "invest". In my case, I wonder what my options are to do exactly this? Open myself another private pension? And how do I know my remaining allowance? 

zagfles said:

Note there's also a tax relief limit of 100% gross of your "relevant earnings" into a pension. Interest and other "unearned" income doesn't count.  

Is "relevant earnings" the same as the £40,000 limit? I thought it's 100% of your work earning up to £40,000 limit?
"unearned" income includes share gain and rent income I guess? Sorry I am noob.

zagfles said:

The LTA (bit over £1M limit) is complicated but basically you pay high rates of tax when you take the pension out if you exceed it. For DB schemes the annual income is multiplied by 20 eg if you have a DB pension of £20k a year that counts as £400k towards the LTA. 

So the LTA includes both DB scheme and my private pension, in my case? Thanks!

zagfles

The PIA should be somewhere on the statements or online but if not ask the scheme for the PIAs from the last few tax years. Then use an annual allowance calculator like

https://www.hl.co.uk/pensions/contributions/carry-forward-rule/annual-allowance-calculator

The problem is it's hard to predict what the PIA will be in the current tax year in a DB scheme as it depends on inflation, payrises etc.

See here for what relevant earnings means https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm044100  This is NOTHING WHATSOEVER to do with the annual allowance, ignore any drivel which says things like "100% of your work earning up to £40,000 limit", it's complete rubbish particularly for people in DB schemes. The earnings limit is a different thing to the AA, you can't get tax relief on more than 100% of your earnings, above link explains it.

Loads of threads on here about this - problem is too many clueless people inc supposed financial journalists and even IFAs try to oversimplify things by combining separate unrelated limits, but they have completely different rules, for instance the AA works on PIAs but the relevant earnings limit works on personal contributions (not employer, not PIAs), the AA allows carry forwards but the RE limit doesn't, so it can't be done, they need looking at separately.

LTA includes all pensions except state pension.

noClue

@zagfles I still need to get my head around re your last reply! Most complicated thing I have dealt with lol

noClue

zagfles said:

See here for what relevant earnings means https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm044100  This is NOTHING WHATSOEVER to do with the annual allowance, ignore any drivel which says things like "100% of your work earning up to £40,000 limit", it's complete rubbish particularly for people in DB schemes. The earnings limit is a different thing to the AA, you can't get tax relief on more than 100% of your earnings, above link explains it.

Loads of threads on here about this - problem is too many clueless people inc supposed financial journalists and even IFAs try to oversimplify things by combining separate unrelated limits, but they have completely different rules, for instance the AA works on PIAs but the relevant earnings limit works on personal contributions (not employer, not PIAs), the AA allows carry forwards but the RE limit doesn't, so it can't be done, they need looking at separately. 

@zagfles OK I think I finally get my head around. If I understand correctly, apart from the 40,000 allowance you get another 100% relief on your relevant earnings up to 3,600? I looked at the list, and don't think I have any relevant earnings (yet)...

AlanP_2

The PIA is calculated after the end of the tax year by the TPS scheme administrators and if they don't include it on your annual statement ask them for it - but remember it will be a tax yer behind.

Assuming you don't get a massive payrise then the PIA figure will stay broadly the same each year give or take a bit.

You can contribute (Annual Salary - PIA) gross into a PP or SIPP or whatever.

As you earn £36k the £40k Annual Allowance doesn't apply to you, it is there to limit the amount of tax relief that people earning >£40k can get through pensions.

The £3,600 limit is also irrelevant to you, it is for those who have no "relevant income", which in practice means not working, and is the upper limit of what they can pay in to a pension and get tax relief allowed. 

zagfles

noClue said:

zagfles said:

See here for what relevant earnings means https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm044100  This is NOTHING WHATSOEVER to do with the annual allowance, ignore any drivel which says things like "100% of your work earning up to £40,000 limit", it's complete rubbish particularly for people in DB schemes. The earnings limit is a different thing to the AA, you can't get tax relief on more than 100% of your earnings, above link explains it.

Loads of threads on here about this - problem is too many clueless people inc supposed financial journalists and even IFAs try to oversimplify things by combining separate unrelated limits, but they have completely different rules, for instance the AA works on PIAs but the relevant earnings limit works on personal contributions (not employer, not PIAs), the AA allows carry forwards but the RE limit doesn't, so it can't be done, they need looking at separately. 

@zagfles OK I think I finally get my head around. If I understand correctly, apart from the 40,000 allowance you get another 100% relief on your relevant earnings up to 3,600? I looked at the list, and don't think I have any relevant earnings (yet)...

What?? Employment earnings are "relevant earnings". What do you mean get another 100% relief? You've totally misunderstood. They work independantly. The AA has one set of rules, the tax relief limit another. Don't even think about "maxing out" pension contibutions until you've got your head around that. Read this thread, it has a lot of other people misunderstanding this https://forums.moneysavingexpert.com/discussion/6043855/understanding-carry-forward/p1

zagfles

AlanP_2 said:

The PIA is calculated after the end of the tax year by the TPS scheme administrators and if they don't include it on your annual statement ask them for it - but remember it will be a tax yer behind.

Assuming you don't get a massive payrise then the PIA figure will stay broadly the same each year give or take a bit.

You can contribute (Annual Salary - PIA) gross into a PP or SIPP or whatever.

As you earn £36k the £40k Annual Allowance doesn't apply to you, it is there to limit the amount of tax relief that people earning >£40k can get through pensions.

The £3,600 limit is also irrelevant to you, it is for those who have no "relevant income", which in practice means not working, and is the upper limit of what they can pay in to a pension and get tax relief allowed. 

The highlighted two paragraphs are complete rubbish. See the thread I linked above.

zagfles

Or here's another couple of threads that explain it in a different way

https://forums.moneysavingexpert.com/discussion/6122881/a-few-tax-relief-questions/p3

https://forums.moneysavingexpert.com/discussion/comment/76833367#Comment_76833367

noClue

zagfles said:

noClue said:

zagfles said:

See here for what relevant earnings means https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm044100  This is NOTHING WHATSOEVER to do with the annual allowance, ignore any drivel which says things like "100% of your work earning up to £40,000 limit", it's complete rubbish particularly for people in DB schemes. The earnings limit is a different thing to the AA, you can't get tax relief on more than 100% of your earnings, above link explains it.

Loads of threads on here about this - problem is too many clueless people inc supposed financial journalists and even IFAs try to oversimplify things by combining separate unrelated limits, but they have completely different rules, for instance the AA works on PIAs but the relevant earnings limit works on personal contributions (not employer, not PIAs), the AA allows carry forwards but the RE limit doesn't, so it can't be done, they need looking at separately. 

@zagfles OK I think I finally get my head around. If I understand correctly, apart from the 40,000 allowance you get another 100% relief on your relevant earnings up to 3,600? I looked at the list, and don't think I have any relevant earnings (yet)...

What?? Employment earnings are "relevant earnings". What do you mean get another 100% relief? You've totally misunderstood. They work independantly. The AA has one set of rules, the tax relief limit another. Don't even think about "maxing out" pension contibutions until you've got your head around that. Read this thread, it has a lot of other people misunderstanding this https://forums.moneysavingexpert.com/discussion/6043855/understanding-carry-forward/p1

@zagfles the pru link is gold. PRetty confident I grasp the idea now.

Now in practice if I want to max out, how do I execute it?
Assuming I've opened a private pension.
Once I get PIA at the end of finance year and calculate my spare figure "x", do I need to fill in any form? Or I guess I will pay in a lump sum "x" to the private pension, and ask HMRC for tax return?

If I have some spare cash, I guess it is worth to pay in at least some extra pension for tax efficiency? Also, what kind of private pension I will be looking for? Can you think of any relevant links here?