13/03/2024

Payroll Pensions Tax

Annual Allowance Charge (AAC)
Electing for the Pension Scheme to Settle the Tax

With the next General Election fast approaching, the Chancellor of the Exchequer, Jeremy Hunt came to Parliament to deliver his Spring Budget. Below are some of the main announcements that have come out of this Budget as well as a reminder of ones from prior Budgets/ Statements that may impact the 2024/25 tax year.

Where a taxpayer makes pension contributions exceeding their available annual allowance, an income tax charge may arise on the excess as if it were the taxpayer’s top slice of income. Where all conditions are met, the taxpayer may elect for the charge to be settled from their pension scheme. This is known as the mandatory scheme pays.

Annual Allowance Charge, Pension scheme contributions and tax

The two conditions that must apply are:

  • The AAC for the tax year across all of the individual’s pension schemes is greater than £2,000.
  • The contributions (or ‘deemed’ contributions as regards a final salary scheme) into that particular pension scheme (in isolation) exceed the annual pension allowance.

For the election to be valid the taxpayer would need to make it at any time between the end of the tax year in which the AAC arose and 31st July following the end of the next tax year. For 2023/24 the deadline is 31st July 2025.

If the conditions are met and the election is made, the individual and the pension scheme become jointly and severally liable for the AAC.

If the pension scheme pays, there is a consequential adjustment made to the member’s pension pot. For money purchase schemes the tax is simply deducted from the member’s pension scheme. For final salary schemes, a much more complex calculation is carried out ‘on a basis that is just and reasonable having regard to normal actuarial practice’.

The annual allowance for the 2023/24 tax year and onwards was £60,000. Even if in that particular year the annual allowance was reduced because of the taxpayer’s high adjusted income or having already flexibly accessed one of their pension pots, the annual allowance threshold condition, specifically in relation to mandatory scheme pays, remains at £60,000.

It is important to note that it is only the tax charge relating to the excess of the contribution paid (or deemed paid) into that particular pension scheme, over the annual allowance, that the pension scheme administrator is obliged to pay under the mandatory scheme pays rules.

Pension scheme contributions

To help demonstrate this, we have set out two examples based on 2023/24 tax rates and thresholds:

Example 1
The individual was a 45% taxpayer and had paid into 2 pension schemes:

Pension scheme 1: £37,000
Pension scheme 2: £29,500

There was no unused annual allowance from earlier years to bring forward. After deducting the annual allowance of £60,000, there was excess AAC of £6,500. The income tax charge would be £2,925 (£6,500 x 45%).

In this case, the mandatory scheme pay would not apply because the pension contribution into each scheme was below the 2023/24 annual allowance threshold of £60,000.

Example 2
The individual was a 45% taxpayer and had 3 pension schemes. They paid the following pension contributions:

Scheme 1: £62,500
Scheme 2: £3,000
Scheme 3: £1,500

There was no unused annual allowance from earlier years to bring forward. After deducting the annual allowance of £60,000, there was excess AAC of £7,000. The income tax charge would be £3,150 (£7,000 x 45%).

In this example, mandatory scheme pay could apply with regards to Scheme 1, but only in respect of the tax due on AAC of £2,500 above the 2023/24 annual allowance limit of £60,000. Therefore the pension scheme will settle tax of £1,125, and the individual would be liable for the other £2,025.

Annual allowance and paying into your pension for future savings

If you believe you would meet the conditions for the mandatory scheme pay and would like assistance in making an election for the tax to be settled from your pension scheme, please get in touch with us.

We can also provide advice on making pension contributions and the availability of your annual allowance.

You can also read more about pensions annual allowance tax charge on the Government website