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Adviser  >  Technical Central  >  Information & guidance  >  Contributions  >  Contributions

Contributions & allowances

This analysis focuses on pension contributions and also briefly covers the lifetime allowance charge, transitional protection and the key advice issues for financial advisers.

What can be paid in?

There is no difference between different types of pension scheme. Individuals can contribute to any number of pension plans subject to the limits outlined below.

Individuals

Member contributions are unlimited. However there is a limit on the amount of gross contributions that a member can pay each year and benefit fully from tax relief. This is restricted to:

  • The higher of £3,600 or 100% of salary – subject to the annual allowance (see below)

Special rules apply for those who are not resident in the UK.  Further details can be found in Contributions to Registered Schemes for Overseas Individuals.

Employers

Employer contributions count towards the annual allowance (see below). Also, it is up to the Employer's local inspector of Taxes whether or not the entire contribution will be relievable for tax purposes. Further details can be found in Employer contributions and tax relief.

Annual allowance

An annual allowance for pension savings applies each year. Under a money purchase (MP) scheme this is simply the value of the contributions paid in a scheme year. However, under a defined benefit (DB) or cash balance (CB) scheme it is the increase in the value of a member's rights over the pension input period. 

Within this allowance, tax relief on gross member contributions is restricted to the higher of £3,600 or 100% of salary. Employer contributions are not restricted in this way but they may not receive tax relief on the entire contribution. Members are subject to a tax charge on the amount of any contribution (both member and employer) paid in excess of the annual allowance each year. The tax charge will be at the member's marginal rate of tax. This also applies to any benefit increase under a DB or CB scheme over the annual allowance.

The Government initially confirmed details of the annual allowance amounts that will apply for the tax years 2006/07 to 2010/11. It has now been confirmed that from 2011/12, the annual allowance will be £50,000. The table below confirms the annual allowance for each tax year to date:

Tax Year

Annual Allowance

2006/07

£215,000

2007/08

£225,000

2008/09

£235,000

2009/10

£245,000

2010/11

£255,000

From 2011/12

£50,000

There is an exemption from the annual allowance in a year if benefits are taken on grounds of serious ill health or if the member dies.

Carry forward

Carry forward allows unused annual allowance from pension input periods ending in the previous three tax years to be carried forward and added to the annual allowance for the current pension input period. More details can be found in How carry forward works.

The annual allowance applies in total to all pension benefits a member may have. The table below details how these benefits are valued when testing against the annual allowance:

Type of benefit

Value of rights

Notes

Money Purchase Benefits

The total contributions paid in any one-scheme year, excluding age-related rebates.

This includes all member, employer and third party contributions.

Cash Balance Plans

 

 

The increase in the value of the member's rights over the scheme year.

When working out how much the benefits have increased by, increase the value of the plan at the beginning of the pension input period by the increase in CPI over the 12 month period to the September before the start of the tax year in which the annual allowance is being calculated. This is then compared with the value at the end of the period.

The rights to be valued will include partial benefits taken during the year, any rights transferred out to another registered pension scheme, and any pension debits. The value of any rights given on transfers in to the scheme and any pension credits can be excluded.

Defined Benefits Schemes

 

 

 

The increase in value of the member's rights over the scheme year.

When working out how much the benefits have increased by, increase the annual pension amount at the beginning of the pension input period (this is the pension that the member would get if they retired now at normal pension age) and multiply it by 16. If the scheme also gives the member a lump sum in addition to the pension (i.e. not by commutation of pension), add this on. The total should then be increased by the increase in CPI over the 12 month period to the September before the start of the tax year in which the annual allowance is being calculated.

Deduct this amount from the value at the end of the pension input period; the end value shouldn't be increased by CPI.

The rights to be valued will include any benefits taken during the period, any rights transferred out to another registered pension scheme, and any pension debits. The value of any rights given on transfers in to the scheme and any pension credits can be excluded.

Lifetime allowance (LA)

The LA creates a ceiling on the value of pension benefits that can be built up by a member in a registered pension scheme (unless primary or enhanced protection applies or when a pension debit is made since 6 April 2006). Details of the LA for the tax years 2006/07 – 2012/13 onwards are as follows: 

Tax Year

Lifetime Allowance

2006/07

£1,500,000

2007/08

£1,600,000

2008/09

£1,650,000

2009/10

£1,750,000

2010/11

£1,800,000

2011/12

£1,800,000

From 2012/13

£1,500,000

The LA applies to the value of all pension benefits built up by a member. When benefits are taken (crystallised) they are tested against the LA. The valuation basis depends on the way in which benefits are taken. The table below details how benefits are valued:

Type of arrangement

Valuation basis for benefits crystallised

Defined Benefits

DB schemes can only offer a scheme pension. A scheme pension involves paying a pension for life out of the scheme assets or buying an annuity out of the scheme assets.

The value of the annual amount of pension promised by the scheme is multiplied by a standard valuation factor of 20:1. This factor includes an allowance for dependant's benefits up to the level of the member's pension at date of death and for annual increases of 5%. Any DB scheme that provides better increases can apply to HM Revenue and Customs for a scheme specific valuation factor which can be higher than 20:1.

Defined Lump Sums (otherwise than by commutation) are valued using a factor of 1:1 and are added to the above value.

Money Purchase (including Cash Balance) benefits

Capped drawdown
The valuation basis is based on the actual fund value (market value of the assets) used to secure either:

  • Income Drawdown, or
  • Short-term annuities

Secured Pension
The valuation basis used depends on the option chosen when benefits are crystallised. These are:

  • Lifetime Annuity - This is simply valued on the basis of the fund value used to secure the lifetime annuity.
  • Scheme Pension - Same as DB above.

    If a scheme provides separate Tax-Free Cash Lump Sum (TFC) and not by way of commutation this will be valued based on a valuation factor of 1:1 and added to the value above.

Lifetime allowance (LA) charge

The lifetime allowance charge applies to members who have benefits in excess of the LA when benefits are taken. Those who have opted for enhanced protection on their pre 6 April 2006 benefits will be fully exempt from this charge provided they do not contribute to any further pension arrangement after 6 April 2006. However those who have opted for primary protection will be subject to a LA charge on the benefits value over their personal lifetime allowance. The LA charge can apply in either of two ways or a combination of both depending on how the excess benefits are taken. The charge is:

  • 25% on any income taken, and
  • 55% if taken as a lump sum.

Transitional protection

Members could protect their pre 6 April 2006 rights from the LA by selecting from two forms of protection or both. These had to be applied for by 5 April 2009.  The two forms are:

Primary Protection (PP)

Enhanced Protection (EP)
  • This was available to anyone who had pre 6 April 2006 funds in excess of the LA of £1.5m on 5 April 2006 and wanted to register their own personal lifetime allowance (PLA).
  • The benefits value on 5 April 2006 is expressed as a factor which is used to calculate the member's PLA. 
  • This enhanced lifetime allowance factor will be increased by 20% until the LA is greater than £1.8 million when it will increased in line with the increase to the LA at the point benefits are paid on retirement/death (known as a ‘crystallisation event’).
  • Any amounts in excess of this will be subject to a LA charge.
  • Contributions can continue if suitable.
  • The TFC will be protected as a monetary amount if it exceeded 25% of the LA on 5 April 2006. The amount payable will be the amount of TFC available at 5 April 2006 increased by 20% until the LA is greater than £1.8 million when it will increased in line with the increase to the LA at the point benefits are taken. 
  • This was available to anyone who wanted full protection from the lifetime allowance charge.
  • There was no minimum fund to register for EP. Provided you also registered for PP (if applicable) you retain the right to opt for PP at a later date if necessary.
  • Anyone who selected EP had to stop being an active member of all registered pension schemes prior to 6 April 2006 and cannot build up any further benefits in a registered pension scheme on or after 6 April 2006, with the exception of any rebate payments that commenced prior to 6 April 2006. Anyone who does, without advising HM Revenue and Customs, will face a fine.
  • If the member was entitled to TFC of >25% of the benefits value at 5 April 2006 the amount of TFC when benefits are taken will be the amount of TFC at 5 April 2006 increased by 20% until the LA is greater than £1.8 million when it will increased in line with the increase to the LA. If they were entitled to >25% of the LA at 5 April 2006, when benefits are taken the TFC will be based on the same percentage of the benefits value as it was on 6 April 2006. The maximum amount of TFC that can be paid is equal to the LA when benefits are taken.

Fixed protection

What is fixed protection? A member who registers for fixed protection will keep the lifetime allowance of £1.8 million after 6 April 2012 (when the lifetime allowance reduced to £1.5 million).

Anybody who does not have not have either primary protection or enhanced protection can apply for fixed protection but anyone who opted for fixed protection must have stopped being an active member of all registered pension schemes prior to 6 April 2012.

The deadline for applying for fixed protection was 5 April 2012.

Fixed protection is lost if the member breaks one of the following conditions.

  • They start a new arrangement other than to accept a transfer of existing pension rights
  • They have benefit accrual after 6 April 2012 
  • They break the restrictions on where and how they can transfer benefits.

The member must tell HMRC if fixed protection is lost.

The following table sets out what ‘benefit accrual’ means.

Type of Plan

Value of benefit

Money Purchase (other than Cash Balance) benefits

  

This includes all member contributions, employer contributions and contributions paid by other people on the member’s behalf.

The exceptions to the 'no contribution rule' are:

  • contributions may continue to a life assurance policy providing death benefits that started before 6 April 2006.
  • National Insurance rebates paid to the scheme will not cause you to lose fixed protection.

Defined Benefits and cash Balance benefits

For defined benefits or cash balance arrangements benefit accrual will occur if in any tax year from 2012-13 onwards, the value of the pension rights over the tax year have gone up by more than the 'relevant percentage', which is:

  • An annual rate used to increase benefits and which was specified in the scheme's rules on 9 December 2010.
  • If no rate is specified, the percentage by which the consumer prices index (CPI) increased in the year ending in September of the previous tax year. If there is no increase or a fall in the CPI in this period, then the percentage rate is nil.

Defined benefits schemes normally specify a percentage rate by which deferred benefits will increase each year until the time when the member takes their benefits. For an active member, benefits will normally increase in value by reference to years of service and pensionable salary rather than by a percentage rate. So the relevant percentage for an active member of a defined benefits scheme will be the increase in CPI

 The following table sets out the conditions for transfers.

Type of Plan

Transfer Conditions

Money Purchase (other than Cash Balance) benefits

Can only be transferred to another money purchase arrangement which is a registered pension scheme. 

Defined Benefits and cash Balance benefits

Can be transferred to:

  • a money purchase arrangement under a registered pension scheme
  • another cash balance arrangement if the transfer is made because:
    • the pension scheme making the transfer is winding up or
    • the employer has sold all or part of their business and the benefits are being transferred to the new employer's scheme

Fixed protection will stop if the lifetime allowance rises to be more than £1.8 million. The member’s lifetime allowance will then be the higher lifetime allowance.

Auto Enrolment

A member will be automatically enrolled into a new scheme under the provision of Pensions Act 2008 by an employer and unless they opt out within one month they will lose their fixed protection.  Care should be taken when the member changes employer as they will be automatically enrolled into their scheme.

If an employer auto enrols a member into their pension scheme and this is not under the Pensions Act 2008 provisions then they will lose your fixed protection unless there is a legally binding scheme rule that will treat you as not having been a member of the scheme. This applies even if you have cancelled the pension contract under the FSA cancellation rules.

 

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.

In addition, the information provided is also based on our current understanding of the relevant Finance Acts.

Published 29 September 2004

Updated 4 April 2012

For professional advisers only