This guide is for financial advisers only. It mustn’t be distributed to, or relied on by, customers. It is based on our understanding of legislation as at May 2023.
Normally, an individual will need to pay an annual allowance charge if their pension savings in a tax year exceed the annual allowance limit that applies to them, and they don’t have sufficient unused allowance to carry forward from the previous three tax years. An annual allowance tax charge will apply to any excess.
For more information on the ‘standard’ annual allowance, please refer to the Annual Allowance guide and for information on when the annual allowance is reduced for higher earners, please refer to our Tapered Annual Allowance (TAA) section of that guide.
It’s possible for someone to have an annual allowance charge liability for a tax year despite their total pension savings being less than their available annual allowance. For example, this could happen where the money purchase annual allowance (MPAA) applies to an individual, they have made pension savings into a money purchase arrangement and these exceed the MPAA limit for the tax year.
So, someone could incur an annual allowance charge by exceeding the annual allowance or tapered annual allowance (plus any carry forward amounts), or the MPAA.
For more information on the MPAA refer to the Money Purchase Annual Allowance section of the annual allowance guide .
An annual allowance charge is a tax charge on the individual regardless of who was responsible for the excess pension savings (such as contributions by an employer).
If an annual allowance tax charge is due it’s payable at a person’s marginal tax rate taking into account their taxable income and the amount of their excess pension savings for the relevant tax year.
The marginal rate(s) of tax chargeable that applies will depend on where the individual is classed as living in the UK.
Scottish taxpayers (with an S rate identifier at the start of their tax code) would be subject to an annual allowance tax charge based on Scottish income tax rates and tax bands. Similarly, Welsh tax payers (with a C rate identifier at the start of their tax code) would be subject to an annual allowance tax charge based on Welsh income tax rates and tax bands.
For the rest of the UK, the charge could, in whole or in part, be at 45%, 40% or 20%.
The annual allowance charge is usually paid through the individual’s self-assessment tax return. However, provided certain conditions have been met, an individual can ask their pension scheme to deduct part or all of the charge from their pension savings. This is known as ‘scheme pays’.
The pension scheme administrator pays the annual allowance charge direct to HMRC on the individual’s behalf, and their pension savings are reduced accordingly. There are certain conditions that need to be met for an individual to have the right to use this facility.
All registered pension schemes must offer a scheme pays facility. However, an individual must meet all of the following conditions to have the right to use scheme pays on a mandatory basis:
- the individual’s pension savings – either contributions or benefit accrual – in the pension scheme have exceeded the ‘standard’ annual allowance for the relevant tax year (the MPAA and TAA are not relevant at this stage).
- the individual’s total annual allowance charge for the relevant tax year – across all savings in registered pension schemes – has exceeded £2,000.
- the notice for scheme pays is made within the timescale permitted.
- the individual hasn’t already taken all of their benefits from the scheme.
Where an individual has pension savings across multiple pension schemes, the maximum amount of charge any scheme can be required to pay is based on the amount by which the individual’s savings in that particular scheme have exceeded the standard annual allowance. There is no minimum amount of charge that a member can ask their scheme to pay but if the amount of charge the individual wants their scheme to pay is less than £2,000 then they would need to confirm to the scheme that their total annual allowance charge is more than £2,000.
Where the MPAA or tapered annual allowance applies, the maximum amount of charge a scheme can be required to pay is still based on the amount by which the individual’s savings in that particular scheme exceed the ‘standard’ annual allowance. This means that even if all of the conditions listed above have been met, an individual who has a reduced annual allowance can’t require their scheme to pay the full amount of their annual allowance charge. A pension scheme may agree to pay the balance on a voluntary basis but is not obliged to do so.
Philip is a high earner and has a tapered annual allowance of £10,000. Philip’s employer pays contributions totalling £65,000 in the tax year to his personal pension. This amount exceeds his annual allowance by £55,000. If Philip has no unused annual allowance to carry forward, there will be an annual allowance charge due on the excess, £55,000 x 45% = £24,750 (assuming the rest of UK income tax rates apply). However, Philip can only require his pension scheme to pay the tax charge that arises on the £5,000 excess above the ‘standard’ annual allowance (£5,000 x 45% = £2,250). This means that Philip may have to pay the £22,500 balance from his other resources, unless his pension scheme agrees to pay this part of the tax charge on a voluntary basis.
Pension schemes can allow access to the scheme pays facility where one or more of these conditions haven’t been met – known as the ‘voluntary basis’ – but are not required to do so.
Any payment made by a scheme on a voluntary basis should be paid to the member’s normal self-assessment tax return deadline. The reason for this is that where a scheme has agreed to pay part or all of an annual allowance charge on a voluntary basis, the liability for the voluntary element of the tax charge remains with the member. This means that any request to use scheme pays on a voluntary basis must normally be submitted much earlier than when the statutory conditions have been met.
A scheme is not obliged to offer scheme pays where:
- it’s being assessed by the Pension Protection Fund at the time the member makes a scheme pays request.
- a scheme pays request has been made but before tax is paid to HMRC the scheme starts to get assessed by the Pension Protection Fund.
- a pension scheme would be unable to make an adjustment to the member’s benefits in the scheme to take account of the tax paid because the benefits to be adjusted include ‘contracted-out’ rights.
- the MPAA or tapered annual allowance has been exceeded but the standard annual allowance hasn’t.
A scheme may also apply to HMRC for a discharge of their liability to pay a charge if doing so would substantially harm the interests of other members of the scheme or where it would not be reasonable for the scheme to pay a charge (for example, where the value of a member’s benefits is not enough to meet the charge).
This is the responsibility of the member (with help from their adviser, if they have one). The member should simply tell their scheme or provider how much of the charge they want the scheme to pay. This can be done using a ‘scheme pays notice’.
There is no industry standard form, but any notice requesting scheme pays must be made in writing or electronically. The notice must contain certain information and declarations. Most schemes and providers have produced suitable forms that their members can use for this purpose.
For a pension scheme to become jointly and severally liable to an annual allowance charge, it must receive a notice no later than 31 July in the year following the tax year in which the annual allowance charge relates.
For example, if an annual allowance charge relates to the 2022/23 tax year, then the deadline for submitting a scheme pays notice to a pension scheme would be 31 July 2024. Once a pension scheme has received a notice for scheme pays, and the necessary conditions have been met, it can’t be withdrawn. However, the amount of charge that an individual has asked their pension scheme to pay can be amended later by submitting a revised notice.
The deadline stated above can be brought forward in the following circumstances:
If a member intends to take all of their benefits from a pension scheme or if a member will reach age 75 and there will be a BCE at that age*, and a member wants a scheme to pay an annual allowance charge for that tax year or another tax year, then they have to give a scheme pays notice to the scheme administrator before the date on which they either intend to take all their benefits or before the BCE at age 75.
As part of the process of addressing the age discrimination that has affected some scheme members of public sector schemes (commonly referred to as the McCloud judgement), members may receive a retrospective pension input amount for a previous tax year that could mean they incur an annual allowance charge.
Legislation was included in the Finance Act 2022 to cater for situations where an annual allowance charge of £2,000 or more arises because an additional pension input amount has been made for a previous tax year as a result of a retrospective change of facts. The intention is to allow affected members to use the mandatory scheme pays option to pay any annual allowance charge due providing the relevant conditions and timescales are met. The Act applies to any type of registered pension scheme so is not restricted to public sector schemes only. It could therefore apply to benefit accrual in a defined benefit scheme and to contributions made to a defined contribution scheme.
There’s a deadline for notifying members that a pension input amount has been added to their pension scheme for an earlier tax year, where that change in the pension input amount results in an annual allowance tax charge of more than £2,000. A scheme administrator must advise the member of the pension input amount change:
- on or after 2 May in the year following that in which the tax year ends, and
- before the end of the period of 6 years beginning with the end of the tax year in question.
If the member is able to use mandatory scheme pays and wants to do so, they must give a scheme pays notice to their scheme administrator by the earliest of:
- the end of the period of 3 months, beginning with the day that the scheme administrator gave the member information about the additional pension input amount, and
- the end of the period of 6 years beginning with the end of the tax year in question.
For example, assume an additional pension input amount is made on 1 August 2023 to a pension scheme that increases the pension input total for the 2016/17 tax year, and this results in an annual allowance charge of more than £2,000. The scheme administrator must inform the member of this by 5 April 2024 at the latest.
If the scheme administrator actually informed the member of this on 1 August 2023, then the individual would need to give a scheme pays notice to the scheme administrator by the earliest of:
- 31 October 2023, and
- 5 April 2024.
So, if intending to use mandatory scheme pays, the member would need to give a scheme pays notice to the scheme administrator by 31 October 2023.
Note – where no additional pension input amount has been added to a member’s pension for an earlier tax year, then the deadline for giving a scheme administrator a scheme pays notice remains 31 July of the year following the end of the tax year in which the annual allowance charge arose. So, if an annual allowance charge arises in 2022/23, then the member must give a scheme pays notice for using mandatory scheme pays by 31 July 2024.
Where a pension scheme pays part or all of an individual’s tax charge, there must be a corresponding reduction in their benefits, otherwise the member may become liable to an unauthorised payments charge. Under a money purchase arrangement, the member’s fund is reduced by the amount of the charge (including any early withdrawal charges, if any). For defined benefits arrangements, there is flexibility as to how a scheme reduces a member’s accrued benefits, but any adjustment must be ‘just and reasonable’. Dependants’ pensions, other death benefits or contracted-out rights such as guaranteed minimum pensions can’t be reduced to pay an annual allowance charge.
*A BCE will take place at age 75 if there are uncrystallised benefits or if there are drawdown funds held that were set up after 5 April 2006.
Where an individual intends to use scheme pays but there is a transfer of all of their benefits from one scheme to another before they submit a scheme pays notice, they can submit the notice to the receiving scheme. If all of the statutory conditions for scheme pays were met in relation to the transferring scheme, the receiving scheme must comply with the notice. In other words, it does not become a voluntary scheme pays request for the receiving scheme.