Annual allowance: essential principles: when the annual allowance charge does not apply
An individual will not be liable to the annual allowance charge where:
- their pension saving (total pension input amount) for the tax year is less than the annual allowance, or
- their total pension input amount is more than the annual allowance but using carried forward unused annual allowance from recent previous tax years reduces the amount of pension saving over the annual allowance to nil. PTM055100 explains how the carry forward rule works, and
- the money purchase annual allowance does not apply.
There are however three other situations where part or all of an individual’s pension savings will not be liable to the annual allowance charge for the tax year. These are if the individual:
- retires due to severe ill-health, or
- is a deferred member whose benefits do not increase beyond certain levels.
Section 229(3)(b) Finance Act 2004
The annual allowance charge does not apply in the tax year that the individual dies. This is because for the tax year in which an individual dies their total pension input amount (pension saving) is set at nil.
For tax years before 2016-17, pension input periods did not have to align with the tax year. Individuals could therefore make pension savings in a pension input period that began in the tax year in which the individual died but ended in the following tax year. Any such pension savings do not count towards the annual allowance.
A pension input period for an arrangement starts on 1 January 2013 and ends on 31 December 2013 (‘pension input period ‘X’’).
The next pension input period starts on 1 January 2014 and ends on 31 December 2014 (‘pension input period ‘Y’’).
The individual dies on 31 January 2014.
The pension input amount for pension input period ‘X’ would normally count for tax year 2013-14 but does not because the individual died before the end of tax year 2013-14.
The pension input amount for pension input period ‘Y’ would normally count for tax year 2014-15 but does not because the individual died before the end of tax year 2014-15.
Note that any outstanding annual allowance charges in respect of tax years before the tax year in which the individual died are still payable.
Sections 229(3)(a) and (4) and 279(1) Finance Act 2004
There will be no pension input amount for an arrangement if for the tax year concerned (i.e. for the tax year in which the pension input period ends) the individual meets any of the following conditions for the arrangement.
- The individual becomes entitled to a serious ill-health lump sum from that arrangement (see PTM063400 for payment conditions).
- The individual becomes entitled to all their benefits under that arrangement because they are unlikely to be able to work at any time up to state pension age. The scheme administrator needs evidence from a registered medical practitioner that the individual is unlikely to be able to do any type of gainful work, other than in an insignificant way, before state pension age. PTM063400 explains what is meant by a registered medical practitioner.
This means that the individual is not able to continue in their current job and is not likely to be able to take any other paid work to the extent that this is significant. For example, the individual could undertake voluntary work or unpaid work where out of pocket expenses are reimbursed or small amounts of travelling or subsistence payments are made. Any paid work should be insignificant, for example it should be infrequent or only for a few days during the year and the payment must be small in amount, not just as a proportion of previous pay or salary.
- The individual is a member of the UK armed forces who becomes entitled to benefits from the arrangement and those benefits are not taxable due to s641(1) Income Tax (Earnings and Pensions) Act 2003. Guidance on this subject can be found in the the Employment Income Manual at EIM74302.
Pension input amounts under those arrangements that meet the above conditions will be deemed to be nil, and so there can be no annual allowance charge against that pension saving. This is the case for the pension input period that ends in the tax year that the individual becomes entitled to benefits under any of the above conditions. It will also apply for tax years before 2016-17 where a pension input period began in the tax year in which the individual became entitled to benefits under any of the above conditions but ended in the following tax year (i.e. it applies in exactly the same way as the example in the Death section above illustrates).
- pension inputs under arrangements that don’t meet the severe ill-health conditions continue to count towards the annual allowance or money purchase annual allowance. Those inputs may be liable to the annual allowance charge if they are more than the annual allowance or money purchase annual allowance (if applicable).
- any outstanding annual allowance charges in respect of tax years before the tax year in which the individual met the severe-ill health conditions are still payable.
Section 230(5B, 5BA, 5BB, 5BC & 5C) and 234(5B, 5BA, 5BB, 5BC, 5BD, 5BE & 5C) Finance Act 2004
An individual who under either a defined benefits or cash balance arrangement is:
- a deferred member for the whole of the pension input period
- a deferred member for part of the pension input period and then a pensioner member for the rest of the pension input period, or
a deferred member from the beginning of the pension input period until
- there is a recognised transfer from the pension scheme of all the sums or assets held for the purposes of, or representing accrued rights under, the arrangement in connection with the individual, and
- after the transfer, no rights accrue under the arrangement (from which rights have been transferred) to (or in respect of) the individual during any remaining part of the pension input period
is treated as having no pension input amount (pensions saving) for that arrangement if the following conditions are met.
For the arrangement to be treated as having no pension input amount any increase in the member’s benefits under the arrangement cannot be more than:
- the ‘relevant percentage’, plus
- the ‘relevant statutory increase percentage’.
Note - for this purpose rights to a GMP do not have to be taken into account when considering the increase in the member’s benefits under the arrangement. Effectively, if either of the above increase conditions is met in relation to the deferred member’s other benefits under the arrangement, the rate of increase that must be given to the GMP can be ignored.
If an individual has left a pension scheme but their future benefits are still linked to their final salary the individual is not a ‘deferred member’ for the purpose of the tax rules. This is because the individual is still accruing benefits to the continued salary link. Any pension saving (calculated in the usual way for pension input amounts generally, including the CPI uplift on the opening value) counts as a pension input amount.
An individual is likely to be a deferred member in the following situations:
- they have left their employer and their pension benefits are still held under the scheme
- they joined their employer’s pension scheme and later opted out of it. By opting out you do not build up benefits in the pension scheme. Existing benefits will continue to be invested (if money purchase) or will increase in accordance with the pension scheme rules (if defined benefits), for example by a percentage each year as required by legislation.
For a defined benefits arrangement this means that the individual’s deferred pension benefits are not affected by their continued employment and any increase in pay. If the individual’s pension rights are still based on their current salary and so that benefits increase if they receive a pay rise (even though the amount of their pensionable service does not change) then they are not a deferred member.
The provision operates ‘per arrangement’: an individual may be a member of more than one arrangement. If the individual has more than one arrangement and is a deferred member in one but making pension savings in another then the first arrangement gets the ‘nil pension input amount’ provision (subject to the increase condition being met) but the pension savings in the second arrangement are subject to the normal annual allowance rules.
An example of how this might arise is if the type of benefits an employer gives their employees may have changed over time. For example, an employer might have given benefits on a final salary (defined benefits) basis for a period of time, but changed its pension provision for subsequent service. For service since the date of the change, it provides the employee with money purchase pension benefits. Provided that the employee’s continued employment has no effect (in fact or by way of provision in the rules) on those final salary benefits they will be a deferred member in relation to those final salary benefits.
It does not matter if the final salary and money purchase benefits are provided by the same pension scheme or by different pension schemes. The individual would be a deferred member for the defined benefits (final salary) arrangement and an active member of the money purchase arrangement. Provided the benefits increase restrictions are met the individual would not have a pension input amount from the defined benefits arrangement but would have a pension input amount for the money purchase arrangement.
PTM053910 gives more information and examples on when the annual allowance charge does not apply to deferred members.