Section 14 - Annual Allowance limits (tax on LGPS pensions)

The AA is the amount by which the value of pension benefits may increase in any one year without having to pay a tax charge. This is in addition to any Income Tax paid on pensions once in payment.

If the value of pension savings in any one year (including pension savings outside of the Local Government pension Scheme (LGPS) are in excess of the AA limit, the excess savings will be taxed as income.

The Government has reduced the AA limit several times. Further changes to the AA have been made with the alignment of the Pension Input Period (PIP) to the tax year, which has resulted in special transitional rules for the 2015/16 tax year. Additionally, there have been changes for higher earners from 6 April 2016.

The AA limits are as follows:

Most people will not be affected by the AA tax charge because the value of their pension savings will not increase in a year by more than £40,000, or, if it does they are likely to have unused allowance from previous years that can be carried forward.

Members are most likely to be affected if they:

• Have a lot of Scheme membership and receive a significant pay increase;
• Pay a high level of additional contributions;
• Are a higher earner;
• Transfer final salary pension rights into the LGPS from a previous public sector pension scheme under the preferential club transfer rules and the salary (full time equivalent) upon joining the LGPS is somewhat higher than the salary when they left the previous scheme;
• Combine a previous LGPS pension benefit that was built up in the final salary section of the LGPS with their current pension account and the salary (full time equivalent) has increased significantly since leaving and re-joining the scheme;
• Have accessed flexible benefits on or after 6 April 2015; or
• Retire on ill-health grounds with enhanced benefits and don’t satisfy HMRCs definition of serious ill-health.

Southwark Pension Services will inform members if their LGPS pension savings exceed the AA limit in any tax year by no later than 6 October of the following tax year. This will only be calculated on their benefits in the Fund, calculations in relation to benefits held elsewhere will not be provided.

The increase in the value of a member’s pension savings in the Fund in a year is calculated by working out the value of the benefits immediately before the start of the PIP, increasing the value by inflation and then comparing it with the value of the benefits at the end of the PIP.

The PIP is the period over which pension growth is measured. From 6 April 2016, PIPs for all pension schemes was aligned with the tax year – 6 April to 5 April. Prior to 2016/17, the PIP for the LGPS was 1 April to 31 March, except for the year 2015/16 when special transitional rules apply.

In the LGPS, the value of pension benefits is calculated by multiplying the amount of annual pension, plus any in-house additional contribution contracts by 16, and adding any lump sum they may be automatically entitled to from the pension scheme and in-house AVCs that have been paid during the year.

If the difference in the value of pension benefits at the end of the PIP, less the value of pension benefits immediately before the start of PIP (adjusted for inflation) is more than the AA limit, then the member may be liable to pay a tax charge.

It is important to note that the assessment for the AA covers any pension benefits a member may have where they have been an active member during the year, not just benefits in the Fund. For example, if the increase in the value of LGPS benefits was calculated as £30,000 in 2014/15 when the AA limit was £40,000, but a member also had an increase in the value of other pension benefits of £15,000 in the same year, that would mean a total increase in pension benefits of £45,000.

If they did not have any carry forward, they would be liable for a tax charge for the amount they exceeded the AA limit by, even though at face value, they did not breach their AA limit in either scheme.

Members would only be subject to an AA tax charge if the value of their total pension savings for a year increase by more than the AA limit for that year.

However, a three year carry forward rule allows the carry forward of any unused AA from the previous three years. This means that even if the value of the pension savings increase by more than the AA limit in a year, they may not be liable to the AA tax charge.

For example, if the value of the pension savings in 2014/15 increased by £50,000 (i.e. by £10,000 more than the AA limit), but in the three previous years had increased by £25,000, £28,000 and £30,000, then the amount by which each of these previous years fell short of the AA limit for those three years, would more than offset the £10,000 excess pension saving in the current year. There would be no AA tax charge to pay in this case.

To carry forward unused AA from an earlier year, members must have been a member of a tax registered pension scheme in that year.

The Finance (No 2) Act 2015 introduces two important changes to the AA with effect from 6 April 2016:

1. An AA taper for high earners from 6 April 2016; and
2. An adjustment the PIP during 2015/16 such that it becomes aligned with the tax year from 6 April 2016.

From the tax year 2016/17, the AA was tapered for members who have what’s known as a threshold income in excess of £110,000, and an adjusted income in excess of £150,000. For every £2 that adjusted income exceeds £150,000, the AA limit will be tapered down by £1 (to a minimum of £10,000).

Threshold income includes all sources of income that are taxable e.g. property income, savings income, dividend income, pension income, social security income (where taxable), State Pension income etc. Please note, members are not allowed to deduct from taxable income any amount of employment income given up for pension provision as a result of any salary sacrifice made on or after 9 July 2015.

The PIP is the period over which pension growth is measured. Up until 2014/15 the PIP in the LGPS ran from 1 April to 31 March. From 6 April 2016, PIPs for all pension schemes were aligned with the tax year – 6 April to 5 April. Special transitional arrangements apply for 2015/16 meaning that there are two PIPs in 2015/16, as set out below:

1. Pre-alignment tax year - 1 April 2015 to 8 July 2015 – the revised AA limit during this period is £80,000; and
2. Post-alignment tax year - 9 July 2015 to 5 April 2016 – the AA limit for this period is the amount of the £80,000 not used up from the pre-alignment tax year (subject to a maximum of £40,000) together with any carry forward available from the three previous years.

If members have any benefits in a defined contribution pension (DC) arrangement which they have flexibly accessed on or after 6 April 2015, then the Money Purchase Annual Allowance (MPAA) rules may apply. However, the MPAA will only apply if total contributions to a DC arrangement in a PIP exceed £10,000. However, the Government reduced that figure to £4,000 from 6 April 2017.

Generally, if contributions to a DC scheme exceeded £10,000 (or £4,000 from April 2017), LGPS savings will be tested against a reduced AA of £30,000 (£36,000.00 from April 2017) and members will pay a tax charge in respect of the DC saving in excess of £10,000 (or £4,000 from April 2017).

If members have accessed flexible benefits, they will be provided with a flexible access statement; members should provide Southwark Pension Services with a copy of this statement.

Flexibly accessed means taking a cash amount over the tax-free lump sum from a flexi-access drawdown account, taking an uncrystallised funds pension lump sum (UFPLS), purchasing a flexible annuity, taking a scheme pension from a DC scheme with fewer than 12 pensioner members or taking a stand-alone lump sum if you have primary but not enhanced protection.

If the AA limit is exceeded in any year, members are responsible for reporting this to HMRC on their self-assessment tax return.

Southwark Pension Services are only obliged to notify members if LGPS benefits (plus the amount of any in-house additional contributions contracts and in-house AVCs they may have paid) within the Fund exceed the AA limit in a year, by no later than 6 October of the following tax year.

If members have an AA tax charge that is more than £2,000 and pension savings in the LGPS alone have increased in the year by more than the AA limit, they may opt for the LGPS to pay some, or all of the tax charge on their behalf. The tax charge would then be recovered from their future pension benefits – this is referred to as Mandatory Scheme Pays.

If the member does not satisfy the above criteria fully – e.g. has a TAA – they can still apply for the LGPS to pay some, or all of the tax charge on their behalf. The tax charge would then be recovered from their future pension benefits – this is referred to as Voluntary Scheme Pays.

If members want the LGPS to pay some or all of an AA tax charge on their behalf, they must notify the Southwark Pension Services no later than 31 July in the year following the end of the year to which the AA charge relates, e.g. 31 July 2019 for tax year 2018/19.

However, if the member is retiring (and draws all of their benefits from the LGPS) and they want the LGPS to pay some or all of the tax charge on their behalf from their benefits, they must tell the Southwark Pension Services before they are in receipt of those retirement benefits.

If you think some of your members are affected by the AA, more information including an AA checking tool, is available on the Government’s website at www.gov.uk/tax-on-your-private-pension/annual-allowance.

NOTE - The rules governing AA can be complex and are subject to change; an AA guide in the LGPS guides provided by the Local Government Pensions Committee is available online. If members are unsure how to proceed they are advised to obtain independent financial advice. For help in choosing an independent financial adviser visit the Money Advice Service.

The issuing of Pension Savings Statements is dependent on receipt of accurate earnings details for the period in question and may be later than 6 October if the required data is not delivered by an employer.