Back in 2006, an attempt was made to simplify pensions legislation. It didn't work. There truly is little that is simple about the UK pension system, and it is massively rules-based, particularly when taking the tax treatment of contributions and benefits into account.
HMRC, in its latest pensions newsletter, has provided details of another complex aspect of pensions tax relief. It seems that many high earners forget to give details about their pension contributions on their self-assessment tax returns.
Government sets limits on how much income tax relief a person can receive on contributions paid to a registered pension scheme. For most people, that limit is 100% of their gross earned income with a contribution ceiling of £40,000. However, higher earners may see that £40,000 tapered down by £1 for every £2 they earn above £150,000. The maximum for some may be down to £10,000. These figures are known as the "annual allowance" and the "tapered annual allowance."
Where contributions in a tax year exceed these figures, they need to be reported in the person's self-assessment tax return. By reporting these "breaches" of the limits, HMRC can then impose an "annual allowance tax charge" to recover the tax relief that should not have been granted.
It's complicated, though. If you are a member of a defined benefit pension scheme, then the scheme calculates the amount of annual allowance you have used by reference to the growth in the value of your defined benefit pension. Some pension scheme members are forgetting to fill in this part of their self-assessment return and therefore not declaring the excess means the tax charge is not applied. When the HMRC catches up with these forgetful people, they are likely to have to face a large tax bill.
It's made even more complex because schemes don't typically notify a member who has breached the tapered annual allowance.
The good news is that a financial planner can help you with these calculations and ensure that you are reporting the correct numbers to HMRC.