Pensions accumulation frequently asked questions

No.

If scheme rules allow, a member may make a contribution by transferring shares into their pension scheme or using other in-specie assets.

Shares may be transferred to a scheme as a contribution as long as the shares are eligible, either:

• If the shares have been gained through a save as you earn scheme, and are transferred into the pension scheme within 90 days of the member exercising the right to acquire them.
  or
• The shares have been part of a share incentive plan, and have been transferred to the pension scheme within 90 days of the member asking for the shares to be transferred to them or, if earlier, the release date in relation to the shares.

The value of the contribution for tax purposes will be the market value of the above shares on the date they are transferred to the scheme.

Other shares and other assets (eg a property) can also be paid into the registered pension scheme as an ‘in-specie’ contribution as long as the pension scheme allows for this within their scheme rules and the asset is acceptable to them.

In these circumstances HMRC insists that any in-specie transfer received must match the true contribution liability that has been made with the intention to pay the contribution by transferring assets. This can cause problems with assets being used that have a degree of market volatility and rapidly changing prices.

It is possible for an employer to pay a pension contribution with an alternative in-specie asset subject to the rules detailed above applying. Also, consideration would have to be given to the rules relating to employer related investments being held within a scheme.

There is no defined maximum contribution an employer can pay. As long as it can be proved the contribution is exclusively for the purposes of the UK business, tax relief is not restricted on the contribution an employer makes on behalf of the employee.

Any contribution made over the annual allowance will create an annual allowance charge. This charge will be levied on the member. This can cause potential problems for the member as the contribution that has been paid is a legitimate contribution and cannot be refunded, so the member will have to find the money for the charge.

Example 1:

A member earns a salary of £120,000 and makes a personal pension contribution of £25,000 gross.

The employer recognises the essential nature of this employee and contributes into their pension plan an amount of £20,000. Under these circumstances the combined pension contributions are below the annual allowance which can be paid as contributions with no annual allowance charge.

Example 2:

A member earns a salary of £220,000 and makes a personal pension contribution of £45,000 gross.

The employer recognises the essential nature of this employee and contributes into their pension plan an amount of £50,000. As the total pension contributions (£95,000) are in excess of the current annual allowance of £50,000 there is an excess of £45,000.

Although the excess has been created by the employer’s contribution, the excess charge will be levied on the member at an appropriate rate. The appropriate rate is determined by adding the amount subject to the charge to the member’s ‘net income’. The appropriate rate is:

• 20% on that much of the chargeable amount that, when added to net income, does not exceed the basic rate limit.
• 40% on the amount which exceeds the basic rate limit but does not exceed the higher rate limit,
• 50% on any part of the excess which exceeds the higher rate limit.

This charge may be avoided however by utilising pension input periods that result in pension contributions being allocated to different tax years, or by making use of carry forward of unused annual allowance from the three previous tax years.

Where a member of a defined benefits scheme has, for example, been promoted and receives a retrospective increase in benefits, the resulting increase may mean the client is over the annual allowance for the current year but may still be able to offset some or all of any excess by using the carry forward of unused annual allowance rules.

Member contributions are generally restricted by pension providers based on tax relief gained on the contribution rather than the overall size of the contribution.

In theory, a personal contribution has no restriction other than the annual allowance. However, pension providers will generally only accept tax relievable personal contributions.

For purposes of tax relievable contributions the maximum amount that can be paid is the higher of £3,600 or 100% of UK relevant earnings (ie employee earnings, self-employed earnings and patent income). These figures are always quoted on a gross basis so it should be remembered that personal contributions to personal pension based registered pension schemes will be made net of basic rate tax, with the pension provider claiming the basic rate of tax back from HMRC. If the member is a higher rate tax payer they will generally need to claim any additional relief via their self assessment forms or if they do not fill out one of these via a stand alone claim.

It should also be noted that HMRC treats all contributions from other sources, which are not seen as being from a current or previous employer, as a third-party contribution. A third-party contribution will be treated as though the member had made the contribution. This means the member will be able to claim personal tax relief at their highest marginal rate (the third-party contributor will give up all rights to the money and cannot themselves claim tax relief). The member will also have to ensure that this contribution is counted when looking at the total tax relievable contributions they can make as outlined above, as well as the total for annual allowance purposes.

The annual allowance applies in total to all increases in pension entitlement an individual may have. The list below details how these increases are valued when testing against the annual allowance:

Benefit value and calculations.

Money purchase arrangements – the total contributions paid in any one pension input period, excluding age-related rebates. This includes gross contributions paid by or on behalf of the individual, and their employer.

Cash balance arrangements – the increase in the value of the individual’s rights over a pension input period. When working out how much the benefits have increased by, the amount at the beginning of the year must first be increased by the higher of 5% or the percentage increase in the RPI or any other rate specified by HMRC. This is then compared with the value at the end of the year.

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 benefit arrangements – the increase in the value of the individual’s rights over a pension input that started on or after 14 October 2010.. Benefits will be valued using a standard valuation factor of 16:1 regardless of age or sex. Any personal contribution the member is making in addition to the increase in member’s benefits for the year is ignored for this calculation. Any increase in lump sum rights (ie not by commutation) will be taken to be the actual lump sum and added on to the value given above.

For a pension input period that started before the 14 October 2010 but will end in the 2011/12 tax year the value of pension benefits accrued between the start of the input period and the 13 October 2010 will be valued using a 10:1 valuation factor. The accrual beyond that date to the end of that input period will use the 16:1 factor.

The rights to be valued will include any 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 into the scheme and any pension credits can be excluded.

Deferred benefits must increase by the greater of 5% or the percentage increase in the RPI or any other rate specified by HMRC before the 16:1 factor is used.

A pension input period (PIP) is the period of time over which contributions are made to an arrangement that will count towards the appropriate annual allowance. The last day of the PIP will determine which tax year’s annual allowance the contributions will count against. For example, if a PIP started in June 2010 and ends in June 2011, this will count towards the 2011/12 annual allowance of £50,000.

Generally, each PIP can run for any period of time up to 12 months. However, there can only be one pension input period ending in any one tax year per arrangement.

The first PIP commences on the date of the first relievable pension contribution made to an arrangement and ends on 5 April of the same tax year, unless an earlier or later date is nominated.

A nomination date cannot be more than 12 month after the start date of the PIP. A nomination for an end date after 5 April can be made after 5 April but this cannot be a date before the nomination is made. Skandia takes advantage of the nomination process. For information on how Skandia arrangements operate please click here.

For example, Colin wants to set up a new Collective Retirement Account by making a single lump sum contribution of £2,000 on 2 January 2012. His first PIP will start on 2 January 2012 and would normally end on 1 January 2013 which will mean that the £2,000 contribution will count against Colin’s 2012/13 annual allowance.

If Colin wants that contribution to be set against his 2011/12 annual allowance he can nominate in writing at the time of making the initial contribution that the initial PIP should end on a date that is no later than 5 April 2012.

Once the first PIP has ended the next PIP will commence immediately afterwards. It will automatically last until the anniversary of the end date of the first PIP, unless a nomination is made for it to end earlier or later. The nomination must be a date in the tax year following the tax year in which the previous PIP ended in, and can’t be a date before the date the nomination is made.

For example, Sheila has a Collective Retirement Account where the second PIP started on 6 July 2011 and will therefore normally end on 5 July 2012. Sheila could not nominate an end date which fell before 6 April 2012 but could choose any date up until 5 April 2013 as long as the date chosen is on or after the date the nomination is made.

The annual allowance for the 2011/12 tax year is £50,000, and will remain at £50,000 for subsequent tax years although indexation may apply from 2016/17 tax year.

Where the employer is a limited company they can normally treat any pension contribution as a business expense and offset against corporation tax due, as long as the ‘wholly and exclusively’ rules are met in relation to the UK trade being carried out. Where the employer is a sole trader or partnership the contributions will be set against the income tax liability of the sole trader or partners within a partnership.

A registered pension scheme member will be subject to a 40% tax charge on the amount of any contribution (both individual and employer) paid in excess of the annual allowance applicable to the tax year in which the pension input period ends and where all relevant carry forward of unused annual allowances from pension input periods ending in the 3 previous tax years has been used up.

• This charge will not apply to pension savings for an arrangement in the 2011/12 tax year onwards where the individual:
  – dies
  – retires on the grounds of serious ill-health, or
  – is a deferred member of that arrangement (provided the benefits do not increase more
     than CPI or an annual percentage rate in force in the scheme rules on 14 October 2010).

Tax relief is normally granted in respect of the trading period in which the pension contribution is paid to the registered pension scheme. However, if the contribution is significantly larger than that made in the previous year it may be necessary for the tax relief to be spread over a number of years. An employer contribution needs to be spread for tax relief purposes where it:

• is more than 210% of the contribution paid in the previous chargeable period, and
• the ‘relevant excess contributions’ (RECs) are £500,000 or more.

A chargeable period is the company’s accounting period. The timescale over which a contribution is spread varies – it depends on the amount of the REC and can be between two and four years. RECs are defined as the excess over 110% of the amount paid in the previous chargeable period.

Note: Tax relief can be claimed in the current chargeable period on the excess where the employer ceases to carry on business.

Yes, it is called a short service refund. A refund can only be taken from an occupational pension scheme if the member leaves the scheme within two years. Once somebody has been in a pension scheme for at least three months they also have to be offered a transfer of benefits. This transfer value must include the value of any employer contributions. There is no statutory entitlement to a preserved benefit for those with less than two years service.

Special rules apply when benefits include protected rights.

Up to 5 April 2010 tax was deducted at a rate of 20% on the first £10,800 of the refund and then 40% on anything over £10,800. From 6 April 2010 tax will be deducted at a rate of 20% for the first £20,000 of the refund and then 50% on anything over £20,000. The scheme administrator will deduct tax from the payment and account for the amount of tax deducted to HMRC.

Employer contributions must be ‘wholly and exclusively’ for the business before they can be granted corporation tax relief by the local Inspector of Taxes.

Controlling directors often take a low salary but high dividends from the business in order to save on National Insurance contributions. If they want to make high (in relation to salary) employer pension contributions, HMRC will look at the client’s total remuneration package that includes both salary and the pension contributions being provided by the employer when making a decision relative to the authorisation of tax relief on the employer contributions.

Where there are non controlling directors or close relatives of the controlling director(s) for whom employer contributions are being made however, these contributions are unlikely to receive tax relief if they are not in line with contributions made for any other unconnected employees doing the same work within the business.