Geraldine had earned £240,000 for many years but had never really engaged with her pension saving. She had contributed 5% of her salary as a combination of employer and personal contributions for as long as she could remember. In February 2019, prompted by a conversation with her parents about retirement and pensions, she decided that she probably wasn’t saving enough and would like to contribute more. Geraldine was vaguely aware of the annual allowance: she remembered her parents saying that they kept an eye out to check how much they could contribute each year. Geraldine wanted to pay in as much as she could. She arranged a meeting with Joey, a financial adviser, to discuss things further.
Joey had some bad news for Geraldine: because of the tapered annual allowance rules which were introduced on 6 April 2016, her annual allowance was much lower than it would have been previously. Joey explained that as Geraldine’s income excluding pension contributions was above £110,000 and her income including pension contributions was above £150,000, she would be affected by these rules. The tapering reduces the annual allowance by £1 for every £2 of income above £150,000, down to a minimum allowance of £10,000 for those whose total income is above £210,000. Geraldine fell into this category.
Joey then confirmed that as Geraldine had been contributing 5% of her salary, £12,000, for years, she had already inadvertently exceeded her tapered annual allowance for the last two tax years. Geraldine was concerned until Joey confirmed that it is possible to use unused allowance from up to three previous tax years in order to make larger contributions. Joey explained that when you carry forward unused allowance, you always have to start at the earliest of the three tax years first.
Geraldine first overpaid in the 2016/17 tax year by £2,000. The earliest tax year she could carry forward from was 2013/14. As Geraldine contributed £12,000 in that tax year too and the annual allowance was much higher – £50,000 – there was more than enough unused allowance to cover her overpayment in 2016/17. Geraldine realised that if she had thought about her pension saving sooner, she could have made a larger contribution in 2016/17 to use some more of the unused allowance from 2013/14. However, as carry forward would only allow her to go back three tax years, it was too late and the rest of the unused allowance from 2013/14 was lost.
Joey confirmed that the situation for 2017/18 was similar: Geraldine exceeded the tapered annual allowance that year by £2,000 but she had plenty of unused allowance from 2014/15 to cover this. The rest of the unused allowance from that year was also lost.
That brought them to 2018/19. Starting from the earliest tax year first, Geraldine could carry forward unused allowance from 2015/16, 2016/17 and 2017/18: however, she already used her full allowance in 2016/17 and 2017/18. That only left 2015/16.
Joey explained that 2015/16 was a strange year for annual allowance purposes, due to an exercise to align everyone’s pension input periods (a period of time over which pension savings are measured and tested against the annual allowance) to the tax year. This involved splitting the tax year into two and introducing some transitional measures for testing against the annual allowance. In order to work out how Geraldine’s contributions in 2015/16 were tested against the allowance and how much she had available to carry forward, Joey needed to know exactly when the contributions were paid. Geraldine checked her records and found that her monthly contributions of £1,000 were paid on the 15th of each month.
Joey knew that 2015/16 was split into the ‘pre-alignment’ and ‘post-alignment’ periods. The pre-alignment period ran from 6 April 2015 to 8 July 2015. Therefore Geraldine made £3,000 of contributions in that time. The annual allowance for the pre-alignment period was £80,000. For those not affected by the money purchase annual allowance (MPAA), the annual allowance for the post-alignment period was nil, plus up to £40,000 of unused allowance from the pre-alignment period. This meant Geraldine’s allowance for the post-alignment period was £40,000. She made £9,000 of contributions in that time, leaving her with £31,000 of allowance to carry forward and use in 2018/19.
Joey confirmed that Geraldine could make £41,000 of contributions in 2018/19 without exceeding her total available annual allowance. From 2019/20, if her income and the tapered annual allowance rules remained the same, Geraldine’s total annual allowance would be £10,000 each year, as she would have fully used the allowance in each of the years she might otherwise have been able to carry forward from. Joey knew this was less than Geraldine would have liked – after all, it’s less than she was already contributing.
Joey explained to Geraldine that the annual allowance (including variations such as the taper) did not limit how much she could contribute to her pension: it only limited the amount of tax relief she could benefit from. If her contributions exceeded her annual allowance, she would pay an annual allowance charge which would in effect take back the tax relief she would be assumed to have received on the excess. While tax relief is a big incentive for pension saving, the rest of the contribution would still benefit from the other tax advantages of a pension wrapper, such as tax free investment growth and a potentially advantageous inheritance tax position. Therefore higher contributions may still be worthwhile. Joey agreed to explore other options for Geraldine to boost her retirement savings, and arranged to meet with her again soon.