Annual Allowance: Scheme Pays

Overview

When the Annual Allowance changes were made in April 2011 it became apparent that more people would be affected by an Annual Allowance charge.

As a result of this two main actions were taken, the introduction of Carry Forward described in our article Carry forward of unused annual allowance for pension savings and the possibility for people with a charge to pay it from their pension benefits.

The individual concerned notifies, and sometimes will pay, the annual allowance charge through their self-assessment. There may be instances where the member can ask their scheme to pay the charge by reducing their pension benefits - known as ‘scheme pays’. Please note, even where the scheme pays the charge, the member must declare this through self-assessment.

We look at using scheme pays to meet charges where total pension inputs for the member exceed their AA limit (which may be the standard AA of £60,000, the Money Purchase AA of £10,000 or a tapered AA somewhere between £10,000 and £60,000 (previously the taper was between £10,000 to £40,000 during the tax years 2016/17 to 2019/20 and £4,000 to £40,000 during the tax years 2020/21 to 2023/24)).

Key points

All annual allowance charges must be reported through self-assessment, regardless if the individual pays from their own funds or uses a ‘scheme’ pays’ option

Mandatory scheme pays will not apply for the full amount of any charge where the excess is in respect of a MPAA or TAA excess

Where the conditions for mandatory scheme pays do not apply, it is entirely up to a scheme whether they choose to offer a voluntary scheme pays option

The timescales for paying the AA charge differ depending on how it will be paid ie individual/ voluntary scheme pays versus mandatory scheme pays

Checking annual allowance limits

First, establish pension input amounts for all schemes, bearing in mind it is possible to be a member of multiple schemes with the same provider (such as having Defined Benefits and Career Average or an AVC). A simple way to do this is to request a pension savings statement (PSS) from every scheme where the individual was an active/ accruing member in the tax year.

Remember, personal contributions paid to a pension scheme for life cover count towards the annual allowance where the client receives tax relief, and all employer pension contributions are tested against the annual allowance regardless of whether or not they qualify for corporation tax relief.

Next, once all relevant figures are known, consider if total pension input amounts for the completed tax year exceed the client’s available annual allowance (which may be the standard AA, the MPAA or a tapered AA). If they do, where eligible, check for unused annual allowance for the three previous tax years which may be carried forward to reduce or absorb the excess inputs.

Carry forward can be used for any defined benefit pension input amounts and also money purchase input amounts paid before an MPAA trigger event. Remember you cannot use carry forward once the MPAA is triggered to increase your allowance for money purchase inputs paid after the trigger event.

Read our MPAA - case studies article for further information.

If total pension input amounts are less than the available annual allowance (including carry forward) for the relevant tax year, keep a record of your calculations in case HMRC ask for evidence. Our annual allowance calculator has a print/ save to pdf function that could help with this.

If total pension input amounts are greater than the total AA, then the member must complete a self-assessment tax return. Even if the member would not normally be subject to self-assessment they must complete this if they have an annual allowance charge to pay.

NB members need to report the annual allowance charge on their Self-Assessment tax return even if they ask their scheme to pay the charge for them.

Pension Savings Statement (PSS): automatic and non-mandatory

What is a Pension Savings Statement?

A standard PSS provides the total amount of the pension inputs made to the scheme for the most recently completed tax year; the total amount of pension inputs made to the scheme for each of the pension input periods ending in the previous three tax years (for 2015/16 this will be shown separately for the pre and post-alignment periods) and the amount of the standard annual allowance for the previous three years.

If the member has flexibly accessed their pension benefits, they may receive a money purchase pension savings statement - if total money purchase inputs exceed the money purchase annual allowance (MPAA).

When will a client automatically receive a PSS from their scheme?

There are two prompts which require a scheme to automatically provide a PSS for a completed tax year:

Pension input amounts to the scheme, in the tax year, exceeded the standard AA, or
The scheme administrator believes the individual has flexibly accessed benefits and money purchase input amounts to the scheme, in the tax year, exceeded the MPAA

It’s important to remember that even though a member flexibly accesses benefits (called a trigger event) they must also have post-trigger event money purchase input amounts in excess of the MPAA for that tax year before they become subject to a reduced annual allowance for the remainder of their pension savings for that tax year (the alternative AA).

Deadline for providing a PSS which is required automatically

The member must be given a PSS for the relevant tax year by 6 October following the end of that tax year.

Some schemes require the scheme administrator to receive information from another person, e.g. an employer, to allow the pension input amount to be calculated. There are regulations covering the specific information to be provided to the scheme administrator. In the event the scheme administrator has not received this information on time, the deadline for giving the PSS to the member is extended by three months from the day the scheme administrator receives the required information.

Deadline for providing a non-mandatory PSS requested by the member

The scheme administrator has until the later of:

three months following receiving the member request, and

6 October following the end of the tax year

(but subject to the same caveat above where the scheme administrator relies on information from another person to calculate the pension input amount).

Scheme administrator reporting requirements

Importantly, where a scheme automatically sends a PSS to a member, part of the HMRC requirements means they also have to let HMRC know a PSS was sent. This means that HMRC could anticipate the member reporting a tax charge through self-assessment.

Does receiving an automatic PSS always mean there’s a charge

Members should not assume receiving a PSS is telling them they have a tax charge to pay. This is not always the case. It can simply mean the scheme have sent it to comply with their own HMRC reporting requirements.

An automatic Pension Savings Statement (PSS) from the scheme warns the member their pension input amounts may have exceeded their annual allowance. An individual scheme cannot know if a member has any available carry forward so they are unable to work out if a tax charge applies. This is the member’s responsibility.

Where a PSS is received automatically, this is a prompt for them to check their annual allowance position and report any excess amount and tax charge if required.

Where relevant tax year annual allowance calculations for the member are already complete, including a record of any carry forward used to absorb excess input amounts, no further action should be required.

There is no process to ‘claim’ carry forward. The member should keep a record of their annual allowance and pension input amounts in case HMRC conduct an audit.

Where a member is affected by a tapered annual allowance (TAA), they may need to review earlier calculations if they were based on assumed taxable income figures.

Further information in our Tapered annual allowance article and you can use our calculator to help with the sums.

If there is a tax charge, who pays?

Ultimately, the member. Whether they pay from their own resources or ask their scheme to pay the charge on their behalf - which will be met by the scheme reducing the client’s pension fund/ benefit entitlement. The scheme can only be compelled to pay the charge where the inputs into that scheme exceed the standard AA and the AA charge (not excess) is over £2,000. Even then, they may only have to pay some of the member’s charge. Although the scheme may agree to pay AA charges voluntarily.

Mandatory scheme pays conditions

There are prescribed conditions which, if met, mean the scheme must* agree to a member’s request to pay up to a maximum amount of the tax charge on the member’s behalf. This is called Mandatory Scheme Pays.

*unless the scheme has been taken over by the PPF, is being assessed by the PPF before the tax charge is paid, or the only benefits held in the scheme are Guaranteed Minimum Pension (GMP) rights which cannot be reduced to meet payment of the tax charge.

The conditions are that:

The member’s annual allowance charge liability for the tax year has exceeded £2,000, and
their pension input amount for the pension scheme for the same tax year has exceeded the standard annual allowance amount (NB not based on either MPAA or TAA amount), and
The member notice (for details of the content required see here) must be submitted by the deadline specified by legislation. For an AA excess in 2022/23 and 31 July 2024. It can be brought forward to a date (i) prior to the member becoming entitled to all of their benefits from the pension scheme or (ii) before reaching age 75 (if once they reach age 75 they will have benefits that will be tested against the remaining available Lifetime Allowance at that time).

Where these conditions are not met, the scheme may agree to a request on a voluntary basis.

Where a client exceeds the MPAA, then condition 1. above is based on the total input in excess of the standard AA only.

Reporting the annual allowance tax charge

Once the client has worked out their available annual allowance, including any carry forward where eligible, they can then work out if their total pension inputs exceed this available annual allowance. When there is an excess amount, they then work out the tax charge due.

The annual allowance charge is not at a fixed rate but depends on the client’s taxable income, the amount of their pension saving which exceeds their annual allowance and whether they pay UK, Scottish or Welsh rates of income tax. To find out the tax charge due, the client must work out the rate (or rates) of tax that would apply if their excess pension savings were added to their taxable income. Using UK rates of tax, the amount of the annual allowance charge can be in whole or in part at 20, 40 or 45 per cent, depending on the client’s taxable income and the amount of their pension savings over the available annual allowance. It’s worth noting that there is no availability of any unused personal allowance, the AA charge starts at 20%.

A member subject to Scottish Rates of Income Tax (SRIT)/ Welsh Rates of income Tax (CRIT) will pay their annual allowance charge at the relevant SRIT rates or CRIT rates.

The charge must be reported on the member’s self-assessment tax return (even if the scheme pays the charge). You can read details of this process in our main annual allowance article.

Deadlines to pay charges

If the member intends to pay the tax charge themselves or their scheme have agreed to pay the charge on their behalf on a voluntary basis, the payment deadline is the normal self-assessment deadline i.e. 31^st January following the end of the relevant tax year. So for an annual allowance excess in the 2022/23 tax year, the tax charge must be paid by 31^st January 2024.

If mandatory ‘Scheme Pays’ applies, this deadline is much later. The member must give their pension scheme a notice stating (amongst other information) the amount of annual allowance charge they require their scheme to pay and the tax year this relates to. The deadline for submitting the notice is by 31^st July in the year following the year in which the tax year to which the annual allowance charge relates ended. So, again using an annual allowance excess for the 2022/23 tax year, this deadline will be 31^st July 2024. The scheme then administer the ‘Accounting for Tax’ process, which works on quarterly returns and specific set payment dates, meaning the tax charge may be paid as late as 14 February 2025.

31 July 2023: the deadline for any members with an annual allowance excess for tax year 2021/22 to notify their scheme with a mandatory scheme pays request. This should already be in hand where relevant - as we’ve covered here, the total AA charge amount should already have been reported in the self-assessment tax return made by 31 January 2023.

Accounting For Tax (AFT) process

The AFT process, used by pension schemes, uses quarter dates for reporting and paying tax. The deadline for a voluntary scheme pays tax payment (where the conditions for mandatory scheme pays are not satisfied) is actually the same as the member’s self-assessment deadline, i.e. 31 January following the end of the tax year the charge relates to. However, as the AFT process would be used, in reality this brings the payment date forward.

If the scheme reported the tax charge for the quarter ending 31 December they wouldn’t actually pay the charge until 14 February – missing the 31^st January deadline.

So, in order to make payment by the member’s self-assessment deadline, the scheme would need to report and pay tax in respect of the quarter before, ie quarter ending 30 September, and payment by 14 November. A member would need to be quick off their mark in asking their scheme to pay their annual allowance charge within these tight deadlines (which may be a reason for some schemes being reluctant to offer voluntary scheme pays).

You can find full details of the AFT process and timings here.

Example for MPAA excess

Annual Allowance charges can be partly paid by ‘Scheme Pays’ with the remainder being paid by the member

Barry first joined a pension scheme in the 2021/22 tax year. This allowed him a standard annual allowance of £40,000. His pension inputs were £32,000, leaving £8,000 unused and available to carry forward, for up to 3 later tax years.

In 2022/23 Barry’s adviser told him he had an annual allowance of £48,000 (standard £40k plus £8k carry forward) so could pay £4,000 per month, which he paid from 28^th April 2022 to 28^th March 2023 inclusive. However, without consulting his adviser Barry flexibly accessed some pension benefits on 1 December 2022. Barry did not understand the consequences of triggering the money purchase annual allowance.

We need to look at contributions paid both before and after the trigger event.

Before - 28 April to 28 November = 8 months x £4kpm is £32,000

After – 28 December to 28 March = 4 months x £4kpm is £16,000.

Once you have flexibly accessed your benefits, future money purchase contributions are tested against the money purchase annual allowance. You cannot carry forward unused annual allowance from earlier tax years to increase the MPAA. For tax year 2022/23 this allowance was £4,000.

What is the Annual Allowance excess amount?

Barry’s pre-trigger event contributions of £32,000 are tested against the £36,000 alternative allowance plus carry forward of £8,000, so £44,000 in total. This does not give rise to an excess, however, Barry has paid £16,000 after his trigger event which means he has paid an excess of £12,000. We cover the full operation of the MPAA rules here.

How much is the tax charge?

The amount of the annual allowance excess is added to the top part of Barry’s taxable income. This is purely to find the tax rate to use for the charge. It is not treated as income for calculations of other tax implications ie it will not lead to the loss of personal allowance etc.

Adding the £12,000 excess to Barry’s taxable income (£90,000) and using UK rates means the tax charge is due at 40%. £12,000 x 40% = £4,800.

Is mandatory 'Scheme Pays' an option?

We covered the conditions that require to be met for a mandatory ‘Scheme Pays’ notice to apply earlier.

In summary, the conditions are:

The member's Annual Allowance charge liability for the tax year has exceeded £2,000, and
their pension input amount for the pension scheme for the same tax year has exceeded the standard Annual Allowance amount, and
The member notice must be submitted by the deadline specified by legislation.

Where a client exceeds the MPAA, then condition 1. above is based on the total input in excess of the standard AA only. The £12,000 excess only partly relates to pension savings over £40,000 so the calculation of the tax charge is £8,000 x 40% = £3,200. As this exceeds £2,000 this condition is satisfied.

The pension input of £48,000 has all been paid to the same scheme so condition 2. above is also satisfied.

Finally, providing Barry submits a scheme pays notice by 31 July 2024, condition 3. above will also be met.

In summary, Barry can require his scheme to pay some of his tax charge ie £3,200 of the total charge due of £4,800.

If Barry asks his scheme to pay £3,200 and he intends to pay the remaining £1,600 himself, what would the process and payment deadlines look like?

Date	Event
1 December 2022	Barry flexibly accessed pension benefits and triggered the MPAA
5 April 2023	Tax year ended and pension input amounts (PIA) paid between 6 April 2022 and 5 April 2023 can be accurately calculated
6 October 2023	Scheme Administrator must automatically give Barry a PSS by this date as he has flexibly accessed pension benefits and his money purchase contributions in 2022/23 exceeded the £4,000 allowance.
31 January 2024	Barry must submit his self-assessment tax return (showing the full annual allowance charge due of £4,800) and settle the £1,600 he is paying to HMRC. At this time he will of course settle any other tax due.
31 July 2024	Barry must have provided his scheme with a completed notice requiring them to pay £3,200 of his annual allowance charge.
31 December 2024	This is the quarter end date relating to the mandatory ‘Scheme Pays’ notice received above
14 February 2025	This is the payment deadline relating to the quarter end date 31 December 2024he scheme will report and pay the £3,200 tax charge using the ‘Accounting For Tax’ (AFT) process to meet this HMRC deadline.

As you can see, where the scheme pay the charge under the mandatory ‘Scheme Pays’ rules, the deadline is much later than for a client paying the tax charge personally.

Planning

Paul, based in Rotherham, is a member of a defined benefit pension scheme which has an accrual rate of 1/60^th for each year of service. His pensionable pay in tax year 2022/23 was £210,000 which means he gained (210,000/60) £3,500 pa pension entitlement, we’ll assume he’d no pay rise or the gain would be higher.

Where a member exceeds their AA limit, plus any allowable carry forward, it may be necessary to work out a few sums to decide if the scheme pays (where possible) or the member pays. This can be quite tricky for defined benefit schemes and you’ll need guidance from the scheme to find out how benefits are reduced i.e what commutation factors will apply.

Is using scheme pays better or worse for the member

This depends on how much pension will be used to meet the charge. It’s a straightforward monetary value from money purchase funds but, for defined benefits, you’ll need to consult the scheme rules to find out how much pension must be given up to pay the charge. Legislation doesn’t dictate how pension benefits must be reduced, only that the scheme must make the adjustment on a demonstrably just and reasonable basis using normal actuarial practice.

Case study

Paul, based in Rotherham, is a member of a defined benefit pension scheme which has an accrual rate of 1/60^th for each year of service. His pensionable pay in tax year 2021/22 was £210,000 which means he gained (210000/60) £3,500 pa pension entitlement, we’ll assume he’d no pay rise or the gain would be higher.

To make the annual allowance sums simpler let’s assume CPI was nil, and this equates to a pension input amount of (3,500 x 16) £56,000. We’ve worked out Paul’s adjusted income and find that he is subject to a tapered annual allowance of £27,000, meaning an AA excess of £29,000. Adding this amount to Paul’s other taxable income means the tax rate for his charge is 45%, i.e £13,050.

Paul’s scheme administrator has sent him a Pension Savings Statement (PSS) as his inputs have exceeded the annual allowance. As mentioned before the scheme won’t necessarily have enough information to know if any member actually has an AA excess, as they won’t have information for any other schemes their members may be contributing to. In any event, they’re only responsible for tracking member’s standard or money purchase annual allowance in their scheme. Everything else, e.g. tracking available carry forward of unused AA, is up to each individual member. The scheme information received by Paul confirms the factor for giving up pension to pay an AA charge will be 20:1.

Using 20:1 means a reduction in Paul’s pension of (13,050/20) £652.50 pa. Paul has the choice to give this up or pay £13,050 today to buy, from his scheme pension age, £652.50 pa inflation-proofed income for life. It’s up to Paul if he considers this to be good value for money.

Pension planning requires you to know your client’s needs and intentions, then do the sums to work out if the net benefit makes it worthwhile. For starters:

How much will scheme pays cost?

Where else could the money (equal to the amount of the charge) be invested to get similar income?

Is the aim to use the pension for retirement income, or to pass on after death?

Might there be a desire to transfer out in future, what would the transfer value on £652.50 be?

And perhaps checking solvency levels for the DB scheme and the likelihood of it being referred to the Pension Protection Fund (PPF), as this could ultimately restrict personal entitlement to income due to PPF’s application of compensation caps.

For details of our generic six step planning guide please refer to Lifetime allowance and annual allowance planning for the high net worth client.

Is there a further benefit if the member pays?

If a member could afford to pay the tax charge on their own, then they have a decision to make; whether to request Scheme Pays or to pay their own way. Looking at the cost of paying the charge from the member’s bank versus the value of pension funds / benefits they would have to give up has to be considered.

If the member pays all of the tax charge themselves, it removes money from their estate that might otherwise be subject to Inheritance Tax (IHT), whilst leaving the full pension benefit earned in an IHT friendly environment (probably!).

Defined benefit pensions include dependent’s pensions after member’s death. Retaining the higher member’s pension will have the knock-on effect of keeping this too.

Beware though some schemes may only offer ‘mandatory’ scheme pays. This means they would only pay the part of any tax charge relating to the pension input amount exceeding the standard AA (i.e. not the full charge relating to a MPAA or tapered annual allowance excess).

The McCloud case and changes to scheme pays deadlines for revised pension savings statements

In December 2018 the court of appeal found that the changes made in 2015 to the firefighters and judicial schemes was discriminatory against younger members. In July 2019 the government announced that they would view this ruling as applying to all public sector scheme.

As such schemes will have to implement a remedy to ensure that no such discrimination occurs. In February 2021 following a consultation period the government announced that public sector schemes will have a “Deferred Choice Underpin”.

This will allow members a choice at retirement if they take the benefits from the final salary or career average schemes for members that are in scope for this.

As a consequence of this, by making the choice at retirement there may be differing annual allowance usage for the affected years and members may have lower/higher annual allowance usage historically and may have lower/higher annual allowance charges that may apply.

Some members may also face changes in their contributions in respect of the remedy period, which may also affect their income tax position.

Where a member has already retired, a member’s total pension income may also change, and tax will be payable on any increase in pension.

Given this from 6 April 2022 if a member receives a revised pension savings statement they can now access mandatory scheme pays for up to 6 years (from the end of the tax year in question) after the revision.

If a member is provided with a revised pensions savings statement before 2 May in the year after the end of the tax year (so for 2021/22 tax year, by 2 May 2023), the original Scheme Pays deadline of 31 July 2023 applies.

If a member is provided with a revised pensions savings statement before 2 May in the year after the end of the tax year, they then have three months from the date of the new statement to inform the scheme that they wish to use mandatory scheme pays.