Pensions and tax
Carry forward allows you to make pension contributions in excess of the annual allowance and receive tax relief.
Making use of unused annual allowances
Carry forward allows you to make use of any annual allowance that you may not have used during the three previous tax years, provided that you were a member of a registered pension scheme. You can use carry forward if you’re an active member currently building up pension benefits, a deferred member with paid-up pension benefits, a pensioner member in receipt of pension benefits from your pension scheme or a pension credit member where you have a share of your ex-partner’s pension. If an annuity policy is in the name of an individual and, when the contract was made, the annuity policy was not of such a type to be from a registered pension scheme, then the individual cannot be a pensioner member and therefore cannot use this to qualify for carry forward.
Carry forward may be particularly useful if you are self-employed and your earnings change significantly each year or if you’re looking to make large pension contributions.
To use carry forward, you must make the maximum allowable contribution in the current tax year (£40,000 in 2019/20) and can then use unused annual allowances from the three previous tax years, starting with the tax year three years ago.
You can’t receive tax relief on contributions in excess of your earnings in a tax year and you only receive higher rate tax relief to the extent that you have paid it.
If a particular tax year’s unused annual allowance is not fully used, it can only be carried forward for up to three years, after which it is lost.
If you are using carry forward to make larger pension contributions, you will only receive tax relief on total contributions that you pay into your pension scheme(s) that do not exceed your earnings in the tax year that you pay them. If you're considering paying gross contributions that exceed your earnings, you may want to think about spreading the contribution over two (or more) tax years to maximise the amount of tax relief that you can receive. In addition, you will only receive higher rate tax relief to the extent that you have paid it, which is another reason why you may wish to spread large contributions over two (or more) tax years.
If you are self-employed and run your own business
If you run your own business, the situation is a bit different. One of the advantages of being an incorporated trader is the ability to switch contributions between the individual and the company depending on nature and level of income from the business.
If the individual wants to make the contribution themselves with full tax relief on it, they need sufficient earned income (i.e. salary – dividends do not count for this purpose) to cover the contribution.
The company is able to make whatever contribution it likes to the employee’s pension fund, regardless of the amount of salary/ dividends the employee receives.
It is important that correct legal form is followed here - the company is not making the contribution on behalf of the employee (in which case it would be treated as an employee contribution) but is making an employer contribution in its own right.
As an employer contribution to a registered pension scheme, it does not count towards the employee’s taxable remuneration from the company. The contribution does count towards the employee’s annual allowance but the individual can benefit from the carry forward rules.
In terms of the company’s profits, the payment is an expense of employing staff and in practice would be allowed as a deduction against trading profits of the company for Corporation tax purposes. The downside is that if the contribution is significant, it will reduce the amount of profit that is transferred to the company’s distributable reserves, which in turn may limit the amount of dividend that can be paid for the accounting period.
In addition, every deduction against trading profits has to pass a ‘wholly and exclusively for the purposes of the trade’ test. It is important to speak to your tax/financial adviser to see whether it is appropriate to make contributions on this basis.
Money Purchase Annual Allowance
You now have more choice when drawing your defined contribution (also known as DC or money purchase) pension savings. The choices available to you can include a flexi-access drawdown fund or taking your entire savings as a one-off cash lump sum/series of one-off cash lump sums, also known as an ‘Uncrystallised Funds Pension Lump Sum (UFPLS).’
The Money Purchase Annual Allowance (MPAA) was introduced on 6th April 2015 and was set at £10,000 gross per year. The government reduced the MPAA to £4,000 gross per year to contributions made from 6th April 2017.
If you wish to take your pension benefits flexibly and continue to pay into a defined contribution scheme, your annual allowance will be reduced to £4,000 from the day after flexible benefits are first taken. This means that any savings made before the MPAA is triggered are not penalised. Where an individual is subject to the MPAA and they want to pay more than £4,000 into their money purchase pension scheme, they cannot carry forward any unused annual allowances from the three previous tax years.
Bill is a self-employed electrician. He has been paying £1,500 per month into his personal pension for the last five years. Over the last year, Bill has been working on a very large contract and anticipates that his profits for 2019/20 will be £120,000. Bill understands that he can reduce his tax liabilities by contributing to his pension and would like to pay in a further £40,000 during 2019/20.
Bill is currently paying £1,500 per month from his bank account into his pension plan. This payment is net of basic rate income tax so his gross contribution is calculated to be £1,875 per month [ £1,500 / (1 – 20% basic rate of tax) ], or £22,500 per year. Bill wants to pay an additional £40,000 into his pension. Again, this is the amount net of basic rate tax so the gross contribution is £50,000. Paying this amount would cause Bill to exceed his annual allowance but by using carry forward, he can make use of his unused annual allowances over the previous three years.
In 2019/20 Bill will pay £22,500 gross in regular contributions. He can therefore set £17,500 of the additional contribution against his 2019/20 annual allowance to bring it to the maximum of £40,000.
Bill also has unused annual allowances over each of the last three years, so he elects to use carry forward and use his unused allowance of £17,500 from 2016/17 and £15,000 of his unused allowance from 2017/18.
|Tax year||Annual allowance||Bill’s regular contributions (gross)||Unused annual allowance||Bill’s gross additional contribution||Remaining annual allowance|
|Total of Bill’s additional contribution||£50,000||£20,000|
By using carry forward, Bill can receive tax relief on his total gross contributions of £72,500 in 2019/20 (£22,500 regular contributions + £50,000 additional contribution). If he has another good year next year, he may want to make a further additional contribution to his pension. After making full use of his annual allowance in 2020/21, he could then use carry forward to utilise his unused annual allowances over the (then) three previous tax years, so he could make an additional pension contribution of up to his 2020/21 annual allowance plus the unused £20,000 from the previous 3 years. Please note, he has fully used his 2019/20 annual allowance.
Sam is a self-employed carpenter and earns £30,000 a year. He currently pays £200 a month into a personal pension. As Sam gets 20% tax relief at source on his contribution, his gross monthly contribution is £250 a month equivalent to £3,000 a year.
Sam has just finished a project for a client where he was paid £40,000 and he wants to pay this amount into his personal pension as a ‘one-off’ contribution. He knows this payment plus his regular contribution will exceed the £40,000 annual allowance, but he says he has unused annual allowances from previous tax years to allow this ‘one-off’ payment for tax relief purposes.
However, halfway through the tax year, Sam cashed in another personal pension he had for £20,000, as a one-off lump sum. Because Sam has taken this, his annual allowance has now been reduced to £4,000 for the remainder of the tax year and he cannot carry forward any unused annual allowances from previous tax years.
So, in Sam’s case, the maximum he can pay as a one-off lump sum for tax relief purposes in addition to the regular contributions he pays is £2,500 gross (i.e. £4,000-(6* £250)=£2,500). In future tax years, the maximum gross contribution he can pay to money purchase arrangements is £4,000.
Where can I find out more?
If you need more information, please contact us. A pension specialist from our team will be happy to help with whatever pensions-related question you have. Our help is always free.