However, the gross amount contributed in excess of the annual allowance is subject to a tax charge calculated at the individual’s tax rate.
Contributions exceeding the annual allowance cannot be refunded to avoid paying a tax charge. Not only is this not sufficient grounds for a refund in HM Revenue & Customs’ eyes, and could be treated as an unauthorised payment, the Pensions Tax Manual confirms that the annual allowance tax charge would still apply.
The good news is that the annual allowance tax charge is not punitive. It effectively neutralises the tax relief received on the contribution. It is calculated by adding the value of the excess contributions to the member’s taxable income for the tax year and applying the corresponding rate of income tax. More than one rate of tax may apply.
Due to the way the charge is calculated, it is important that any higher or additional rate taxpayers who are paying into relief at source schemes remember to claim any extra tax relief they are entitled to from HMRC.
There are two options for paying the charge. The first is to pay the charge personally to HMRC through self-assessment, but if your client does not wish to do this, they may be able to use the “scheme pays” method, which allows the charge to be paid directly from their pension.
A pension provider can be asked to pay an annual allowance charge from their scheme if the charge is at least £2,000 and contributions to the scheme that tax year exceed the £40,000 standard annual allowance.
To use scheme pays, your client must notify their pension provider by July 31 in the next calendar year following the tax year in which the charge arises. For example, if the charge relates to the 2021-22 tax year, they must notify the scheme administrator by July 31 2023.
Where these conditions are not met, or the deadline for notifying the scheme is missed, the scheme may still offer to pay the charge on a voluntary basis.
Although it is not offered by all schemes, voluntary scheme pays can help limit the impact of the annual allowance charge on your client’s pension, as it allows the charge to be paid by a different scheme than the one the excess contributions were made to.
This can be particularly useful for those with DB schemes, who may opt for the charge to be paid from a DC scheme where the impact on their future benefits will be lessened.
When the annual allowance is restricted
While the standard annual allowance is £40,000, there are two circumstances where someone may have a reduced amount.
