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Annual Allowance and Scheme Pays for DC Schemes

Mandatory Scheme Pays - Summary

Only available if paid in more than the standard annual allowance to one scheme.
Can only insist scheme to pay if tax charge is greater than £2,000.
Can only insist scheme to pay excess associated with their scheme.
Must ask scheme to pay by 31 July in the year following the tax year the excess charge arose.

 

 

 

What is scheme pays?

Historically many people have paid in more than the available annual allowance. This used to create a tax charge of 40% on the excess over their available annual allowance. This tax charge had to be paid by the member. When the annual allowance was reduced in 2011 to £50,000 from £255,000 there was concern that many more people would be caught by annual allowance excess charges. To this end HMRC introduced new legislation to allow for the carry forward of unused annual allowance. At the same time the annual allowance excess charge changed from a straight 40% to being charged at the member’s marginal rate of tax.

HMRC also introduced an alternative method of taking any annual allowance excess charges. This new method was called “Scheme Pays”.   

The annual allowance charge is paid via self-assessment but it may be possible for the pension scheme to pay some/all of the tax charge.  The scheme can be required to pay when certain conditions are met, and if they are not met the scheme may decide to pay voluntarily.

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Conditions needed for mandatory scheme pays to apply

The conditions laid out for scheme pays that need to be met are straight forward

  • The annual allowance tax charge generated for the tax year exceeds £2,000.
  • The individual would have had to have paid in more than the standard annual allowance.
  • The individual has not already taken all of their benefits from the scheme.
  • The request for the scheme to pay is made within the legislative timescales.

The scheme only has to account for any tax charge based on the total contribution and excess actually paid into their scheme. This would mean that if the client has paid into 2 schemes, the scheme being requested to operate scheme pays would only be responsible for the amounts in excess of the annual allowance within their scheme.
Even if the tapered annual allowance applies, a scheme can only be required to pay a tax charge on excesses if total contributions to the scheme are more than the ordinary annual allowance

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Information required from the member to apply for scheme pays

The pension scheme will confirm what they specifically require, but this will need to include;

  • Name
  • Address
  • National insurance number
  • Amount of the liability the member wants the scheme to pay
  • They must confirm the tax charge has been calculated using the correct rate
  • They understand they cannot withdraw the scheme pays request
  • They understand that the pension will be adjusted to reflect the tax charge reduction.

It is also possible for the member to have a tax charge greater than £2,000 but request the scheme to pay an amount less than £2,000. In these cases the member will need to confirm that their total liability is greater than £2,000.

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Time scales to pay the excess charge

Realistically the member will always pay the tax charge. However, they may have the option of paying the charge directly themselves or by the scheme pays option. There are very different deadline for each of these methods that would need to be met.

Pay personally or voluntary scheme pays
If the member elects to pay the excess payment themselves or if the scheme is willing to offer voluntary scheme pays (i.e. where the pension scheme does not have a legislative duty to pay) the payment deadlines are the same as self-assessment dates. This means the deadline will be 31st January following the tax year the excess payment tax charge was created. For example, an excess annual allowance charge in relation to tax year 2019/20 would need to be paid by 31st January 2021.

Statutory scheme pays
If however the scheme has to offer the facility to pay the tax charge the timescales are longer. This, in part, is due to the longer process needed. The process would be;

  • The member creates and annual allowance excess payment.
  • The member has until 31 July in the year following the tax year the annual allowance tax charge relates to tell the scheme they want to use scheme pays.
  • The pension scheme will record this on the AFT (accounting for tax) return applicable for that quarters return.
  • The payment will be due 2 months and 14 days later

For example, if an annual allowance tax charge is created in the tax year 2019/20 and this falls within the scheme pays regulations, the member will have to tell the scheme by 31 July 2021 at latest. The scheme will have record of this and report this on the AFT return for the quarter ending on 30 September 2021. The tax charge needs then to be paid by 14 November 2021. 

Late payment
Ultimately the member is liable for any late payment charges.
If the tax due is not paid on time there are 2 types of additional charge which can be made.
Firstly there is interest payable on a daily basis for late payment. This interest rate is set by HMRC and can be varied. The interest will be accrued from the date due until the date the tax charge is paid.
There is also a late payment penalty. This is applied where the tax charge has not been paid within 30 days of the due date. The charge will be 5% of the outstanding amount after 30 days. There will also be a 5% tax charge applied if still not paid after 6 and 12 months. 

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The adjustment to the member’s benefits

A defined contribution (money purchase) scheme will simply deduct the amount paid from the value of the member’s fund.
A defined benefit (final salary) scheme will adjust the benefits that have accrued for the member under the scheme.
Any other kind of pension scheme will decide what adjustment is appropriate to how the benefits will be paid from the scheme.

The member’s pension scheme will be able to confirm how and when it will make the adjustment to the member’s benefits.

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Examples

There are many situations within the scheme pays parameters that need to be considered.
This is not as simple as working out the tax charge owed and, as long as this is less than the excess over the annual allowance paid into that scheme, they will pay the tax charge.
The simple examples below may be of help.

 

Tax year 2019/20

Jane is a higher rate tax payer.
She has paid £60,000 into her pension with no carry forward available.
This gives an annual allowance excess of £20,000.
On this basis the additional £20,000 is added to her tax bill.
This means the tax bill is £20,000 x 40% = £8,000.

Scenario 1 – contribution into 1 scheme
Jane has only paid into this one scheme.
The scheme excess over the annual allowance is £20,000.
This means that the scheme can pay 40% of this excess.
In this case the full tax amount can be paid for by the scheme.
Jane needs to request scheme pays no later than 31 July 2021.

Scenario 2 – contributions into 2 schemes
Jane paid £50,000 into this scheme and £10,000 into another scheme.
The only scheme that has to pay the tax bill is the scheme with the £50,000 contribution.
The scheme excess over the standard annual allowance is £10,000.
This means that the scheme can pay 40% of this excess.
Under the legislation the mandatory amount the scheme must pay is £4,000 only (£10,000 x 40% = £4,000).
Jane needs to request scheme pays no later than 31 July 2021.
The additional £4,000 liability would need to be covered directly by the client or by voluntary scheme pays.
The options relating to the £4,000 need to be elected and paid by 31 January 2021.
 
Scenario 3 – Tapered annual allowance
Jane is an additional rate tax payer with a tapered annual allowance of £10,000.
Jane paid £60,000 into her only pension scheme.
The scheme excess over the tapered annual allowance is £50,000.
However, the scheme excess over the standard annual allowance is only £20,000.
This means that the scheme can pay 45% of this excess.
Under the legislation the mandatory amount the scheme must pay is £9,000 only (£20,000 x 45% = £9,000).
Jane needs to request scheme pays no later than 31 July 2021.
The additional £13,500 liability (£30,000 x 45%) would need to be covered directly by the client or by voluntary scheme pays.
The options relating to the £13,500 need to be elected and paid by 31 January 2021.


Scenario 4 – Tapered annual allowance in 1 scheme which also offers voluntary scheme pays
Jane is an additional rate tax payer with a tapered annual allowance of £10,000.
Jane paid £60,000 into her only pension scheme.
The scheme excess over the tapered annual allowance is £50,000.
However, the scheme excess over the standard annual allowance is only £20,000.
This means that the scheme can pay 45% of this excess.
Under the legislation the mandatory amount the scheme must pay is £9,000 only (£20,000 x 45% = £9,000).
Jane needs to request scheme pays no later than 31 July 2021.
In addition the scheme offers voluntary scheme pays and Jane requests this.
As this is voluntary the scheme will have to report and pay tax by 31 January 2021.
As you can see the pension scheme now has to accommodate 2 payments dates.

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The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown on the title page. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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