We’ve received a few questions from clients on how “scheme pays” works for those that have exceeded contributions above their designated allowances. Scheme pays is a method whereby as the name suggests, the tax charge can be paid by the pension scheme.
If an individual exceeds the annual allowance (AA) and an AA tax charge is due, they can ask their pension scheme to pay the charge on their behalf with a corresponding reduction in benefits. The pension scheme is only obliged to facilitate the payment of the charge if certain conditions apply.
What are the conditions?
The pension scheme has to facilitate the AA tax charge if the following two conditions apply within the timescales:
- The AA tax charge for the tax year across all pension schemes is greater than £2,000.
- The pension input amount to the scheme the charge is to be taken from is greater than £40,000 for the same tax year.
The AA of £40,000 is the standard AA for 2018/19.
If these conditions are met and scheme pays is being used, the individual and the scheme becomes jointly and severally liable for the AA tax charge. This means the individual and the scheme are jointly liable for the charge as well as being individually liable for the full amount.
What if the individual’s AA is reduced because of tapering or the money purchase annual allowance (MPAA) is triggered?
If the individual has a reduced AA due to the MPAA applying or their AA is tapered due to having higher earnings, this does not affect the conditions above. The minimum of £40,000 still applies.
How are the pension benefits reduced?
Under a money purchase scheme, the fund is reduced by the amount of the tax charge including any early withdrawal charges which apply. Under a final salary scheme, the scheme calculates the reduction in benefits. This reduction has to be just and reasonable.
What is the deadline for applying for scheme pays?
The pension scheme must receive the request to pay the charge from the funds no later than 31 July in the year following the tax year in which the AA tax charge was incurred. It’s not possible for the member to tell the scheme before the end of the tax year in which the charge relates to.
For example, if an individual has an AA tax charge for 2017/18 and meets the conditions for scheme pays, they should ensure their request is with the scheme before 31 July 2019.
This deadline will be brought forward if the individual intends to take all of their benefits or will reach age 75 in a year that they want to make use of scheme pays. The individual needs to give the request to pay the charge from the funds to the scheme before taking benefits or reaching age 75 in these circumstances. This will allow the scheme to make any AA tax charge payments before the benefits come into payment.
How does an individual elect for scheme pays?
The individual should make the request in writing to their pension scheme. This request should be signed and dated.
What if the scheme pays conditions do not apply?
If the conditions do not apply, the pension scheme is not obliged to offer scheme pays. If the member is due to pay an AA tax charge and scheme pays does not apply, then the individual would pay the tax charge through their self-assessment.
It is worth noting that most pension scheme providers only offer scheme pays when both the conditions have been met.
As usual, get in touch with one of our consultants who are here to help you navigate the complexities of pension planning.