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How much can I carry forward?

A reader asks if pension carry-forward rules discriminate against lower earners
How much can I carry forward?

In an article on pensions in a recent issue, it was stated: “You can pay in up to 100 per cent of your annual earnings or £40,000 a year to a pension, whichever is lower. It’s also possible to carry forward unused pension allowances from the previous three years when you fill in your self-assessment form and make additional contributions. But you need to have earnings of at least the total amount you are contributing in the relevant tax year unless your employer is making the contribution.”

I have been informed by various sources that the carry-forward provision only applies to people earning £40,000 or more. Affluent people are most likely to put sums into pensions and to use low/under- contributions in previous years. But It would be quite unfair if the lower-paid were deprived of an opportunity to do so.

My understanding is that someone earning £60,000 could carry forward £40,000. Someone earning £40,000 could carry forward £40,000 and someone earning £25,000 could carry forward zero.

I would be grateful and so pleased to learn that I am wrong, and that the actual answer is that someone earning £25,000 could carry forward £25,000 so long as they earned that in the relevant tax year.

Can you clarify this for me,

P Coates

 

Gary Smith, chartered financial planner at Tilney, replies: The annual allowance represents the maximum amount of tax-relieved pension funding that can be made for an individual during each tax year. While the standard annual allowance is currently £40,000, it might be possible to contribute more than this if you have unused allowances from the previous three tax years by claiming a carry-forward allowance. For high-earning individuals (those earning above £240,000 including employer contributions) their annual allowance will be tapered, with the annual allowance reducing to £4,000 for those earning above £310,000. If an individual has released some income from a pension using flexible pension rules then they will trigger the money-purchase annual allowance (MPAA), which will restrict pension funding to £4,000 (gross) per tax year, with no carry forward available.

The annual allowance rules cover both personal and any employee contributions and there are specific rules associated with contributions that are made personally. Where an individual does make a personal contribution (and this could be funded from an inheritance etc), they are able to contribute the lower of: 

  1. Their available annual allowance, plus any carry-forward allowance, or
  2. Their net relevant earnings (this is effectively your salary), or
  3. If the individual does not have any net relevant earnings, a contribution of £3,600 (gross).

What this means in practice is that, if someone earns £30,000, then the maximum they could contribute personally into a pension would be £30,000 (gross), even though they might have a higher annual allowance available to them. If they had triggered the MPAA, they would only be able to contribute £4,000 (gross). When an individual makes a personal contribution, they receive basic-rate tax relief on the contributions they make, meaning they would only need to contribute £24,000 to fund a £30,000 (gross) contribution (this represents £6,000 in tax relief). If you consider that an individual earning £30,000 will only pay £3,486 in income tax, the tax relief received exceeds their personal income tax liability.

If the same individual was a member of their employer’s pension scheme, and the employer decided to contribute £10,000 into the pension for them, the combined contributions of £40,000 would fully utilise their available annual allowance for that tax year. If the employer decided to contribute £15,000 into the pension then their combined inputs would be £45,000 and they would have to carry forward £5,000 from the previous three tax years (subject to availability) to avoid an annual allowance tax charge being suffered.

In terms of the carry-forward rules, you can only do this once you have fully exhausted the annual allowance for the current tax-year. Using the three earnings scenarios that you have quoted, I will illustrate the actual carry-forward positions available to them: 

  1. Individual with a salary of £60,000: The maximum that an individual could contribute personally into a pension, would be restricted to £60,000 (gross) and this assumes that they have some unused carry-forward allowance from the previous three tax years available to them. Assuming they do, then £40,000 would fully exhaust their current tax year annual allowance, with £20,000 carried forward from the previous three tax years. If their employer was also making contributions for them, they would be able to carry forward more than £20,000 (subject to availability) to avoid an annual allowance tax charge being suffered.
  2. Individual with a salary of £40,000: If the individual was only making personal contributions they would not be able to carry forward any unused annual allowances as their contributions would simply exhaust their current tax year annual allowance (assuming no MPAA has been triggered). They would only be able to claim carry forward if their employer was making contributions in addition, which pushed the cumulative contributions above £40,000.
  3. Individual with a salary of £25,000: Under the pension funding rules, this individual can only contribute £25,000 (gross) personally and would not be able to carry forward any unused allowances from the previous three tax years. If their employer was also making contributions, they would only need to carry forward any unused allowances if the employer contributions exceeded £15,000, as they would need to exhaust the £40,000 standard annual allowance initially.

Where carry forward is available, it is also important to highlight that you can only carry forward the unused allowances for that tax year and you can only go back for the previous three tax years. I will provide an example in the table below: 

 

Tax-Year

Annual allowance

Total contributions

Unused allowances

2021/22

£40,000

 

 

2020/21

£40,000

£20,000

£20,000

2019/20

£40,000

£15,000

£35,000

2018/19

£40,000

£30,000

£10,000

 

If you remember, you can only carry forward unused allowances once you have fully exhausted the current tax year's annual allowance of £40,000. So, assuming an individual had earnings of £70,000, they would initially have to contribute £40,000 to fully exhaust the 2021-22 tax year allowance. Thereafter, they could contribute a further £30,000 personally, carrying forward £10,000 from the 2018-19 tax year and £20,000 from the 2019-20 tax year (you always carry forward from the earliest of the three previous tax years). During the 2022-23 tax year, and assuming their earnings remain at £70,000, they could again contribute £70,000 (gross), with the remaining £15,000 carried forward from 2019-20 as well as £15,000 from the 2020-21 tax year. During the 2023-24 tax year, the maximum they could contribute would be £45,000 (gross), as they would only have £5,000 of unused allowance remaining from the 2020-21 tax year to carry forward.

While it will be possible for those earning more to potentially contribute more into their pensions, this is not something unique to the current pension funding rules as, even prior to the introduction of the new pension rules in April 2006, pension funding was both age- and salary-restricted. Indeed, given that the annual allowance rules are not age-related, it is slightly more favourable to those on lower incomes than under previous legislation.