‘Scheme pays’ is a mechanism by which an annual allowance charge can be paid by a pension scheme, rather than the client paying it personally. This has the advantage of the client not having to find additional funds to pay the charge.
The annual allowance is a cap on the total amount paid into pensions for an individual’s benefit in a single tax year. It includes any money paid in personally plus the associated tax relief from HMRC that goes directly into the pension, any contributions paid in by the employer, and if anyone else pays in that would also be included (again plus the tax relief from HMRC). If benefits are being built up in a defined benefit or final salary pension scheme, the value of the benefits accrued each year also count.
There are four different annual allowances in place, and an annual allowance charge arises when any of the annual allowances applying to the client are exceeded.
1. Annual allowance (AA)
The standard annual allowance applies to most people and is set at £60,000.
2. Money purchase annual allowance (MPAA)
The MPAA applies once benefits have been flexibly accessed (most commonly by taking a flexi-access drawdown or uncrystallised funds pension lump sum payment). As the name suggests, this only applies to money purchase / defined contribution schemes, so does not impact the ability to accrue benefits in defined benefit schemes. The MPAA is £10,000 and applies to contributions paid after the date it is triggered.
3. Tapered annual allowance (TAA)
Clients with income above £200,000 may have their annual allowance reduced from the standard £60,000 down to a minimum of £10,000. Tapering applies where “adjusted income”, which includes employer pension contributions, exceeds £260,000. For every £2 above this level, £1 of annual allowance is lost. Adjusted income would need to be above £360,000 for the maximum taper to apply.
4. Alternative annual allowance (AAA)
The AAA only applies to defined benefit pensions when the MPAA has been triggered and exceeded. The AAA is usually £50,000 (£60,000 less £10,000 MPAA) but can be lower if tapering applies.
Those who have not flexibly accessed their pension benefits (i.e. have not triggered the MPAA) can use carry forward to reduce or eliminate any charge. Unused allowance from the three previous tax years can be used.
If the MPAA has been triggered, then carry forward can only be used in relation to defined benefit accrual.
The excess above the relevant allowance is known as the chargeable amount. This is added to the individual’s income for the year and income tax applied at the applicable rate.
Clients can pay the annual allowance charge from their own funds through their self-assessment. Alternatively, they may want to ask the scheme to pay the charge on their behalf. Scheme pays can be used if:
Scheme pays can only be used when the £60,000 annual allowance is exceeded
In reference to scheme pays, it is the AA that must be exceeded, i.e. £60,000. If only the MPAA or TAA has been exceeded, then scheme pays cannot be used. However, it may still be possible to use ‘voluntary scheme pays’ instead – more on this below.
For the scheme to be required to pay the charge the member must usually notify the scheme by 31 July in the tax year two years after the tax year to which the annual allowance charge relates. For example, for a charge relating to the 2023/24 tax year, the notification must be received by 31 July 2025.
However, due to the McCloud ruling relating to public services pension reforms, the deadline is extended if the charge arises because of a retrospective change of facts. Where the member has received information from the scheme administrator about a change in the pension scheme input amount the deadline is extended to 31 July that follows the end of the period of six years after the end of the tax year concerned. This extension applies to all schemes if the conditions are met, not just public sector schemes. For example, if the charge relates to 2019/20 tax year the deadline is 31 July 2026.
The member cannot notify the scheme before the end of the tax year in which the charge arises except for when they intend to fully access their pension, or if they are approaching age 75 with unaccessed funds or funds in drawdown. In these cases, the notification must be received before the funds are accessed or age 75 is reached.
If the two conditions are met, and the scheme is notified before the deadlines stated above, then the scheme will become jointly liable with the member for paying the charge. Once the notification has been submitted, if the conditions are met, then the member cannot withdraw the notice.
If the member has transferred benefits from the scheme into which benefits were accrued giving rise to the charge, and they would otherwise meet the conditions for scheme pays then they can no longer require the ceding scheme to pay the charge but can instead require the new scheme to pay – providing the notification deadline is met.
When the conditions for scheme pays are not met, then a scheme may pay the member’s annual allowance charge on a voluntary basis.
This means voluntary scheme pays can be used to pay charges arising from exceeding the MPAA or TAA even if the AA is not exceeded. It can also be paid from a scheme even if no contributions were made to it in the tax year concerned. For example, a higher earner in a defined benefit scheme may exceed their tapered annual allowance due to benefit accrual in that scheme but could have the charge paid on a voluntary basis from a SIPP or other personal pension they also hold.
Voluntary scheme pays can be used to pay any annual allowance charge
As the name suggests, schemes do not have to offer this facility, and they do not become jointly liable for the charge. As the liability remains with the member, the payment made by the scheme under voluntary scheme pays should be paid by the member’s normal self-assessment deadline, i.e. 31 January in the tax year following that in which the charge arose.
To ensure that this deadline is met, the scheme will need to account for the tax charge in the third quarter, which runs from 1 July to 30 September. The tax for this period is paid to HMRC by 14 November. If the request is received in quarter four (1 October to 31 December), this tax is only due to HMRC by 14 February, so the 31 January deadline is unlikely to be met.
The scheme can still pay the charge on a voluntary basis at a later date but there is a risk the member may receive late payment interest charge, current rates for which can be found here – HMRC interest rates for late and early payments. In practice, this charge has not always been applied when the self-assessment has stated that the scheme will be paying, but this cannot be guaranteed.
To pay an annual allowance charge under the voluntary rules, the scheme will need confirmation of pension input amounts to other schemes (if applicable), the amount of the charge, and the amount the member wants the scheme to pay.
It is also possible for the member to pay some of the charge personally, and some from the scheme.
Clients who have exceeded any of the annual allowances are required to report this to HMRC by completing a self-assessment tax return, even if they have not previously completed a return. They will need to complete the ‘Additional Information’ pages of the tax return (pages SA101 in the paper return). The boxes that need to be completed are in the ‘Pensions Savings Tax Charges’ section.
In box 11 you should enter the amount that the scheme has paid, or will pay, under either scheme pays or voluntary scheme pays.
HMRC has produced guidance on completing the ‘Pension Savings Tax Charges’ section, and a working sheet to calculate the amount of the charge. Both these documents can be found here: HS345 Pension savings – tax charges (2024).
The annual allowance charge is calculated by adding the amount of excess pension savings to income for the year, then income tax is payable at the appropriate rate, which may be across different tax brackets.
An important point to remember is that the annual allowance is not penal, it is simply reclaiming the tax relief that the individual is not entitled to above the annual allowance. Effectively this means that the excess contribution is not tax relieved. It is important that higher and additional rate taxpayers claim their higher / additional relief via self-assessment in the usual way, so the annual allowance charge offsets it.
It is worth noting that exceeding the annual allowance is not a valid reason to have a contribution refunded. The annual allowance is a limit on tax relief available, not on making contributions to a pension scheme. Any contributions returned solely on this basis would be treated as an unauthorised payment by HMRC, with tax charges applying. Importantly, it would not undo the fact that the contribution was made in the first place, so the annual allowance charge would not be avoided.
Annual allowance charges often arise due to a miscalculation, or new information coming to light. Where the charges are unexpected, scheme pays can be a useful tool to soften the blow, as clients do not need to find the money personally. If the charge has arisen largely due to defined benefit accrual, using voluntary scheme pays from a personal pension the client also holds could be a particularly useful option, if the scheme permits.
The charge is simply deducted from the member’s pot for a defined contribution scheme, whereas defined benefit schemes must reduce the member’s accrued benefits appropriately. Depending on this actuarial calculation, using a defined contribution pension could be a better option then the defined benefit reduction. As ever, each case would have to be looked at on an individual basis.