Members of pension schemes in the UK enjoy tax relief on contributions paid in and are also able to draw part of their retirement benefits as a tax-free lump sum on retirement. Pension incomes are however taxed as earned income under the PAYE system.
Use the ‘Cost of contributions’ modeller to see just how much tax relief you receive.
There are however limits to the maximum benefit you can build up in any one year and the maximum benefits you can draw at retirement and still enjoy beneficial tax treatment.
USS provides very valuable benefits and is designed to allow you to build up a pension of 1/80th of your pensionable salary for each year plus three times this pension as a tax-free lump sum, as standard.
Many members may not build up enough pension through normal contributions for a variety of reasons; they may have joined the scheme later in their career, had a career break or plan an early retirement.
There are therefore two Additional Voluntary Contribution (AVC) facilities members can use to increase the value of their retirement benefits whilst still receiving tax relief on contributions.
The big attraction of any AVC is that you receive tax relief on your contributions at the highest rate for which you are liable, so it’s a very attractive way to save tax and build up greater retirement benefits, including a tax-free lump sum on retirement.
There are limits though, on how much retirement benefits you can build up each year, called the Annual Allowance and on the final value of your retirement benefits, called the Lifetime Allowance. There’s also a limit to the maximum amount of tax-free cash you can take at retirement.
Annual Allowance (AA)
This limit is expressed as a capital value, for the 2011 year in which it was introduced the limit is £50,000. For 2014/15 this limit will be reduced to £40,000. It is the capital amount by which your pension benefits have grown during what’s called a Pension Input Period (PIP), which for USS is 1 April to 31 March each year.
You then multiply this figure by a factor of 19.
How does it work?
In the Career Revalued Benefits section you need to know how much pension you have earned in the year and simply multiply that by a factor of 19.
So, if your pension was
1 year X 1/80 X £42,000 = £525.00 pa
the amount of the annual allowance used up would be:-
£525 X 19 = £9,975.00
In the example above the AA is well within the £50,000 limit, therefore you would have considerable scope to pay AVCs if you so wished.
For a member of the Career Revalued Benefits section to exceed the Annual Allowance in any particular year you would need to build up a pension of £50,000/19 = £2,631.58 pa. You do need to add to this though the amount of any AVCs paid.
How does the Revalued benefits AVC affect the Annual Allowance?
If you buy extra benefits by lump sum, the full amount of benefit being purchased will be added to the ‘closing value’ in the Annual Allowance calculation.
If you decide to buy an additional pension of £1,000pa by monthly contributions you are buying extra benefits gradually over time. So, if you were buying an additional £1,000 pa pension over a period of 10 years, then each year you are buying £100 of pension. This is the amount you include in the closing value in the Annual Allowance calculation in addition to the standard benefit you have built up.
How does a Money Purchase AVC affect the Annual Allowance?
This is very easy to work out. The gross amount deducted from your pay (before tax relief) is the value you add in to the Annual Allowance calculation.
So, using the example above, where the Annual Allowance used up was £9,975 (before any AVCs paid), if you had paid £10,000 over the year into Money Purchase AVCs, then the amount of the Annual Allowance used up would now be £19,975.00.
So, it’s much easier to work out how much you can pay in to the Money Purchase AVC and stay within the Annual Allowance limit.
If you receive a transfer-in into USS this is excluded from the calculation of the AA.
If you exceed the AA there is scope to utilise unused allowances from up to the previous three years. If you are still in excess of the limit then anything over the £50,000 is added to your gross taxable pay and taxed under the PAYE system, meaning that the tax charge could be 20%, 40% or perhaps 50%, depending on the level of your taxable pay.
What if I do get a tax charge under the Annual Allowance?
It is your responsibility to settle this with the HMRC. However, if your tax charge is more than £2,000 and the Annual Allowance value of your USS benefits was over £50,000, then you can elect that USS pays the tax charge for you.
Of course this doesn't come free; there will be a reduction to the value of your benefits in exchange for the payment of the tax bill. To see the rates click here.
Lifetime Allowance (LTA)
This limit is to the maximum amount of retirement benefits you can build up at retirement. Again it is expressed as a capital value, for the tax years up to April 2012 it is £1.8 million reducing from April 2012 to £1.5 million. This will be further reduced to £1.25 million for the 2014/15 tax year.
To exceed the £1.5 million limit you would need to have 40 years’ service in USS and be earning around £130,000 a year.
For more information, please see the 'Limits to tax relief and tax-free benefits' factsheet'.
Maximum tax-free cash
As well as a limits above there is a limit on the amount of tax-free cash you can receive which is 25% of the value of your total benefits at retirement` (or 25%of the LTA if this is lower - £375,000 currently).