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. 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.
To work out the AA for yourself you first need to work out the value of your pension on the 1 April and increase that value by the rise in the Consumer Price Index (CPI) for the previous year.
Then work out the value of your pension on the following 31 March and work out the difference between the two. Then multiply this figure by 19. This is your AA for that particular tax year.
How does it work?
If you had 20 years’ service on 1 April and your pensionable salary was £40,000 then your pension on 1 April would be:-
20 X 1/80 X £40,000 = £10,000.00 pa
CPI increase: 3.1% (actual rate over 12 months to 30 September 2010)
Pension after CPI increase = £10,000 X 1.031 = £10,310.00
At 31 March the following year your pensionable salary was then £42,000 pa, your pension at 31 March was therefore:-
21 X 1/80 X £42,000 = £11,025.00
So, the increase in your pension over the year was:-
£11,025 - £10,310 = £715.00 pa
And the capital value to check against the AA would be:-
£715 X 19 = £13,585.00
In the example above the AA is well within the £50,000 limit, therefore you would have scope to pay AVCs if you so wished.
How does an Added Years AVC affect the Annual Allowance?
For Added Years, if you are paying regular monthly contributions, you are purchasing additional service gradually over time. For example, if you were buying an extra year of service over a 10 year period then for each year you would be securing 1/10th of the total service, this additional service is added to value of your benefits for AA purposes at the end of each year.
If you choose to buy extra service by lump sum, the full amount of service being purchased will be added to the ‘closing value’ in the Annual Allowance calculation.
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 £13,585 (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 £23,585.00.
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.
Please note:
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.
The £50,000 limit is however generally only of concern to high earners with long service.
Following are some tables illustrating the point at which you might exceed the AA. The AA figure is affected by your length of service, salary and annual increases in that salary.
In this example a 5% pay increase was received during the year. Look at the figures in red for the point at which the member has exceeded the AA in the year.
As you can see for this member to be affected they would need 40 years’ service and a pensionable salary of between £120,000 and £126,000 per annum.
In the next example we have some more extreme scenarios, in terms of the level of pay increase.
We can see that a member on a salary at the start of the year of £20,000 with 30 years’ service who receives a big increase in pensionable salary, in this case 50%, would see a very large increase in one year to the value of their pension. This is a feature of final salary scheme; increases in your pay result in a direct increase to the value of your pension, based on all of your service in the scheme at that point.
It is important to remember that benefits are valued for Annual Allowance purposes in line with the USS pensionable salary definition. During periods of high price inflation but low salary inflation, your pensionable salary may be greater than your actual salary.
This member would however be able to look back over the last 3 years and utilize unused allowances from those years.
For an example, let’s assume they had only used £10,000 in each of the last 3 years.
Therefore they have £50,000 - £10,000 (£40,000) multiplied by 3 of unused allowances, making £120,000 plus the current year’s allowance of £50,000, making £170,000 in total.
Therefore, even though in the year the amount of allowance used was £71,730.00 they will not be subject to a tax charge because they had £120,000 from the previous three use to use up.
To estimate how close you are to the limit take a look at the Annual Allowance tool.