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Hi.The contribution for a defined benefit pension scheme is calculated in a completely different way from a money purchase scheme.With a money purchase scheme, its simple. The annual allowance or contribution limit for any one tax year on which tax relief can be obtained is a cash amount, ie the lesser of £40,000 (for 2014/15) or 100% of net relevant earnings. Unused allowances from the three previous tax years can be brought forward but it may not be possible to absorb them all if the level of earnings in the current tax year is insufficient.As you will see from the notes here, here (see example 2) and here, the calculation of your deemed contribution is more complex and not related to the level of actual contributions which are based on actuarial computations. The deemed contribution for any one tax year is the difference between the opening and closing valuations for the input period which ends in that tax year. Take a look under the heading "Pension input amounts and the annual allowance test" and "Defined benefits arrangements" here for confirmation of what is compared to the annual allowance to determine whether a breach of the annual allowance has occurred.I hope this helps but let me know if you have any further questions.
Many thanks for your response.
I have looked at Example 2 that you provided on the link to the HMRC technical page RPSM06108010.
My question though is: whether the rule that one cannot contribute more than 100% of Net Relevant Earnings includes just actual cash paid in, or the capitalised (factor of 16) element as well?
So, in the example of Rose, if her salary was, say, £41,000 in 12/13 would that have had any bearing upon restricting her annual allowance to £41,000 rather than £50,000?
[RPSM05200060 states: For most people the amount of tax relief they can have on their pension contributions is limited to 100% of their relevant UK earnings that are chargeable to income tax for the tax year]
Insofar as a defined benefit pension scheme is concerned, the deemed contribution is calculated by comparing the opening and closing values of the fund. The actual contributions by you and your employer are largely academic. See under the heading "Defined benefit arrangements" here.Defined benefit schemes are much more generous in terms of what one gets out at the end because the contributions required are not nearly as much as a money purchase scheme requires to provide a similar pension (hence their gradual phasing out by employers).In the example, Rose's deemed contribution for 2012/13 is £55,000 which is £5,000 over the annual allowance of £50,000 for that year. However, there will be no annual allowance charge on her as she has sufficient unused allowances from earlier years to absorb the excess.The capitalised element is the pension contribution, not the actual cash contributions. If Rose's salary had been £41,000 in 2012/13 and her deemed contribution for that year was £55,000, she will have overpaid by £14,000 and unless she had unused allowances from the three earlier tax years, she will suffer an annual allowance charge on £14,000.The maximum amount on which Rose could get tax relief would be limited to £41,000, 100% of her earnings, not the £55,000 deemed contribution, as her salary is less than the annual allowance of £50,000 (plus the unused allowances brought forward). See section 3 Annual Allowance here. The pension fund trustees would tell Rose what her maximum required contribution was and it would be nowhere near 100% of her earnings given the generosity of defined benefit pension schemes.
All the annual allowance does is determine whether an annual allowance charge will be payable by the employee.
Thank you for your response.
To follow on from the example: "The capitalised element is the pension contribution, not the actual cash contributions. If Rose's salary had been £41,000 in 2012/13 and her deemed contribution for that year was £55,000, she will have overpaid by £14,000 and unless she had unused allowances from the three earlier tax years, she will suffer an annual allowance charge on £14,000".
So, if Rose earnt £39,000 in 2011/12 and had a deemed contribution of £16,000 in 2011/12, then would it be correct to say that Rose has a carry forward allowance in 2011/12 of £23,000 (being £39,000 less £16,000)? This £23,000 would of course still be sufficient to cover the overpayment of £14,000 in 2012/13.