Tax relief
Pension contributions are deducted from pay before tax. This means that for an employee who pays tax at 20%, every £1 contributed to the scheme actually only costs 80 pence of net pay. In addition prior to 6 April 2016 members paid a lower rate of National Insurance as the LGPS was contracted out of the State Second Pension (S2P) (formerly known as SERPS).
Everyone is entitled to receive the basic state pension, subject to the National Insurance contributions they have paid throughout their career, and any individual who pays national insurance contributions at the not-contracted-out A rate qualifies for a "top-up" to the basic state pension, from the State Second Pension (S2P). As previously mentioned, the LGPS is contracted-out of S2P. Instead of paying a higher rate of National Insurance contributions a member of the LGPS pays pension contributions in order to provide an alternative pension to that provided by S2P. The LGPS guarantees that the pension contributions paid will provide a LGPS pension at least equivalent to that provided by S2P and, in most cases, a good deal better than S2P.
Members of the Scheme between 6 April 1978 and 5 April 1997 accrued a Guaranteed Minimum Pension (GMP). The GMP is the minimum amount of pension that would have been paid by the additional part of the State Scheme (SERPS now S2P) had not-contracted-out National Insurance Contributions been made to the State Scheme instead of pension contributions being made to the LGPS.
A GMP becomes payable from State Pension Age and is split into 2 elements, pre 6 April 1988 and post 5 April 1988. The GMP is not an additional amount to the benefits paid by the LGPS but forms part of those benefits. All increases due on the pre 6 April 1988 GMP are paid by the Department of Work and Pensions (DWP) as part of the State benefit. Increases of up to 3% on the post 5 April 1988 are paid by the LGPS. Where the increase due is more than 3% the balance is paid by the DWP.
With effect from 6 April 2006 ("A" Day) a new tax system for all pension schemes, including the Local Government Pension Scheme (LGPS), was introduced. All previous tax rules and regulations have been replaced with a single set of rules giving pension scheme members greater choice and flexibility in how they wish to save for retirement. It is now possible for individuals to pay more towards their retirement and to save into more than one pension scheme at the same time. As a result of this change in tax rules the regulations governing the Local Government Pension Scheme were amended to take account of over-riding tax legislation.
From 6 April 2006, the requirement to limit member contributions to 15% of taxable earnings was removed and instead annual and lifetime allowances were introduced. The annual allowance means that in each tax year an individual can receive tax relief on contributions to one or more pension plans up to a total amount of the greater of:
- £3,600 gross
- up to 100% of relevant UK earnings (including employment income and self-employed income). Where more than the maximum contribution is paid into pension arrangements a tax charge will be due.
Those individuals who have the potential to go over the lifetime allowance will need to keep the value of their pension funds, from all sources, under review to assess the risks of incurring a lifetime allowance charge. It is important that members of the LGPS seek independent financial advice if they believe they may be in danger of exceeding the lifetime allowance when taking into account any other pension arrangements they may currently, or previously, have contributed to.
The annual and lifetime allowances for previous years are as follows:
| Tax Year Beginning | Lifetime Allowance | Annual Allowance |
|---|---|---|
| April 2014 | £1,250,000 | £40,000 |
| April 2015 | £1,250,000 | £80,000 (transitional rules apply) |
| April 2016 | £1,000,000 | £40,000 (unless tapering applies) |
| April 2017 | £1,000,000 | £40,000 (unless tapering applies) |
| April 2018 | £1,030,000 | £40,000 (unless tapering applies) |
| April 2019 | £1,055,000 | £40,000 (unless tapering applies) |
| 2020/21 to 2025/26 | £1,073,100 | £40,000 (unless tapering applies) |
The annual and lifetime allowances will be reviewed every five years commencing in 2010. These changes to the tax rules mean that individuals have the flexibility to increase their pension saving and to plan for their retirement. It is important to remember that it is all sources of pension income that have to be considered when calculating these allowances not just the benefits derived from membership of the LGPS. However, where individuals only have membership of the LGPS and do not contribute or have not contributed to any other pension arrangement either now or in the past, only a very small number of scheme members will be affected. Indeed, to put it in context, only employees earning more than £139,000 per annum with 40 years membership of the scheme will currently be affected. This is because the fund value of benefits has to be calculated by multiplying pension by 20 (i.e. any pension in payment after any lump sum commutation) and adding the amount of any lump sum retirement grant.
The annual allowance limits the amount of tax-privileged "savings growth" relating to an individual's pension benefits each year. Benefits in excess of the annual allowance will become subject to a tax charge. Each year (except the one in which they die or become entitled to all of the benefits from a pension arrangement) the growth in a scheme member's benefits (referred to as the "pension input amount"), must be compared to the annual allowance. It is worth noting that the onus to carry out these checks is on the individual and not the pension scheme administrators or the employer.
The pensions input amount for a tax year is the amount of the increase in the value of the member's benefits during the pensions input period ending in that tax year. The pension input period is 1 April to 31 March each year.
Testing against the Annual Allowance (active members)
The pension input amount is determined in the LGPS by working out the accrued benefits at the beginning and the end of the pension input period, applying a formula and then working out the difference between the two.
The formula for calculating the pension input amount is:
[(10 x PE) + LSE] - [(10 x PB) + LSB]
where:
PE and LSE are the accrued pension and lump sum values at the end of the pension input period, and
PB and LSB are the accrued pension and lump sum values as at the beginning of the input period.
The result is then compared to the annual allowance for the tax year in which the pension input period ends. If the member has other pension arrangements then it is the total of all input amounts that is compared with the annual allowance.