A 5 minute guide to the Tapered Annual Allowance for high earners

Politician’s can hardly resist tinkering with pensions for 5 minutes, and in April 2016 came a number of changes, one of which is the introduction of the Tapered Annual Allowance.

What is the Tapered Annual Allowance?

At present, individuals are able to contribute up to £40,000 (the current Annual Allowance) into a pension each year. Where the Annual Allowance has not been fully utilised in the previous three tax years, the unused allowance may also be carried forward.

With effect from 6th April 2016, individuals with taxable income of greater than £150,000 in a tax year will have their Annual Allowance tapered for that tax year. The tapering will mean that for every £2 of income above £150,000, their Annual Allowance will be reduced by £1. The maximum reduction will be £30,000 and this level of reduction is reached once income reaches £210,000.

Example

Jane’s Adjusted Income is £160,000. Her Tapered Annual Allowance will be reduced as follows:

160,000 - 150,000 = 10,000

10,000/2 = 5,000

40,000-5,000 = 35,000 Annual Allowance available

Definitions of Income

As you might imagine, the definition of “income” is not straightforward and there is a technical definition of exactly what constitutes income. To further complicate matters, there are also two definitions of income which must be considered; Adjusted Income and Threshold Income.

Adjusted Income

Broadly speaking, Adjusted Income is:

- An individual’s income; after deducting such things as trading relief, share loss relief and pension contributions made via the net pay arrangement (essentially contributions to employer pension schemes which are taken from pay before tax and National Insurance is deducted)

PLUS

- Pension contributions made via the net pay arrangement (yes, this basically adds back in the deduction above)!

- Employer pension contributions

- Pension contributions made by non-domiciled persons to overseas pension schemes

Where an individual has received a lump sum from a pension as a result of a lump sum pension death benefit from an individual who died after age 75, this amount is deducted.

Where the Adjusted Income exceeds £150,000, the Tapered Annual Allowance begins to apply, as described above, except where Threshold Income is below £110,000.

Threshold Income

To avoid individuals with a one-off spike in income being caught by these new rules, an easement has been included which means that where Threshold Income is less than £110,000, the Tapered Annual Allowance will not apply. It is therefore necessary to consider how Threshold Income is calculated, which is broadly as follows:

- An individual’s income; after deducting such things as trading relief, share loss relief and pension contributions made via the net pay arrangement (essentially contributions to employer pension schemes which are taken from pay before tax and National Insurance is deducted)

PLUS

- Any salary sacrifice arrangement made on or after 9th July 2015 (essentially, a Salary Sacrifice arrangement involves reducing salary in exchange for an equivalent pension contribution from your employer)

LESS

- Gross pension contributions made by an individual via the Relief at Source (for example, the gross amount of a personal pension contribution)

Again, Where an individual has received a lump sum from a pension as a result of a lump sum pension death benefit from an individual who died after age 75, this amount is deducted.

Interaction with the Money Purchase Annual Allowance

Where an individual has triggered the Money Purchase Annual Allowance, and is caught by the Tapered Annual Allowance, the individual will still be able to contribute £10,000 gross in that year into their pension. However if the individual is a member of a Final Salary (Defined Benefit) pension, the accrual within the Final Salary scheme could be caught by the effects of the Tapered Annual Allowance.

Comment

These new rules add further complication to what should be a simple question: “how much can I pay into my pension”. Care needs to be taken to understand the differences between the Threshold Income and Adjusted Income to determine whether you are affected by these new rules.

Bizarrely, having gone to the lengths of ensuring new salary sacrifice arrangements made on or after 9th July 2015 are not effective for avoidance of these rules, it seems an obvious loophole still exists for some individuals, whereby a contribution to a Personal Pension can be made to reduce Threshold Income below £110,000.

If you would like to discuss how these rules may affect you, please get in touch.

Important Note

This article is intended for information purposes only and should not be considered to be a recommendation. This article is based on our understanding of current and draft pension and tax rules as at the date of this article. Please note that tax and pension rules are subject to change; if you are at all uncertain about the suitability of any option for your circumstances we strongly suggest you seek regulated personal financial advice. You should not take action solely on the basis of this article without seeking advice specific to your circumstances. Please get in touch to find out more.

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