Regular readers of my blogs will know I like to write about my experiences with clients and this blog is no different. I hold regular financial advice surgeries for businesses around the South West and recently met with an employee who was impacted by the tapered annual allowance. They had calculated the correct annual allowance but had incorrectly calculated the unused allowances they could carry forward from previous years. While carry forward is something which is available to mitigate the tapered allowance, there are several criteria which need to be met, some of which they hadn’t understood.
In this two-part series we look at the tapered annual allowance and pension carry forward.
What is the tapered annual allowance?
- The tapered annual allowance was introduced on the 6th April 2016 and reduced the annual allowance for high earners by £1 for every £2 of adjusted income over £150,000. Reducing the maximum annual allowance down to a minimum of £10,000.
- Since 2020 that earnings threshold has increased from £150,000 to £240,000 but the minimum allowance has reduced to £4,000.
Why was the taper introduced?
In an attempt to control the cost of pensions tax relief and help make sure pensions tax relief is fair and affordable the Government looked to limit the amount of tax-relief high earners could benefit from.
What is threshold income?
Threshold income is one of the two ways used to assess if a member is impacted by the tapered annual allowance. It is the starting point of the calculation and if a member has threshold income of less the £200,000 they will not be subject to the tapered annual allowance so there is no need to calculate adjusted income.
Threshold income is calculated as follows:
Total Income minus any lump sum pension death benefits plus any income given up for pension contributions i.e. salary sacrifice set up after 9th July 2015 less any relief at source pension contributions.
Jill has a taxable income of £192,000 in the year to April 2021, she has no lump-sum death benefits but has made pension contributions via salary sacrifice of £10,000 she hasn’t made any personal pension contributions. Therefore, her threshold income is £202,000 (£192,000+£10,000) so she must calculate the adjusted income. Had she made a personal pension contribution of £2,001 her threshold income would be below £200,000 and there would be no need to calculate adjusted income.
TIP Personal pension contributions can be used to reduce your threshold income.
What is adjusted income?
Fundamentally the calculation is the same with just one difference, you now add any employer pension contributions which have been made on your behalf,
If we use the same example as above where Jill has a threshold income of £202,000 any employer pension contribution would need to be added to workout her adjusted income and if this breached £240,000 her annual allowance would be tapered.
What if I breach the annual allowance?
The aim of the annual allowance charge is to reclaim the tax-relief received. Therefore, the amount of pension contribution over the annual allowance must be declared on your self-assessment and is added to the rest of your income and will be taxed at your highest marginal rate. It is the responsibility of the member to declare any contribution over the annual allowance, however, under certain circumstances the pension scheme can pay the tax charges from your pension pot, known as scheme pays.
When the annual allowance was reduced in 2011 it became clear that many more people would be affected by it. Two main actions were taken, the introduction of carry forward which we are going to be looking at in detail in our next blog and the ability for members to pay the annual allowance charge out of their pension pot. There are two possible bases for the scheme paying the charge, mandatory and voluntary.
- The total charge is over £2,000.
- The inputs i.e. amount contributed are more than the standard annual allowance. This is an important point, this would mean £40,000 in the current tax year not the tapered annual allowance.
When the conditions for mandatory scheme pays are not met it may still be possible for the scheme to pay the charge. You should provide a formal request to the scheme with details of amount of the charge and the amount the member wishes the scheme to pay. This notification should be sent into the scheme by the 30th September prior to the deadline for self-assessment of 31st January.
Does this mean I should stop contributions?
This will depend on your individual circumstances, however, provided your employer contributions are more than your tax charge you would still be better off. If you are or think you might be impacted by the tapered annual allowance you should seek specialist advice from a financial planner.
4 Financial Planning
Normally we prefer to try and make or save our clients money, in this case they had a tax bill to pay, but without the help of a financial planner it could have been a lot bigger. So financial planning adds value, but why should you choose 4 Financial Planning?
We focus on just the essentials which are you and your money and use technology to streamline the process. This means we charge far less than a traditional IFA which means more of the returns stay in your pocket and you don’t need to have a small fortune to work with us. Here’s a video on what makes us different.
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A pension is a long-term investment. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The information in this blog is based on the 2020/2021 tax year.