What is the tapered annual allowance?
High earners need to be aware that from the 6th April 2016 their annual allowance for pension contributions may fall from £40,000 to as little as £10,000 per annum. This limit includes pension contributions made by both you and your employer.
Anyone with total income of £150,000 or more could be affected. For every £2 of income over £150,000, your annual allowance will fall by £1. This means that for those with income of £210,000 or more, the annual allowance will be £10,000.
‘Total income,’ encompasses the value of a number of benefits provided by your employer and other income sources. It is not limited to your salary plus bonuses or your take home pay. This means that if your ‘income,’ is lower than £150,000 you could still be caught, particularly if your employer makes large pension contributions.
Going forward, many individuals will have a personal annual allowance which may differ on a yearly basis, this creates complication. Further still, any individual who makes an excess pension contribution may be subject to an annual allowance tax charge. You should seek advice if you believe you are likely to be affected.
A window of opportunity
Pension contributions currently attract income tax relief at an individual’s marginal rate and offer the ability to pass wealth down through generations extremely tax efficiently. For these reasons, maximum funding pensions (but with reference to the lifetime allowance) is in the interests of many but unfortunately the ability to do so for some will be materially impacted.
However, it is not all bad news. The carry forward rules, and transitional rules announced in the latest Budget statement mean that higher earners have a window of opportunity to maximum fund before the 6th April 2016.
If you have any unused allowances from the last three tax years you may be able to use ‘carry forward’. For some the maximum contribution before the end of tax year could be as much as £180,000 for an additional rate tax payer the net cost of making a £180,000 pension contribution could be as little as £99,000. The exact amount depends on your circumstances and to receive this level of tax relief you must have paid enough tax at the top rate.
Further still the Chancellor announced some transitional funding rules which mean that if you made contributions to pensions with pension input periods ending between 6 April 2015 and 8 July 2015, even if you used the full £40,000 allowance, you might be able to invest more this tax year.
What action should I take before April 2016?
1. Speak to your adviser to establish exactly how the new rules will affect you and how you might be able to maximise your retirement position prior to April 2016.
2. Work with your adviser and employer to establish whether there is any scope to change remuneration packages to help offset a potential reduction in tax-efficient pension funding.
Looking past 2016
Pension tax relief costs the government £34.3 billion a year. The rules outlined above will reduce the impact on the Treasury’s purse strings but further changes may come to the fore.
The government has launched a consultation on the tax treatment of pensions to establish whether the current system is fit for purpose. The details are unclear however, many industry commentators believe tax relief will move to a flat rate of between 25% and 30%. Under this regime basic rate tax payers would gain but higher and additional rate tax payers would lose.
Pension contributions should always be made with reference to affordability and personal circumstances but for those that are able to top up their fund now it certainly makes sense to consider acting before April.
Changes are expected to be announced in the March Budget Statement.
For further help and advice about your annual allowance, or any aspect of pension planning, please contact us.