The Tapered Annual Allowance – Can You Escape It?

The Spring Budget 2020 increased the annual allowance income limits, taking many high earners out of the tapered annual allowance.

The new limits explained

Every individual is usually eligible for the standard annual allowance for pension contributions of £40,000 per annum. However, the tapered annual allowance reduces the standard annual allowance when income reaches certain levels. These income limits have recently been increased.

The ‘adjusted income’ limit has risen to £240,000 (up from £150,000), and the ‘threshold income’ limit to £200,000 (previously £110,000).

Tapering reduces the standard £40,000 annual allowance (AA) by £1 for every £2 of adjusted income over £240,000. The minimum annual allowance is £4,000 for anyone with adjusted income of £312,000 or more.

This means many of those previously subject to the full taper will see their annual funding allowance increase by £30,000 per annum. An extra £30,000 of gross funding equates to annual tax relief of £12,000 for a higher rate tax payer, £13,500 for an additional rate tax payer and £5,700 for a company director claiming corporation tax relief.

It’s clear that for some this is really good news, but unfortunately very high earners could see their funding ability cut further. Those with threshold income over £200,000 and adjusted income over £312,000 will get less tax relief, as the maximum annual allowance now drops to £4,000 (previously £10,000).

What is adjusted and threshold income?

It’s important to understand what counts as adjusted income and threshold income. Pension funding is treated differently under the two definitions and this is important in effective planning.

  • Adjusted income is broadly total income plus any employer pension funding. This is relatively easy to identify for money purchase schemes but less so for defined benefits.
  • Threshold income any individual pension contributions are deducted to calculate threshold income.

This means that an individual pension contribution can help avoid the taper.

What else should you factor in?

Redundancy payments. While the first £30,000 is tax free and does not count towards either of the adjusted or threshold income limits, anything above this will count. This may mean an individual not normally subject to the tapering rules is now caught. Good planning can help to navigate these rules.

  • Making an individual pension contribution so that threshold income dips below £200,000 might restore the full £40,000 annual allowance and allow more tax relief on at least part of the taxable redundancy payment. This may be particularly attractive to those near to, or above, the minimum pension age of 55.
  • Care must be taken when accepting an offer of redundancy ‘sacrifice’ whereby the package includes a payment by an employer into the pension scheme. This may be enhanced if the employer offers to pay in their employer National Insurance savings (from 6 April 2020 employers now pay NI on the taxable part of a redundancy payment). However, care should be taken as this will be a new sacrifice arrangement and will count towards both adjusted income and threshold income. In such circumstances, taking the redundancy payment and making an individual contribution may be the better option if it keeps threshold income below £200,000, and retains the full annual allowance.

Carry forward. In order to make a contribution large enough to take threshold income below £200,000, you may need to rely on carrying forward unused annual allowances from the previous three years. When determining how much might be available, remember that the annual allowance in those years might also have been tapered. So even if no contributions were made at all in those earlier years, the amount for carry forward from each year may still be less than £40,000.

Non-deductible relief. Although income tax relief may be available on certain transactions, it may not reduce adjusted or threshold income. These include:

  • Investing in VCT, EIS, and SEIS– income tax relief is given as a ‘tax reducer’ and is based on a percentage of the amount invested. It reduces the final tax bill, but does not reduce taxable income. Adjusted and threshold income are both based on taxable income and are therefore unaffected by such investments.
  • Gifts to charity– Gifts made under gift aid will not reduce adjusted or threshold income.
  • Investment bond gains– The full chargeable gain will be added to adjusted and threshold income – not the average gain used for top slicing relief. This could counter any planning to retain the full annual allowance for this tax year.

 

Summary

Although the increase in the adjusted income and threshold income limits could be read as a pension tax give-away for high earners, the measure was introduced primarily to solve an issue around annual allowance tax charges that existed amongst NHS doctors.

For those who normally have a reduced annual allowance, this may be a window to boost your pension savings with maximum tax relief.

Some suggest the widow of opportunity to do so may be short lived. Speculation surrounding the reform of pension tax relief continues, perhaps unsurprising given current levels of Government debt. It is possible that the rate of relief available becomes less attractive in the future.

For more information on any of the above information or discuss the best way to navigate pension funding for your own personal circumstances, please contact us.

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