Since 6th April 2016, the annual allowance (AA) available for individuals to contribute to their pension pot has been subject to tapering restrictions, meaning certain ‘high earning’ individuals may only be able to contribute as little as £10,000 per annum as opposed to the standard £40,000 limit.
For the purposes of AA tapering, a ‘high earner’ is an individual with an ‘adjusted income’ of over £150,000 per annum and for every £2 of income over £150,000 the individual’s AA will be reduced by £1 to a minimum £10,000 (a £30,000 reduction).
‘Adjusted income’ is broadly the individual’s total taxable income plus the value of any pension savings for the tax year, including both personal and employer pension contributions such as those made via salary sacrifice. This means that a person cannot reduce their adjusted income by simply sacrificing salary or bonus payments in exchange for employer pension contributions.
Whilst many individuals might think they fall below this bracket, it is important to highlight that rather than gross salary income alone, the calculation for adjusted income includes earned salary, bonus, dividends, self-employed profits, benefits-in-kind, pension income and property income plus any personal and employer pension savings during that year.
There is a safety net in place to ensure that lower paid individuals are not affected by the rules in the form of an income floor, known as the threshold income. If adjusted income is more than £150,000 the Tapered Annual Allowance will only take effect if the threshold income limit of £110,000 is also breached. This test is intended to protect those with a spike in earnings and/ or pension contributions. If an individual’s net income (total taxable income less personal pension contributions) is less than the £110,000 threshold, then they will not normally be subject to the AA tapering.
The issue with the new rules is that many individuals will not know their adjusted income figure until the end of the tax year in question and consequently it will be difficult to calculate their AA until this point. Therefore, pension contributions made on a regular basis may need to be restricted to avoid inadvertently falling foul of the new AA rules.
To provide some leeway, it is possible to carry forward unused AA from the three previous tax years and add it to an individual’s AA in the current tax year. Therefore, depending on pension contributions made in the previous three years, any reduction could be offset by carrying forward unused AA.
Clearly the rules regarding annual allowances are extremely complex and can be easy to overlook, particularly if you receive an unexpected bonus or other form of taxable income within any given tax year.
If you earn over £110,000 it may be worth investigating further whether the annual allowance tapering rules affect you. If you are a high earner and have exhausted your previous three years’ AA, there are other tax efficient ways in which you can save for your future.
If you think the Tapered Annual Allowance provisions may affect you, please contact us – our financial advisers would be happy to discuss your situation and advise on the best way forward specific to your personal circumstances.
NB. Tax advice is not regulated by the Financial Conduct Authority