Michael Roberts FPFS
Pension contributions for high earners
Since 2016, individuals with income in excess of £110,000 have been subject to a piece of (in my view) bonkers legislation known as the Tapered Annual Allowance. In short, this means that the amount you can pay into a pension decreases from the standard £40,000 by £1, for every £2 of income you receive in excess of another threshold known as Adjusted Income (which also includes employer pension contributions). Once Adjusted Income exceeds £210,00, the maximum tapering will apply and the Annual Allowance reached its floor of £10,000.
These rules are extremely complex and, because of the nature of the moving parts within the Tapered Annual Allowance calculations, providing an answer to what should be a very simple question; “how much can I pay into my pension”, is exceedingly difficult. Indeed, it is a question that is impossible to answer for those who are unable to be certain of their total income until the end of the tax year.
In addition to the complexity, the legislation also had the unintended consequence of incentivising highly paid doctors, surgeons and other medical specialists to decline to take on extra shifts due to the high level of tax charge they would incur for doing so, as a result of breaching the thresholds. This has been much publicised and has taken far too long to resolve in my view.
In the recent budget, changes to the Tapered Annual Allowance legislation were finally announced. Sadly, the legislation has not been scrapped, but instead the Chancellor elected to tweak the threshold income levels.
From 6th April 2020, the Threshold Income increased to £200,000. This means if your total income is below this, you no longer need to be concerned about the rules. As a planning point, if your income exceeds £200,000, we may still be able to make some adjustments to bring you within this limit; contact us if you’d like help with this.
Furthermore, the Adjusted Income threshold has increased to £240,000. However, the definition of income did not change, which means you need to total all of your income and add in any employer pension contributions. This is made more complex for members of final salary pensions who will need to calculate the notional rather than actual employer pension contribution. The tapering mechanism hasn’t changed either, however the Annual Allowance floor is now £4,000, therefore the maximum taper does not apply until an individual’s Adjusted Income reaches or exceeds £312,000.
As is often the case, there will be winners and losers with these rules as outlined below.
Adjusted Income between £110,000 and £200,000
These individuals will no longer need to concern themselves with the complexity of this legislation, and will be able to contribute the full £40,000 pa into their pension from this year on.
Adjusted Income between £200,000 and £210,000
Complexity remains for these individuals, however whereas they were previously subject to levels approaching the maximum tapering, those with earnings at this level will find they have little or no tapering apply. With some careful planning it may now be possible to avoid the issue altogether.
Adjusted Income between £210,000 and £312,000
It will be mixed news for individuals with Adjusted Income between £210,000 and £312,000; previously they would be subject to the maximum taper and could largely ignore the rules, knowing their Annual Allowance was simply £10,000. Now, they will need to calculate their Annual Allowance each year, but they may be able to make a larger pension contribution than in previous years (although it could also be lower than previous years, for those at the upper end of this income band). In my experience, individuals with income in this bracket often have variable components such as commission, bonuses, LTIPs and other variable emoluments and therefore they will not know with any accuracy until the tax year end how much they can pay into their pension.
Adjusted Income in excess of £312,000
It’s good news and bad news here too. The good news is it’s easy to work out how much you can pay into your pension. The bad news is the maximum tapering applies, so it’s only £4,000 pa; a very low amount compared to the income received. Again, care may be needed if variable income causes an individual to exceed the £312,000 threshold. For example, if a bonus payment is larger than expected, an individual may retrospectively find they no longer have the Annual Allowance they may have been expecting, causing an unexpected tax charge.
Individuals will need to think carefully about the alternatives to pensions for long term savings where they are limited to a relatively low Annual Allowance.
Exceeding the Annual Allowance
The final point for me to cover is; “what happens if I exceed my tapered Annual Allowance”? In essence, you’ll have a tax charge which, given the level of income you need to earn to be affected by these rules, will likely be at 45%. In effect you will not have received any tax relief on the pension contribution that caused you to exceed the limit, but you’ll still have to pay tax when you eventually withdraw the money from your pension. That said, there are circumstances when exceeding the Annual Allowance is the least worst option, so it’s important to seek advice for your specific circumstances; arranging your affairs to avoid the tax charge is not always the best thing to do.
There is also a potential get out of jail free card, by way of Carry Forward relief. If you have not fully utilised your available Annual Allowance in recent years, you may be able to bring this forward to justify a higher contribution in the current year. You will need to know what your total pension contributions were in each previous year (including employer contributions). If you were subject to the tapered Annual Allowance, you’ll also need to calculate your tapered Annual Allowance in each previous year to know how much you can potentially bring forward. I told you it was bonkers
The above article is not advice and is intended only to give a simplified outline of the recent changes to the Tapered Annual Allowance. You should be aware this legislation is highly complex and if feel you may be affected you should seek personal professional advice. Nothing within this article should be taken to be advice in any way, and you should not rely on this article alone in making decisions about your own circumstances. No liability can be accepted as a result of any decisions you may take based on this article. This article is based on our current understanding of the legislation, which may change.
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