Saving within a pension scheme is one of the most tax-efficient ways to save for retirement. The main advantage is the receipt of tax relief on the personal pension contributions.
The Government limits the amount of pension savings an individual can make each year which benefit from tax relief, including employer contributions. This limit is called the ‘Annual Allowance’ and is set at £40,000). However people with an income (including employer pension contributions) over £150,000 will have a lower annual allowance limit. This is called the Tapered Annual Allowance.
If Adjusted income (income including salary, bonuses, savings interest, dividends and any contributions an employer makes to a pension) is greater than £150,000, the Annual Allowance will be reduced. It will be reduced by £1 for every £2 of income above this limit, up to a maximum reduction of £30,000 i.e. if income is £10,000 above the £150,000 limit, the Annual Allowance will be reduced by £5,000.
However, this rule only applies if the Threshold income (total income without the addition of any employer pension contributions) is more than £110,000. This is to ensure those with a one-off spike in their employer pension contributions are not caught by this rule.
The following examples show how this would work for two different individuals:
James has a salary of £100,000 and £20,000 of investment income in the 2018/19 tax year.
His employer makes a contribution of £20,000 and he personally makes a contribution of £20,000.
His adjusted income is £140,000 (£120,000 income chargeable to income tax + £40,000 total pension contributions – £20,000 personal pension contribution)
His threshold income is £100,000 (£120,000 income chargeable to income tax – £20,000 personal pension contribution)
As the adjusted income is below £150,000 James’ annual allowance is not tapered.
This means that in 2016-17 Alice can only benefit from tax relief on pension contributions up to £27,000.
Georgina has a salary of £130,000 and self-employed income of £10,000 in the 2018/19 tax year.
Her employer makes a £30,000 pension contribution and she also make a contribution of £10,000.
Her adjusted income is £170,000 (£140,000 income chargeable to income tax + £40,000 total pension contribution – £10,000 personal pension contribution)
Her threshold income is £130,000 (£140,000 income chargeable to income tax – £10,000 personal pension contribution)
As both her adjusted and threshold income are above the relevant limits, Georgina is subject to the taper. Her £20,000 excess income above the adjusted income limit reduces her annual allowance by £10,000 to £30,000.
As her total contributions are £40,000 she would be subject to the annual allowance charge on the £10,000 excess, unless she had carry forward available.
Simon has his own business and has income made up of salary and dividends of £115,000 that is subject to income tax in 2018/19.
He maximised his pension contributions in 2015/16 and 2016/17 but made no contributions in 2017/18 due to re-investment in the business.
In 2018/19 he wants to maximise his contributions from the business, making use of his carry forward from 2017/18.
If the employer contributes the full £80,000 his situation is:
Adjusted income £195,000 (£115,000 income chargeable to income tax + £80,000 total pension input)
Threshold income would be £115,000 (£115,000 income chargeable to income tax)
As both the adjusted and threshold income are above the relevant thresholds Simon would be subject to taper. The £45,000 excess adjusted income reduces the annual allowance for 2018/19 by £22,500 to £17,500.
The excess of £22,500 would be subject to the annual allowance charge.
However, if Simon makes a personal pension contribution of £5,000 and his company make an employer contribution of £75,000 it changes the situation as follows.
Adjusted income would be £190,000 (£115,000 income chargeable to income tax + £80,000 total pension input – £5,000 personal pension contribution.
Threshold income would be £110,000 (£115,000 income chargeable to income tax – £5,000 personal pension contribution)
As the threshold income does not exceed £110,000 Simon’s annual allowance would not be tapered so no annual allowance charge would apply.
As employer pension contributions are included in the definition of adjusted income, it can be difficult to ascertain the maximum contribution that can be paid without the annual allowance charge being triggered.
This is because the contribution itself reduces the annual allowance available.
The table below contains a sample of the maximum employer contributions that can be paid based on income chargeable to income tax, without triggering a charge where the threshold income is exceeded. This assumes no personal contributions are made and no carry forward is available.
The above should give you a good idea of suggestions that can be made to clients to remove any tapered annual allowance. If you have any queries or want to discuss any specific cases, just call the office on 0845 680 8910.
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