Many high net worth investors will see their annual allowance restricted by the new tapering rules this tax year. The carry forward rule, which allows investors to use ‘leftover’ annual allowance from up to three previous tax years, has been hailed as a possible lifeline for those affected. However, investors will need to take care to avoid an unexpected annual allowance charge.
The issue lies in the fact that an individual’s contributions affect their tapered annual allowance.
A person is subject to the tapered allowance if their ‘threshold income’ is above £110,000 and their ‘adjusted income’ is above £150,000.
| Threshold Income | Adjusted Income |
| Income for the year which is chargeable to income tax (includes income from all sources, including things like dividends) | Income for the year which is chargeable to income tax (same method as for threshold income) |
| + | + |
| The value of any income given up in exchange for pension contributions using salary sacrifice or similar arrangements (only for arrangements established after 8 July 2015) | The value of contributions made through a net pay arrangement |
| – | + |
| The gross amount of personal contributions made using relief at source | The value of employer contributions, including those made as a result of salary sacrifice |
| – | – |
| Any taxable lump sum death benefits which were taxed as income (i.e. paid on or after 6 April 2016) | Any lump sum death benefits which were taxed as income |
The tapered allowance is calculated by reducing the standard allowance (£40,000) by £1 for every £2 of adjusted income in excess of £150,000.
Examples such as the following have been used to show how the taper works.
Ella’s salary is £130,000 per year. In 2016/2017, her employer contributes £30,000 to her workplace pension scheme. Ella also contributes £10,000 gross to a pension which operates relief at source.
Ella’s threshold income for the year is £120,000 (salary – relief at source contributions). Her adjusted income for the year is £160,000 (salary + employer contributions).
Ella is, therefore, subject to the tapered annual allowance. She has £10,000 of adjusted income above £150,000, so her allowance is reduced by £5,000. Her annual allowance for 2016/17 is £35,000.
Have you spotted the problem?
Ella’s annual allowance for 2016/17 is lower than the total value of the contributions. She has exceeded her annual allowance by £5,000 and will face a tax charge unless she is able to use carry forward.
However, this problem can become more prominent as carry forward is factored in.
Consider the following.
Colin first joined his pension scheme in April 2013. His contribution history is as follows:
| Tax Year | Annual Allowance | Contributions | Unused Allowance |
| 2013/14 | £50,000 | £30,000 | £20,000 |
| 2014/15 | £40,000 | £35,000 | £5,000 |
| 2015/16 | £40,000 | £25,000 | £15,000 |
In 2016/17, Colin decides to use carry forward to maximise his pension contributions. Each year, he contributes £25,000 gross to his personal pension, which operates relief at source. Colin’s employer agrees to pay the rest as an employer contribution. The employer contributes £55,000: £15,000 for the remaining allowance in 2016/17 and £40,000 for the unused allowance from previous years. Colin also receives £140,000 as income.
Colin’s threshold income is £115,000 (salary – relief at source contribution). His adjusted income is £195,000 (salary + employer contribution).
His annual allowance for 2016/17 is, therefore, £17,500. With his available carry forward, he had a total possible allowance of £57,500. The £80,000 worth of contributions has therefore taken him £22,500 over the annual allowance.
| Tax Year | Annual Allowance | Contributions |
| 2013/14 | £50,000 | £30,000 |
| 2014/15 | £40,000 | £35,000 |
| 2015/16 | £40,000 | £25,000 |
| 2016/17 | £17,500 | £80,000 |
| Total | £147,500 | £170,000
= £22,500 excess |
Resolving this situation could prove trickier than it seems.
As Colin already makes personal contributions and his employer agreed to pay the difference, the first thought might be to reduce the employer contribution by £22,500.
However, this would lower Colin’s adjusted income to £172,500 (£140,000 salary + £32,500 employer contribution), giving him an annual allowance of £28,750 for 2016/17. His total available allowance would, therefore, be £68,750, but the total value of the contributions is only £57,500.
| Tax Year | Annual Allowance | Contributions |
| 2013/14 | £50,000 | £30,000 |
| 2014/15 | £40,000 | £35,000 |
| 2015/16 | £40,000 | £25,000 |
| 2016/17 | £28,750 | £57,500 |
| Total | £158,750 | £147,500
= £11,250 remaining |
Further calculations would be needed to find the balance between the value of the employer contribution and the reduced annual allowance.
Alternatively, Colin might decide that he should reduce his personal contribution by £22,500 and still ask his employer to contribute £55,000. This would give him a higher threshold income (although this has no material effect in this case), but his adjusted income and annual allowance for 2016/17 would stay the same, at £195,000 and £17,500 respectively.
| Tax Year | Annual Allowance | Contributions |
| 2013/14 | £50,000 | £30,000 |
| 2014/15 | £40,000 | £35,000 |
| 2015/16 | £40,000 | £25,000 |
| 2016/17 | £17,500 | £57,500 |
| Total | £147,500 | £147,500
= no excess contributions or remaining allowance |
In this scenario, Colin is lowering his personal contribution and asking his employer to pay more instead.
It’s reasonable to assume that the employer is unlikely to agree to this unless they adjust other aspects of Colin’s remuneration as a result. However, it’s possible that such changes would affect Colin’s threshold or adjusted income, which could invalidate the calculations again.
It could also put Colin at risk of breaching the anti-avoidance rules, which prevent individuals from manipulating their income in order to achieve a higher annual allowance.
It’s little wonder that so few people are in favour of the tapered annual allowance.
Jessica List is pensions technical analyst at Suffolk Life
It’s little wonder that so few people are in favour of the tapered annual allowance
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