Bernadette Lewis considers the effects of the annual allowance taper on clients over two individual tax years.
Since 6 April 2016 clients on a high income have had their annual allowance for tax relief on pension savings restricted. Advisers may be starting to consider the effects of the taper on clients over two tax years.
The tapered annual allowance applies in 2016-17 and 2017-18 if:
• Adjusted income is more than £150,000, and
• Threshold income is more than £110,000.
If someone exceeds both limits, the £40,000 annual allowance reduces by £1 for every £2 of adjusted income over £150,000, to a minimum of £10,000 once adjusted income is £210,000 or more.
Income types explained
The main elements of adjusted and threshold income are:
Adjusted income
• Net taxable earnings – including bonuses and benefits in kind*
• Net taxable self-employed profits*
• Other taxable income – such as pensions, rent, interest and dividends*
• Gross member contributions benefitting from net pay tax relief
• Employer pension contributions – for defined benefit schemes, the pension input amount minus employee contributions.
Threshold income
• Net taxable earnings/net taxable self-employed profits/other taxable income*
• Add back any new salary sacrifice arranged in connection with pension contributions after 8 July 2015
• Deduct gross member contributions benefitting from tax relief at source.
* Total of all components of net income at step 2 in the section 23 Income Tax Act 2007 calculation.
Example: Cate and Mike
Cate and Mike have identical remuneration. Cate avoids the taper. Mike is caught because he also has income -covered by the savings and dividend allowances (taxable at 0% rather than tax free – see Fig. 1).
Carry forward
Carry forward is available with the tapered annual -allowance. So even if someone’s pension input exceeded the tapered annual allowance in 2016-17, they were able to use any -available annual allowance from the three previous tax years.
This three-year rule also applies for 2017-18, but many people will only have remaining unused annual allowance from 2014-15 and 2015-16. So it is more likely they will have to restrict pension input to avoid annual allowance charges.
For defined contribution schemes, pension input is the total of all contributions paid during the same tax year. For defined benefit schemes, it is safest to obtain a pension savings statement from the administrator.
Some individuals with adjusted income over £150,000 can use carry forward to make a relief at source member contribution, reducing their threshold income below £110,000 and taking them out of scope for the tapered annual allowance.
Example: Stacey
Stacey could be caught by the tapered annual allowance for the first time in 2017-18, after a pay rise takes her salary, adjusted and threshold income to £165,000.
However, she has £23,000 of carry forward available and has funds to make a relief at source member pension contribution of £55,000 gross.
If she does, it would reduce her threshold income to £110,000. She would benefit from the full £40,000 annual allowance for 2017-18 and use just £15,000 of carry forward.
Scheme pays
If someone’s available annual allowance – their tapered annual allowance plus any carry forward – covers their pension input the same tax year, they don’t need to take any action.
If their pension input exceeds their available annual allowance, the annual allowance charge applies to the excess at their marginal rate of income tax – probably 45% in tapered annual allowance cases.
This makes the excess contributions effectively non-tax relievable. The taxpayer declares their liability on their self-assessment tax return.
“Scheme pays” might be an option, but it is only obligatory for a scheme if contributions to it exceed the standard annual allowance and the charge exceeds £2,000.
Bernadette Lewis is financial planning manager at Scottish Widows
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