Tapering of pension annual allowance

In March last year, Rishi Sunak revealed the plans to raise the point at which tapering of the pension annual allowance kicks in from the 2020/21 tax year. Whilst this change came into effect on 6 April 2020, we feel that it is prudent to bring this change to everyone’s attention before the tax year end.

What is the pension annual allowance?

The pension annual allowance is the total amount that can be contributed into a pension each tax year without a tax charge applying. The standard annual allowance is £40,000 for the 2020/21 tax year. The allowance is reduced if an individual has a threshold income above £200,000 and an adjusted income of over £240,000.

What is threshold income?

Threshold income is largely defined as the individual’s net income for the year. This includes all types of income such as salary, rental income, trading profits, interest from saving accounts and dividends.

In summary, threshold income is calculated as follows:

  • Add – All taxable income for the tax year
  • Deduct - Any taxable lump sum pension death benefits accruing in the tax year
  • Add – Income that has been sacrificed for employer pension contributions
  • Deduct - The gross amount of any relief at source pension contributions

If the individual’s net (taxable) income is no more than £200,000 they will not normally be subject to the tapered annual allowance. This means that they will have the full £40,000 pension annual allowance. If, however, the threshold income is in excess of £200,000 then adjusted income needs to be calculated.

Example 1

Mr Smith has a salary of £100,000 and makes a gross personal pension contribution of £5,000 and his employer also makes a pension contribution of £4,000.

Mr Smith’s threshold income is £100,000 - £5,000 = £95,000 (as this is below £200,000 there is no need to calculate the adjusted income).

Example 2

Mr Bloggs has a salary of £220,000 and makes a gross personal pension contribution of £5,000 and his employer also makes a pension contribution of £4,000.

Mr Blogg’s threshold income is £220,000 - £5,000 = £215,000 (as this is above £200,000 the adjusted income needs to be calculated).

What is adjusted income?

Adjusted income is another test which needs to be conducted if an individual’s threshold income is more than £200,000. In summary, adjusted income is calculated as follows:

  • Add – All gross income for the tax year (includes all types of taxable income)
  • Deduct - Any taxable lump sum pension death benefits accruing in the tax year
  • Add – All employer pension contributions made in the tax year

If the adjusted income is above £240,000 then, the £40,000 pension annual allowance starts getting reduced (tapered). For every £2 adjusted income that exceeds £240,000, £1 of pension annual allowance is lost down to a minimum tapered annual allowance of £4,000 which is reached if adjusted income is £312,000 or more (the minimum tapered annual allowance was £10,000 in the last few tax years and the threshold and adjusted income limits were lower).

Example 3

Mr Bloggs has a salary of £220,000 and makes a gross personal pension contribution of £5,000 and his employer also makes a pension contribution of £4,000.

Mr Blogg’s adjusted income is £220,000 + £4,000 = £224,000 (as this is below £240,000 he will have a full £40,000 annual allowance).

Example 4

Mrs Brown has a salary of £320,000 and makes a gross personal pension contribution of £15,000 and her employer also makes a pension contribution of £10,000.

Mrs Brown’s adjusted income is £320,000 + £10,000 = £330,000 (as this is above £312,000 she will only have £4,000 pension annual allowance. This means that the excess pension contribution of £21,000 (£25,000 - £4,000) will be subject to a tax charge unless Mrs Brown is able to use carry forward and has sufficient unused annual allowances available).

In short

If someone's adjusted income is... Then, their pension annual allowance will be...
Less than £240,000 £40,000
More than £312,000 £4,000
Between £240,000 and £312,000 Between £4,000 and £40,000

Why is this important?

It is important for two reasons:

1. An individual may be able to put more into a pension - Someone who might have been tapered in the 2019/20 tax year may not actually be tapered in the 2020/21 tax year. This means that they can put more money into their pensions and get tax relief at up to their highest marginal rate.

2. An individual may be able to put less into a pension - Someone who was tapered fully in the 2019/20 tax year might also be tapered fully in the 2020/21 tax year. If they were to keep the pension contributions the same at £10,000, then they will be hit with an (unnecessary) tax charge on the £6,000 excess contribution. 

How can we help?

We would be pleased to help with further advice in this area. If you would like to discuss any of these matters further or you need advice, please contact Görkem Gökyiğit, Chartered Financial Planner on 0207 490 7766 or email gorkemgokyigit@lfwm.co.uk.

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