The tapered pension annual allowance

The Conservative 2015 Election manifesto forewarned of the intention to further reduce pension tax relief for high earners. The resultant changes, which came into force in April 2016, will be felt for the first time in January 2018, when the balancing tax payments for the 2016/17 tax year fall due. The changes will see an increase in the number of taxpayers facing a pension annual allowance charge, and we highlight below the changes and those individuals most likely to be affected.

The New Tapered Pension Annual Allowance

A tapered pension annual allowance has been introduced for the tax year 2016/17 which links the annual allowance to an individual’s income. The pension annual allowance limits the amount of tax relief available on pension savings each year. The standard rate of the annual allowance is £40,000, but can be reduced to a minimum of £10,000 in the case of high earners. The allowance is reduced by £1 for every £2 of ‘adjusted income’ over £150,000. Individuals with an ‘adjusted income’ between £150,000 and £210,000 will be affected by the tapered annual allowance. Those with an ‘adjusted income’ over £210,000 will have a tapered annual allowance of only £10,000.

The Income Tests

I have referred above to ‘adjusted income’, but it is initially necessary to apply the ‘threshold income’ test. In most cases this is the taxable income, less pension contributions. If this figure is less than £110,000 then the ‘adjusted income’ test need not be applied and the full £40,000 annual allowance is available.

If the ‘threshold income’ exceeds £110,000 the calculation of ‘adjusted income’ is necessary. Broadly, this will be the figure calculated above, but with the growth in the value of a defined benefit scheme, or employer contributions paid into a defined contribution scheme, added to it. 

 The Annual Allowance Charge

The excess of pension growth over the annual allowance is charged at marginal tax rates, which are likely to be 40% or 45% for high earners. In the case of the tax year 2016/17, the additional income tax will be due with the balancing payment on 31 January 2018, and will also increase the payments on account of the subsequent tax year 2017/18, due on 31 January and 31 July 2018.         

Carry Forward Relief and Scheme Pays Election

As in previous years, it is still possible to carry forward unused relief from the previous three years to set against a 2016/17 pension excess charge. It is therefore important for those potentially affected to establish the value of any unused relief available for the years 2013/14 to 2015/16 inclusive.

The Scheme pays election continues to be available for those facing a charge in excess of £2,000, subject to meeting certain conditions. For 2016/17 notices, the deadline for this election is 31 July 2018 Pension benefits are correspondingly reduced as a consequence of a payment following a scheme pays election, and independent financial advice is recommended prior to making any election.

Conclusion

Every individual will be in a different position and there will be no ‘one size fits all’ solution. It may be that you consider the additional tax charge is a price worth paying for the continuing accrual of valuable pension benefits. Those who believe that they may be affected are advised to contact an independent financial advisor with experience of these issues and consider what action might be taken to reduce or eliminate the potential tax charges.

This is a complex subject and there are no easy answers. Identifying the potential problem early, and either taking steps to minimise the impact, or budgeting for the expected tax increase in January 2018 are essential.

We have many years’ experience of dealing with pension as well as personal and business tax issues at Page Kirk LLP, and offer a free one hour consultation if you wish to discuss your business or personal circumstances with us.

Steve Connington
12 April 2017