Since 6 April 2016, where an individual has threshold income of more than £110,000 and adjusted income of more than £150,000, their annual allowance is reduced by £1 for every £2 of excess income, up to a maximum reduction of £30,000. An individual with income of £210,000 or more will only have an annual allowance of £10,000. Any contributions in excess of this will be subject to the annual allowance charge. The annual allowance charge is a stand-alone tax charge but the purpose of it is to remove the tax relief benefit that the contribution will have received.
For these purposes the test is to see if an individual’s adjusted income exceeds £150,000. Adjusted income is their net income (before deducting individual pension contributions or gift aid) and includes the value of any employer pension contributions.
It will therefore be apparent that a person may be subject to these provisions if, for example, he or she has income of £130,000 and a pension provision of more than £20,000 is made for him or her via an employer contribution in a particular tax year.
This could cause some concern for people who have income that hovers around £110,000 whose employers intend to make substantial pension provision – possibly by paying a contribution to make use of the unused relief for previous tax years.
To cover such situations, the rules provide that for the taper to apply the individual must have a threshold income of at least £110,000. An individual whose income falls below the threshold income level will not be subject to the tapering provisions. Individual pension contributions (not employer) can be deducted to determine threshold income (although salary sacrifice arrangements set up after 8 July 2015 will be caught as will earlier salary sacrifice arrangements that require the individual to make an annual declaration).
For those affected, the impact of the annual allowance charge (likely to be 45% for those impacted by tapering) together with income tax on benefit withdrawals of up to 45%, can result in a very high effective rate of income tax.
For previous tax years these taxpayers could have been entitled to higher annual allowances depending on their income levels and the tax year. This could mean that individuals caught by the taper could pay the maximum for 2018/2019 and then make contributions in respect of unused relief from earlier tax years.
Subject to not exceeding the lifetime allowance (see (3) below) it therefore makes sense for individuals who are affected by the tapered annual allowance to:
- pay the maximum contribution for this tax year, which will be dependent on their threshold and adjusted income in 2018/2019, but will not be less than £10,000, and
- pay a contribution in respect of any carried forward annual allowance for the tax year 2015/2016. There may also be some allowance available to carry forward from 2016/2017 and 2017/2018 if either, or both, of those year’s contributions were less than any tapered allowance.
Example – John
John is self-employed. He has adjusted income of £160,000 in 2016/2017 and, 2017/2018 and £160,000 threshold and adjusted income in 2018/2019, £150,000 of which is relevant UK earnings each year. He has not yet made any pension contributions in this tax year. He wants to maximise his pension contributions in this tax year.
In the last three tax years he has made a (grossed-up) contribution of £30,000 on 1 September of each year. His threshold income has been £130,000 a year for each of 2017/2018 and 2016/2017.
Based on this, his annual allowance for 2018/2019 (and 2016/2017 and 2017/2018) is therefore £35,000. He therefore has unused relief of £5,000 for each of 2017/2018 and 2016/2017 and £10,000 for 2015/2016.
So, for example, if John makes a contribution of £60,000 in 2018/2019 this will reduce his threshold income to £100,000 for 2018/2019 so giving him back the full annual allowance of £40,000 for this year. This will mean that he will:
- use his £40,000 annual allowance for 2018/2019;
- use £10,000 of unused relief from 2015/2016, £5,000 of unused relief from 2016/2017, and £5,000 unused relief from 2017/2018.
As we can see, people caught by the tapered annual allowance may be able to use carry forward to make a large enough personal contribution to reduce their threshold income for this tax year below £110,000 and thereby restore their annual allowance to £40,000 for 2018/2019.