Following on from Liz’s blog in regard to the new tax year specific allowances. Jordan wanted to provide a more detailed explanation of the Tapered Annual Allowance and how this could affect you.
The Tapered Annual Allowance was announced by George Osborne in the Summer 2015 Budget but and came into effect a year later on the 6th April 2016. Although this will be the third year of the tapering system it is still a very complex and difficult topic to understand. If you think you might be affected by the Tapered Annual Allowance, it is vital to seek advice from a professional.
Purpose of the Tapered Annual Allowance
The change was intended to reduce the amount of income tax relief available to higher earners who make pension contributions and to reduce the amount of government spending on pension tax relief.
The annual allowance restricts the amount of pension contributions you can receive income tax relief on. The standard annual allowance (the maximum gross amount you can pay into pension) is £40,000 in the current tax year but, if you are subject to the tapered annual allowance this could be reduced to £10,000.
Who is affected?
If your total taxable income is under £110,000 in the 2018/19 tax year, then you should not be affected. Please note the phrase “total taxable income” includes all sources of taxable income and some pension contributions (it is not limited to just your salary).
To see if you might be affected by the tapered annual allowance you can follow these 3 easy steps:
1. Calculate your total income before tax from all sources (Gross total income includes employment income, pension income, rent, bank interest, dividends – essentially any taxable income).
2. Include any new salary exchange or salary sacrifice arrangement which was set up or changed on or after 9th July 2015.
3. Deduct the gross value of any pension contributions you paid under the relief at source method of calculating income tax relief (personal pension contributions).
This is your threshold Income.
If this figure is less than £110,000 you should not be affected by the tapered annual allowance. This means you should continue to be subject to the standard annual allowance of £40,000.
What if I earn over £110,000?
If this is £110,000 or more, you now need to calculate your Adjusted Income:
1. Calculate your total income before tax from all sources (ignoring deductions for pension contributions).
2. Add the value of any pension contributions[1]paid by your employer. This includes contributions paid under a salary sacrifice or salary exchange system, regardless of when this system was originally set up.
This is your Adjusted Income. If this is less than £150,000 you should not be affected by the tapered annual allowance. This means you should continue to have the standard annual allowance.
What if I earn over £150,000?
If this is more than £150,000 you now need to do the following to find your tapered annual allowance:
1. Take your adjusted income figure
2. Deduct £150,000
3. Divide this by 2
4. Subtract this figure from £40,000
This should be your tapered annual allowance for the 2018/19 tax year. If this figure is less than £10,000 your tapered annual allowance is £10,000 (the lowest tapered annual allowance you can have is £10,000 – this will apply to anyone with adjusted income of more than £210,000).
Importantly you can still use any unused annual allowance from the 3 previous tax years on top of your tapered annual allowance under the standard “carry forward” rules. This can allow larger contributions than £40,000 which can maximise tax relief especially for higher earners.
What if I exceed the tapered annual allowance or the standard annual allowance?
You will face an annual allowance charge, which essentially removes the additional income tax relief you received on your pension contribution. This can sometimes be paid by your pension scheme, but it is normally paid by you directly.
You are responsible for ensuring you pay any annual allowance charge due. This will not be automatically done by HMRC, your employer or your pension provider.
What if I’m not sure what to do?
This subject is very complicated, it is recommended you seek professional advice if you think you may be affected or have exceeded the annual allowance. We can find out if you are affected and offer advice on the most suitable way of dealing with this issue, including alternative methods of saving for your retirement or structuring your pension contributions differently.
Any reference to taxation will be based on your individual circumstances. Tax legislation and regulations are subject to change. Investments, and the income from them can fall as well as rise. Your capital is not guaranteed.
For a defined contribution pension this is simply the monetary amount paid by your employer. For a defined benefits pension this is more complicated: it is the annual increase in your defined benefits scheme pension benefits from your employer only.