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Technical insight: Annual allowance tapering

Claire Trott, head of Pensions Technical, Talbot and Muir, examines annual allowance tapering, where the complexity is in the income calculation, which is done in a number of stages

The Summer Budget 2015 brought with it additional complexity for high earners and pension schemes. It was promised in the Conservative Manifesto but I did live in hope it wouldn’t come about especially as the Conservatives got rid of the special annual allowance introduced in 2009 by Labour. Let’s hope that it is simplified as the Bill goes through Parliament but if not planning now is key.

The basics

The actual tapering of the annual allowance is quite simple; the complex part is in relation to working out what income you should be using for the calculations and knowing what someone’s income will be for the tax year, before the end of the tax year.

AA tapering graphFor someone with earnings over £150,000 their annual allowance will be reduced by £1 for every £2 they are over the £150,000, so someone with earnings of £170,000 will have their annual allowance reduced by £10,000. The reduction is capped so that it can’t reduce the annual allowance below £10,000 so for those earning over £210,000 they will not see any additional reduction over the £30,000. The way this is worded is interesting in the legislation because it takes account of future changes to the standard annual allowance, with an emphasis on the £10,000 being a minimum, so taking account of possible future reductions.

Adjusted income

The complexity in all this is the income calculation; it isn’t just earnings from employment or self employment but calculated in a number of stages.

Firstly, you need to know ‘net income’, which is total taxable income (chargeable to income tax) reduced by deductions listed in section 24 of the Income Tax Act 2007, which are reliefs such as trading and share loss relief. You will need to add back in reliefs claimed under net pay arrangements, excess claims also made in relation to net pay arrangements and personal contributions made under net pay arrangements. It they are not domiciled, paying contributions to overseas schemes and receiving tax relief, this will need to be added back in. The last addition is employer pension contributions, which again need to be looked at in more detail. You can however deduct payments received from lump sum death benefits that will be subject to income tax by next year.

Employer contributions are simple if they are being paid to a money purchase scheme, because they are simply the monetary amount. However, if you are looking at a final salary scheme then you need to start by calculating the total pension input amount, for this you will need salary at the beginning and end of the year, accrual rates and the CPI rate from the previous September to calculate the amount of accrual for the year. You then multiply it by 16 and deduct actual contributions paid by the member themselves.

Threshold income

Threshold income is a little simpler and where someone’s threshold income is below £110,000 then there is no need to calculate the adjusted income and taper won’t apply, unless there is thought to be actual avoidance occurring.

To calculate someone’s threshold income you again start the net income as mentioned above and add back any new salary sacrifice arrangements increased or started on or after 9th July 2015 and then deduct payments received from lump sum death benefits that will be subject to income tax by next year.

Salary sacrifice and flexible income

As mentioned above, there are anti avoidance measures in the legislation, which are there to stop people with flexible benefit packages manipulating their income to remain below the threshold or adjusted income level.

Any new salary sacrifice arrangements will be added back into the threshold income for the test and it should be noted that will in theory include those that have to be opted into each year, so if an arrangement is not continuous it will need to be taken account of too. If it is continuous and there is an increase in the amount sacrificed then it should only be the increase that has to be added back in.

For those with flexible income the anti avoidance will look to see if income has been artificially moved from one year to another to gain a higher annual allowance in a certain year. The regulations will look back as well as forward so taking more income this year in order to reduce it next year and benefit from a full annual allowance isn’t possible. The variation in income will be ignored when calculating the threshold income for next year and if applicable the amount of annual allowance lost.

Plan ahead

Although it isn’t possible to adjust income or set up new salary sacrifice arrangements it is possible to try to ensure that members have used up any carry forward they can so it isn’t lost. There is also scope with the transitional rules regarding alignment of pension input periods to get additional contributions in this year that previously may not have been possible. Try to maximise the tax relief on personal contributions this year and for those that are able to, they could utilise any employer contributions that are available; they are not restricted by earnings, unlike personal contributions.

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