What is tapered annual allowance and how does it potentially affect you?

What is the Annual Allowance for pension contributions?

There is an annual limit on the total amount of pension contributions that each person can make without incurring a tax charge (this includes employer and employee contributions) which is called the Annual Allowance. Where the total employer and/or individual contribution exceeds the Annual Allowance a tax charge will apply. The rate of tax will be determined by your taxable income in the tax year. For the 2018/19 tax year the Annual Allowance has been set at £40,000.

What is tapered annual allowance?

Tapered annual allowance comes into effect when a person’s total ‘adjusted income’ is over £150,000 and their ‘threshold’ income is above £110,000.

So, what is ‘adjusted’ and ‘threshold’ income?

In simple terms, ‘adjusted’ income is total taxable remuneration including pension contributions from both the employee and the employer. ‘Threshold’ income ignores pension contributions. Consequently, if your ‘adjusted’ income is above £150,000 and your ‘threshold’ income is over £110,000, your annual allowance will be tapered down.

Tapered annual allowance came into effect after the 2016/17 tax year. Anyone who fell into the catchment area stated above would have their Annual Allowance. Unless a person’s income stays below the relevant thresholds year on year or stays at £210,000 or above year on year, they could find their annual allowance changing each year.

Confusion is often caused when calculating the adjusted and threshold income, particularly when deciding whether particular types of income need to be included. Care needs to be taken when preparing these calculations

How does tapering work?

Tapering works by reducing your annual allowance by £1 for every £2 you earn in excess of £150,000. The maximum taper is £30,000 to give a minimum annual allowance of £10,000, which is reached at an ‘adjusted’ income level of £210,000. Tapering would affect carry forward allowance, if tapering reduced your annual allowance from £40,000 to £20,000 then the tax year which this applied would affect the carry forward. (Carry forward blog)

Money Purchase Annual Allowance (MPAA)

Anyone who has crystallised their defined contribution (DC) pension saving scheme and is also an active member of a defined benefit (DB) scheme the annual pension allowance is reduced to £36,000, this amount will also be affected by taper rules. If you earn £210,000 or more a year rather than your tax-free pension contribution being reduced to £10,000 it would in fact be zero.

Summary

Tapered annual allowance takes into account both ‘adjusted’ income and ‘threshold’ income. As mentioned above the easiest way to look at adjusted income is total taxable income including personal or employer pension contributions whereas threshold income is the same apart from including pension contributions.

What should you think about?

We would highly recommend people with high income seek professional advice from your financial planner to ensure your adjusted and threshold income is calculated correctly to take into account any potential tapered annual allowance.

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