Mitigating the tapered allowance – how to ensure you’re not caught out
The tapered annual pension allowance regime for higher earners has now been in force for a year, but there are potentially many people out there who do not even realise they are affected by it. Below we show you the various ways you might be unaware, and how you can mitigate the impact.
Published on 24 Apr 20173 minute read
Written by Gary Smith
Who does the tapered annual allowance affect?
The tapered annual allowance affects those pension savers who have ‘adjusted income’ that exceeds £150,000 from 6 April 2016 onwards. The calculation of ‘adjusted income’ means that many people won’t actually realise that they exceed the £150,000 level and that they will incur some tapering to their annual allowance entitlement. This is because ‘adjusted income’ includes not only salary and earnings, but also investment income, rent from properties and, crucially, employer pension contributions. If someone earns £140,000 and their employer contributes £20,000 on their behalf, then their ‘adjusted income’ would be £160,000 and they would incur some tapering even though they actually earned below £150,000.
It is made even more difficult for those who are self-employed, as they often won’t know what their taxable income will be until the end of the tax-year. Indeed, we recently did some planning work for a partner in a solicitors’ firm who anticipated a profit distribution of £160,000 but it transpired their profits were £210,000, making it virtually impossible to plan accurately.
So what can you do?
There are four key options available:
- Make use of any unused carry forward allowances from the previous three tax years, as this could avoid a tax charge being incurred
- Affected individuals might seek to transfer income-producing assets to a spouse to reduce their ‘adjusted income’ figure
- Make personal contributions to bring your income below the ‘threshold income’ level of £110,000. This would avoid any tapering regardless of how much the employer contributes
- Ask the employer to reduce pension contributions to avoid any tapered annual allowance tax charges
The fourth option is the one that is currently getting the most publicity and there are reports of some firms capping pension contributions at £10,000, but this might not best suit the individual. If the employer was contributing £20,000 and the individual asked them to reduce this payment to £10,000 to avoid a tapered annual allowance tax charge, then there is no guarantee that the employer would increase their salary by the same amount. In fact, they would probably offer a lower amount to reflect the National Insurance contribution incurred by the employer.
Even if the employer did increase the salary by £10,000, the employee would still pay 45% Income Tax and 2% National Insurance on the increase. In contrast, if they just incurred the annual allowance tax charge of 45% on the £10,000 excess, they would be 2% better off as there would be no National Insurance to pay. Furthermore, as long as the tax charge is more than £2,000 the individual can ask the pension scheme to pay the tax on their behalf.
People should also consider the lifetime allowance and for those who have plenty of headroom available, then maintaining contributions and incurring the annual allowance tax charge could be in their best interest. However, if the individual is close to or has exceeded their lifetime allowance, then they might want to consider reducing contributions to avoid an annual allowance tax charge.
As always, it is imperative to seek professional financial advice to ensure you truly understand your options and do not pay more tax than you should. Through Tilney, we have expert financial planners available across the country. If you would like to find your local financial planner and book a free initial conversation, visit here or call on 020 3131 6179.