You may have never heard of the tapered annual allowance. Generally, if affects people earning over £240,000 and impacts 250,000 people in the UK. With most thresholds frozen and more high-growth companies appearing every week, this number is set to increase.
What Exactly is the Tapered Annual Allowance?
The tapered annual allowance reduces the yearly pension contributions for earners over £240,000. The money saved by allowing for the reduction will be used to lower the government’s debt.
When making pension contributions, there is a limit to the amount you may contribute and receive tax relief. This allowance is £40,000 or 100% of your UK relevant earnings, whichever is the LOWEST.
What income is included?
The list is extensive, but it will include salary/bonus, trading profit, property income, interest on savings & dividends. This link to the government’s website can help calculate your own tapered annual allowance.
Bonuses can cause issues if they’re paid quarterly or towards the end of the tax year. If you wait until they are paid, this could result in the bonus taking you into the taper, but you may already have exceeded your allowance.
How does it work?
- The annual allowance is reduced for anyone with earnings above £240,000 in the tax year 2021/22.
- The annual allowance is reduced by £1 for every £2 of income above £240,000.
- The maximum reduction is £36,000
Therefore, when a person’s earnings reach £312,000 or more, their tapered annual allowance would be just £4,000.
Threshold Income and Adjusted Income?
If your “threshold income” is below £200,000, there is no reduction or requirement to make calculations. You still have an annual allowance of £40,000. Threshold income generally includes everything previously mentioned, except pension contributions
When income exceeds £200,000, the “adjusted income” must be calculated.
The difference between the two is threshold income excludes pension contributions. Adjusted income includes all pension contributions.
This link to Prudential provides a good explanation of the two incomes mentioned above.
The tapered annual allowance can be a significant headache for high earners who are members of defined benefit pension schemes. This is due to how the capital increase is calculated on defined benefit pensions. Defined Benefit pensions and the tapered annual allowance are a subject for another exciting blog.
A word on carry-forward.
Many people, including business owners, seek to maximise pension contributions each tax year. You can often carry forward unused allowances from previous tax years. This is not as simple as assuming you could carry forward £40,000 from previous tax years. The amount to carry forward will be impacted by the type of contributions and possibly current earnings. Crucially, previous years allowances will need to be calculated as there may have been tapering of the annual allowance in those tax years.
What can be done?
You will need to be careful. Paying into a pension is one of the most tax-efficient ways to plan for your retirement. Some people will opt out of a pension scheme. You may also be able to reduce the contributions your employer makes to ensure you do not exceed the allowance. Before opting out of a pension, you should consider the options carefully.
Alternative investments such as Venture Capital Trusts (VCT) and Enterprise Investment Schemes (EIS) provide some tax relief and other benefits with higher allowances. However, these investments come with a higher degree of risk.
Before proceeding with any changes, you should consult your financial planner. Most people with earnings at this level should be working with a financial planner. You should certainly consult an adviser if you’re considering VCTs or EIS.
Get in touch with our team today to discuss working with a financial planner on 01273 076587 or email [email protected].
