Don’t risk getting burned by a surprise tax bill!

10th February 2016

It is probably no surprise that the world of pensions has paradoxically become much more complex since Pensions Simplification came into effect from 6th April 2006.  One of many new terms to emerge was the “annual allowance”, basically the maximum amount people are allowed to pay into their pension pots each year.  For most, this maximum has been set at £40,000 since the 2014/15 tax year.

The Finance Bill 2015, however, provides that from 6th April 2016 the annual allowance for those earning above £150,000 is to be reduced on a tapering basis so that it reduces to £10,000 for those earning above £210,000.  For every £2 of income above £150,000, an individual’s annual allowance will reduce by £1. 

tapers

Now, if you earn less than £110,000 you may breathe a sigh of relief because (at least for the moment!) you will be unaffected by these provisions.  The figure of £110,000 is designated as the “threshold income”, defined as the total amount of income for the tax year on which an individual is subject to income tax:

  • less certain allowances and reliefs, e.g. excess tax relief under net pay pension schemes
  • less any contribution made by an individual to a “relief at source” pension
  • plus the amount of any employment income given up for pension provision as a result of any salary sacrifice or relevant flexible remuneration arrangement made on or after 9 July 2015

For those fortunate enough to be affected, read on…

Here we need to introduce another definition, that of “adjusted income”. You will see from the information given above that the tapering of the annual allowance begins to ‘bite’ from £150,000 providing that you also exceed the “threshold income” figure of £110,000. Adjusted income is defined as:

  • the total amount of income for the tax year on which an individual is subject to income tax (as above)
  • less certain allowances and reliefs, e.g. excess tax relief under net pay pension schemes, gifts to charities and trade losses
  • plus any pension scheme tax relief deducted in the previous bullet-point
  • plus any employee pension contributions deducted from gross salary (net pay arrangements) in the tax year the payment is made
  • plus the value of any employer contributions (which includes any employer contributions as a result of a salary exchange arrangement) for the tax year
  • less any lump sum death benefits paid to individuals in the tax year which were taxable at the individual’s marginal rate (i.e. taxable lump sum death benefits received on or after 6 April 2016)

So how might this actually work, in practice? I often find that an example can help:

Let’s say that Emma has the following income in the 2016/17 tax year:

Income (less allowable reliefs and deductions)   £130,000

Dividend income   £10,000

Interest   £2,000

She makes employee pension contributions of   £10,000  (paid through the net pay arrangement) to her employer’s pension scheme

and her employer contributes   £15,000

Emma’s “adjusted income” is therefore £167,000 (being the sum of the figures above) and she will be subject to the tapered annual allowance.

She loses £1 of allowance for each £2 in excess of £150,000 so her annual allowance is reduced by (£17,000/2) = £8,500. Her new tapered annual allowance is therefore (£40,000 – £8,500) = £31,500 for 2016/17.

As with so many things, especially those which purport to be “simple”, expert guidance is inevitably going to prove beneficial.

Please contact us if you would like to discuss whether and how we can help you.