What it means for you and your pension
On 6 April 2020, changes came into effect for the tapered annual allowance which mean it no longer applies to those with a total income under £200,000 in the 2020/21 tax year. This is good news for those who were previously restricted by the taper and may now wish to make larger tax-efficient contributions to their pension.
Also, those straddling the boundaries of the previous ‘threshold’ and ‘adjusted’ income measures will no longer incur a tax charge on the excess contributions at their marginal income tax rate.
The previous tapered annual allowance during the 2019/20 tax year was a ‘threshold income’ of £110,000 and an ‘adjusted income’ of £150,000.
How does the tapered annual allowance work exactly?
The tapered annual allowance effectively reduces the amount of money that can be contributed to a pension by you and / or your employer while still benefiting from pensions tax relief.
For tax year 2020/21, the total income levels that apply to the tapered annual allowance’s ‘threshold’ and ‘adjusted’ income measures have been increased to £200,000 and £240,000, respectively.
In simple terms, ‘threshold’ income is your pre-tax annual income less any personal pension contributions whereas ‘adjusted’ income includes pension contributions paid by you and your employer. These measures are used together to understand whether you are affected by the How do I work out what my total annual income is?
How do I work out what my total annual income is?
If your earnings are close to either the ‘threshold’ income or ‘adjusted’ income limits, you’ll need to work out accurate figures to know whether you’re affected by the tapered annual allowance.
To understand your ‘threshold’ income, you will need to add together all your taxable income. For example, your salary, bonus, any rental income, interest on savings, and any salary or bonuses sacrificed for pensions contributions since 9 July 2015. You then take away any personal pension contributions you have made from your net pay.
You then ‘adjust’ your threshold income to include any yearly contributions made into your pension. This is now your ‘adjusted’ income. If it exceeds £240,000, you are subject to a tapered annual allowance for 2020/21.
The tapered annual allowance in action
Let’s take a look at Sarah. She is Head of Operations for a well-known car company. Her taxable income and pension contributions are:
To calculate her ‘threshold’ income, Sarah adds up her taxable income: Salary £180,000 + bonus £50,000 +rental income £20,000 + dividend income £20,000, but takes away her personal pension contribution of£10,000, as these contributions were made from her net pay. Sarah’s ‘threshold’ income is now £260,000.
As Sarah has employer pension contributions, and she contributes to her personal pension, she now has to work out her ‘adjusted’ income, including all pension contributions, in the following way: Sarah adds her £260,000 ‘threshold’ income + £10,000 personal pension contribution + £10,000 employer pension contribution to calculate her £280,000 ‘adjusted’ income.
As her ‘adjusted’ income is £40,000 over the £240,000 ‘threshold’, her annual allowance is tapered down by £1 for every £2 above the ‘threshold’. In Sarah’s case this is £40,000/2 = £20,000.
Sarah’s new tapered annual allowance for the 2020/21 tax year is £20,000. It has been calculated by taking the £40,000 annual allowance and taking away her ‘adjusted’ excess income of £20,000.
What should I do if I think the tapered annual allowance affects me?
If you think your annual income level falls within the boundaries of the tapered pension allowance it is important to understand your exposure to avoid incurring an unexpected tax charge. A financial adviser can help you work out what your annual allowance is and advise on adjusting your contributions accordingly.
Individuals who are restricted by the taper should consider if they are able to ‘carry forward’ any unused annual allowance from the previous three tax years to increase the amount they can build up in a pension in the current tax year. You may want to understand what tax reliefs are available to help you minimise your exposure to the tapered annual allowance. Consider using salary sacrifice to reduce your gross income by contributing to charities or purchasing childcare vouchers or protection insurance through work schemes. Your adviser can help you utilise other tax-efficient saving vehicles such as an individual savings account to save for the future. Although your contributions will be out of your net income, your investment gains will not incur tax whilst invested or when you make withdrawals.
Reproduced with permission of Brewin Dolphin
Please note that this document was prepared as a general guide only and does not constitute tax or legal advice. While we believe it to be correct at the time of writing, Brewin Dolphin is not a tax adviser and tax law is subject to frequent change. Tax treatment depends on your individual circumstances; therefore you should not rely on this information without seeking professional advice from a qualified tax adviser. Refer to Tax Thresholds in Wales and Scotland, as appropriate. The value of investments can fall and you may get back less than you invested.
No investment is suitable in all cases and if you have any doubts as to an investment’s suitability then you should contact us. Past performance is not a guide to future performance. The information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.