The Tapered Annual Allowance and how you may be affected
New legislation came into play in March 2020 has made further changes to the link between earnings and the ability to save to a pension scheme. The initiative is in place to restrict the tax relief offered to high earners when considering pension contributions. This document looks at who is affected and how.
What are the new Rules?
From 6th April 2020 most individuals with high income, defined as income above £240k will see the annual contribution limit to a pension scheme reduced.
Current Limitations on Pension Contributions:
For those earning over £40,000 in a year, the annual allowance is restricted to this. This continues to be the case for those earning up to £200k per annum.
For those who earn more than £200k per annum (threshold income), the rules become more complex. For those above £240k (adjusted income) the allowance will become gradually tapered.
How is threshold income calculated?
This is the total income for the year, less certain reliefs. It includes both earned income (e.g. pay) and unearned income (e.g. interest payments). This calculation does not include any employer pension contributions and providing a salary exchange scheme was in place prior to 8th July 2015, these are also excluded.
How is the adjusted income calculated?
Adjusted income is any taxable income (less certain reliefs). It includes the value of pension savings such as employer contributions to defined contribution schemes. If the adjusted income exceeds £240,000, the new taper rules will apply from April 2020.
If the rules apply, what then happens?
The pension annual allowance will be reduced by £1 for every £2 of adjusted income over £240,000. We have prepared a table at the end allowing you to gauge the effect the new rules have over a variety of scenarios. The maximum reduction is £36,000. In other words, if adjusted income exceeds £312,000 the annual allowance is always at least £4,000
What action should high income individuals take?
High income individuals caught by the taper may have to reduce the contributions paid by them and/or their employers, or suffer an annual allowance
Is the reduction permanent?
No, the calculations are made based on income levels each year. Therefore, the annual allowance will be adjusted accordingly.
What happens to unused relief from previous years?
Carry forward of any unused relief from the previous 3 years can still be used by any individual who is subject to a reduced annual allowance. The current year is utilised first before going back 3 years to assess if any remaining allowance is available and coming forward from there.
What about flexible drawdown?
Where an individual flexibly accesses their pension savings, i.e takes some taxable income as opposed to tax free cash, they are subject to what has been called the ‘money purchase annual allowance’ of £4,000. Irrespective of income levels. This level is currently in place and was reiterated in the 2020 Budget to remain at this level indefinitely.
What can you do?
Where a breach of the limit is likely, it may be in the interest of you to be offered the excess employer contribution as salary. This however further burdens the employer with additional National Insurance responsibility. Removing the requirement for employer matched contributions and allowing the employee to retain the right to a non-contributory payment is one method employers are considering.
You can reinvest any excess of contribution refunded to you as cash into a suitable ISA (or net income increased from removing the requirement to match the employer contribution) – a stocks and shares one would be similar to the investment returns enjoyed via typical pension arrangements.
DAM are available to provide advice to those individuals on a 1 to 1 basis where required.