After years of fiddling around and reducing the savings benefits of a pension, on 6th April 2016 the government introduced the Tapered Annual Allowance. This is probably the most complicated and worst of the fiddles so far!
It massively reduces the tax relievable savings you can make into a pension, particularly for high earners. Not only does this impact your take home pay but also has long term implications for Inheritance Tax planning.
What is the Tapered Annual Allowance
Without going too far into all the technicalities, if your gross income is over £150,000, your pension annual allowance is reduced by £1 for every £2 your income is over £150,000.
For example, if your salary is £180,000, then your annual allowance is reduced by £15,000 (£180,000 – £150,000 / 2).
The current pension annual allowance is £40,000. So in the above example the allowance would reduce to £25,000.
The maximum reduction that can made is £30,000. So regardless of how much you earn you will always at least be able to contribute £10,000 into a pension.
If you end up contributing more to a pension than your allowance, then you will be taxed on the overpayment at your marginal rate of tax, which for most people in this situation is likely to be 40% or 45%.
Most impacted by the Tapered Annual Allowance
If your salary is below £150,000 you may think yourself safe but it’s not just salary when it comes to working out your gross earnings for the Tapered Annual Allowance.
#1 – Buy To Let owners
If you receive rental income this will need to be added to your overall earnings for the year, to work out whether you cross the £150,000.
This is another hit to landlords who are already facing additional tax costs from losing mortgage interest relief when working out profits.
#2 – Income from shares and interest from bank accounts
If your equity investment portfolio is not held in a tax wrapper such as a pension or ISA and you receive dividends, this dividend income will need to be added to your gross income figure.
It’s the same position for interest received on unwrapped cash savings.
#3 – Member of a Defined Benefit (final salary) pension
The actual pension input for DB pensions like the NHS pension scheme is worked out differently to defined contribution (money purchase) pensions and you have no control over how much your contribute.
It is dependent on the salary you earn.
Recently many doctors have found that by working more hours, not only are they paying higher Income Tax on earnings but also facing further tax on additional pension contributions over the Tapered Annual Allowance. This has led to doctors calling the situation a ‘workforce crises’ as many are now retiring early or working less.
#4 – Second pension
The Tapered Annual Allowance applies to total pension saving, not per pension.
Again for members of DB pensions, if your pension contributions are below the Tapered Annual Allowance you may end up over if you are contributing to a separate DC pension.
This could be a real possibility for people like doctors who are part of the NHS pension scheme but also do agency work and are auto-enrolled into a private pension.
#5 – Generous employer pension contributions
If you have a DC pension, you may think that if you have a Tapered Pension Allowance problem you could just reduce the amount you put in.
That’s certainly a possibility however, contributions to your pension from your employer are also included in the figure when working out your gross income. This means that your actual salary and income from other areas like rent could be below £150,000 but employer pension contributions on top take you over. A definite tax trap!
If you fall into any of the categories above then do not despair and think you need to end all pension contributions to avoid taxes. This reaction could mean opting out of a pension that loses your family significant death benefits.
It’s vital to understand your net position. Even after applying all the new taxes it still may be in your interest to continue earning more and paying more in pension contributions. Even if this takes you over the Tapered Annual Allowance.
The key is knowing where you stand and what you need to do to get to where you want to be. If you would like help with this then please get in touch so we can carry out a full review for you.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.