Pensions and allowances – part 2

Ever since the annual allowance was first introduced, ironically as part of the pension ‘simplification’ programme on ’A Day’ (6th April 2006), it has changed frequently and is often a source of confusion for clients. Here we look at the current annual allowance, in particular the impact on higher earners.

2019/20 Annual Allowance

The pension ‘annual allowance’ or maximum tax-efficient gross contribution for 2019/20 is £40,000 (or, for personal contributions, 100% of pensionable earnings, if lower). However, the full £40k allowance is only available to those with ’adjusted income’ of up to £150,000 in 2019/20 (‘adjusted income’ is total taxable income plus employer pension contributions) and where ‘threshold income’ is over £110,000 (taxable income excluding pension contributions). For those with threshold income in excess of £110,000 and adjusted income of over £150,000, a lower annual allowance will apply, with a minimum annual allowance of £10,000 for those with adjusted income of £210,000 p.a. or more.

For those with adjusted income over £150,000 per year (and threshold income over £110,000), the annual allowance will reduce on a tapered basis by £1 for each £2 of ‘adjusted income’ over £150,000 per year, as illustrated in the following table:

The above mechanism was brought in for the 2016/17 tax year onwards, but neither the allowances nor the thresholds have been indexed since then, so as earnings increase, more people will find themselves affected by the taper.

To prevent the manipulation of incomes to avoid the £150,000 threshold, two separate methods of assessing income are used; ‘adjusted income’ and ‘threshold income’.

• Adjusted income is total taxable gross income from all sources, including pension, savings, dividend and rental income, less allowable deductions, and it also includes personal AND employer pension contributions.
• Threshold income is total taxable gross income from all sources (pre-salary sacrifice for salary sacrifice arrangements set up after 8th July 2015), less allowable deductions, but NOT including personal or employer pension contributions.

Where annual threshold income is £110,000 or less, there is no requirement to calculate adjusted income and the normal annual allowance of £40,000 will apply, even if annual adjusted income is more than £150,000.

What are the implications of this?

Any contributions in excess of your applicable annual allowance must be reported on your annual tax return and the excess will be subject to an annual allowance charge at up to your highest marginal rate of income tax (20%-45%). The charge can, in some cases, be paid by your pension plan.

As you can see, the calculations to establish threshold and adjusted incomes are highly complex and many individuals, especially those who are self-employed and/or receive a considerable amount of dividend income, will not be certain of their income until the tax year in question has actually ended.

• In such cases, it may be prudent to restrict contributions to £10,000 gross within the tax year itself and then use the ‘carry forward’ rules to use any unused relief from 2019/20 in the 2020/21 tax year and so on (provided that you have sufficient pensionable earnings in the year in which the carry forward contribution is being made).
• Transferring ownership of assets such as shares and rental property to a lower earning spouse could help to reduce levels of adjusted and threshold income (to be effective for tax purposes, this must be a genuine and unconditional gift).
• It may be possible for clients to make higher personal contributions to pensions to keep threshold income to £110,000 or less, but it is not possible for an employee of a firm to reduce threshold income using a post-8 July 2015 salary sacrifice arrangement in connection with pension funding.
• If you have threshold income of £110,000 or more and adjusted income over £150,000, you may need to consult with your employer and arrange for pension contributions to be reduced to a minimum of £10,000 gross, perhaps with a corresponding increase in salary or other non-pension related benefits. You may also need to opt out of any auto enrolment arrangements. Please note that each case should be considered on its individual merits; the most suitable course of action will depend upon the alternatives offered by the employer and the lifetime allowance position, among other factors. This is an area in which we can provide advice if required.
• The taper is also causing problems for those who are active members of final salary schemes, with some potentially difficult decisions to be made with regard to whether or not to remain within the scheme and face hefty tax charges, or whether to opt out and potentially miss out on some of their key employee benefits, such as pension contributions and (in some cases) death in service cover.

In addition to the current annual allowance, it may also be possible to ‘carry forward’ any unused annual allowance from the three previous tax years. However, the annual allowance taper also applies to those three tax years, so, if the annual allowance was tapered in all or any of those years, only the balance of the tapered figure can be carried forward.

To carry forward unused relief, you must have been a member of a registered UK pension scheme within the tax year in question, you must firstly use this year’s full annual allowance before using up the carried forward allowance, and the maximum total 2019/20 tax-efficient personal contribution (annual allowance and carry forward) must not exceed 100% of your pensionable earnings for the current tax year (the earnings limit doesn’t apply to employer/company contributions).

Paradigm Norton is a financial planning firm that can advise and guide you with your retirement and pension planning. To speak to one of the team, call us on 01275 370 670

Understanding the various pension allowances is an important part of your retirement planning and overall lifetime financial planning. Tax legislation is subject to change and depends on individual circumstances.