Reminder of the new restriction to the annual allowance for pension contributions
Since 6 April 2016, individuals with taxable income (adjusted income) in the year of greater than £150,000 have a restricted annual allowance. It is reduced by £1 every £2 of income over the £150,000 limit. The maximum reduction is £30,000 such that anyone with income above £210,000 will have an allowance of £10,000.
The annual allowance in relation to pension arrangements is the maximum amount:
- by which a member’s benefits can increase in a tax year (for defined benefit schemes); and
- which can be contributed to pension arrangements in a tax year (for defined contribution or money purchase schemes).
This includes contributions made by the member or any other person, for example an employer. The total of these figures is the pension input amount (PIA). If the PIA for the tax year exceeds the amount of the annual allowance, the member is taxed on the excess.
The annual allowance for 2011/12 to 2013/14 was £50,000. The annual allowance reduced to £40,000 from 2014/15.
A key point here is that the ‘pension inputs’ figure includes both employee and employer contributions. Therefore, for example, an employee with a salary of £200,000 who sacrifices 10% of their salary entitlement for ‘matched’ employer contributions would previously have had a taxable salary of £180,000 and company pension contributions of £40,000. The pension contribution of £40,000 would not have previously attracted any income tax.
However, under the new rules, that employee would be deemed to have received income of £220,000 in the tax year 2016/17 for the purposes of assessing whether an adjustment is required to the annual allowance (i.e. pension inputs of £40,000 are added back to the taxable salary). Therefore a full abatement will be applied and the adjusted annual allowance for that tax year would be £10,000.
The tapered reduction doesn’t apply to anyone with “threshold income” of no more than £110,000.
Adjusted income and threshold income
Both include all taxable income, not just earnings. Adjusted income includes all pension contributions whereas threshold income includes pension contributions.
How to calculate adjusted income and threshold income
It is possible to utilise unused annual allowances from the previous three tax years on a first in first out basis (i.e. earliest tax year utilised first) and for this purpose the allowances for the tax years 2015/16 and before are not re-assessed under the new abatement rules.
Therefore, if the employee in the above example had contributed less than £50,000 in 2013/14 or made contributions below £40,000 in either 2014/15 or 2015/16, and the unused amounts totalled £30,000 or more, then this would prevent an income tax charge arising on the excess contribution in 2016/17. However, if the pension arrangements outlined above had existed for a few consecutive tax years then it is likely a charge would arise.
The first key action point for those potentially affected by the new rules is to review their existing pension arrangements and consider what impact this could have and when it is firstly likely to create a tax issue. The chosen solution may then be to amend arrangements going forward to prevent a charge from arising, however we would recommend consulting a financial advisor to ensure non-tax factors have been fully considered prior to making any changes.
The other planning point is to consider adjusting pension provisions (again after taking financial advice first) to ensure utilisation of brought forward allowances from the previous three tax years. Many of those affected will choose to make sure they utilise their £10,000 current year allowance and their unused portion from three tax years ago in this tax year and the next two tax years as beyond that the £10,000 limit will prove quite restrictive.
Whilst planning future pension contributions consideration should also be given to the overall lifetime limit which reduced to £1m in April 2016.
If you would like our assistance regarding the tax implications of your pension arrangements, or would like us to introduce you to our recommended financial planning partners then please contact us.
This is intended as a summary and overview of the tax situation and does not constitute investment advice and no action should be taken without first seeking professional advice specific to your circumstances.