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What is the tapered annual allowance and how could it affect you?

by | May 20, 2018 | Pension & Retirement News

The tapered annual allowance is a HMRC classic. You start with a relatively simple concept – limit pension contribution tax relief for higher earners, quite why is a story for another day.

You then complicate it beyond belief by having two different income checks that do and don’t include employer pension contributions but always include bonuses. Bonuses which are invariably paid at the end of the year giving the contributor no time to adjust their pension contributions.

That in turn leads to penalty tax charges to be administered by the employer or pension plan holder. Only through the lens of political jiggery pokery does this system make sense or seem reasonable to anyone.

We could instead offer 30% tax relief to anyone contributing up to £40,000 (less employer contributions) and do away with all this nonsense. And maybe that’s what they are doing in a parallel, more sensible universe.

If you’d like to read on, and perhaps you should to avoid a shoe-ing at the hands of HMRC, then here’s how the tapered annual allowance “works”!

One of the key advantages of saving for your retirement through a pension scheme is the tax relief you receive on the money you contribute, usually available at your usual rate of tax.

The ‘Annual Allowance’ limits the amount of contributions both you and your employer can make to your pension in a year which benefit from tax relief, and is currently set at £40,000.

However, in April 2016, the government also introduced the ‘Tapered Annual Allowance’, which reduced the annual limit for those whose total income exceeds £150,000.

This amount includes your salary, bonuses, dividends, savings interest and employer pension contributions. For every £2 of income above £150,000, your Annual Allowance will be reduced by £1, up to a maximum reduction of £30,000.

So that those who receive a one-off increase in pension contributions from their employer are not unfairly caught out, the government also ensured that the Tapered Annual Allowance only applies to those whose taxable income before employer pension contributions is above £110,000.

Looking at some examples shows how the Tapered Annual Allowance works.

Andy receives a salary of £160,000 in the 2017/18 tax year, with a further £16,000 of pension contributions from his employer. This gives a total income of £176,000, which is £26,000 over the £150,000 limit.

Andy’s Annual Allowance is therefore reduced by £13,000 (half of that amount), meaning the amount of his pension contributions which can benefit from tax relief during 2017/18 is lowered from £40,000 to £27,000.

Bethany, meanwhile, earns a salary of £195,000 in the same year, with her employer making £15,000 of pension contributions.

Her income from rental properties, savings and a share portfolio amounts to £20,000, giving Bethany a total income of £230,000, exceeding the £150,000 limit by £80,000. As half of this amount is £40,000, Bethany will receive the maximum reduction of £30,000.

She will therefore only receive tax relief on up to £10,000 of her pension contributions in 2017/18.

If the Tapered Annual Allowance affects you and you’re wondering whether there are any legal workarounds which can be implemented to avoid being hit by it, the short answer is that there aren’t.

Of course, if your total income decreases then your Annual Allowance will increase again.

But apart from either earning less or reducing the amount you and your employer contribute to your pension (neither of which is a good idea), as long as your total income is over £150,000 you will be subject to the current rules.

 

future proofing your finances

advice@townclosefp.co.uk

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