Thinking of putting more money into your pension pot? Watch out for Tapered Annual Allowance Tax Tricks this year end
PUBLISHED: 13:39 14 February 2017
The new Tapered Annual Allowance governing pension contributions will affect high earners, which is likely to include business owners. Kevin Edwards, Director of Midland Financial Solutions, gives the lowdown on how the new system works so you're not caught out.
The Government’s new Tapered Annual Allowance was brought in on April 6, 2016, but people are only now likely to notice its effects as they sort their tax affairs for this financial year. With an estimated gain of £260million for Government coffers for 2016/7, rising to £1.2billion in 2020/21, the dent in some pockets may be sizeable.
What is the point of the Tapered Annual Allowance?
Put simply, the new tapered allowance introduces some level of taxation on money put into pensions for ‘high earners’. While in the past there was a perception that large sums could be put into a pension pot each year without incurring taxation, that is no longer the case. Because the system is quite complicated, the concern is some people may not realise they will now be taxed until it is too late.
How do I know if I’m affected?
There are two tests which should enable you to work out if you’re affected by the new rules. The first is whether you have a “threshold income” in excess of £110,000. Taxable income could include earnings from employment or self-employment, pension income, interest on savings and investments, dividend income from shares or company ownership, or rental income from property.
The second test is whether you have an “adjusted income” in excess of £150,000. For the adjusted income calculation, any pension contributions paid by an employer are added back in.
Can I make larger contributions than £40,000 to my pension pot in a tax year?
The standard annual allowance is £40,000 per tax-year. However, it can also be possible to make larger contributions using ‘carry forward’ of any unused allowance from previous years. Note this is subject to certain conditions.
I’m a member of a final salary pension scheme – am I affected?
For members of a final salary, or defined benefit, pension scheme – the process of calculating the amount of annual allowance available is not simply a matter of adding up the amount of contributions made into the scheme. The calculations are complex and affect people in schemes such as the NHS, Teacher’s Pension Scheme, Local Authority Pension Scheme, as well as large private sector companies that still run these types of schemes. Individuals in these types of scheme may not know how much of their annual allowance they have used until the end of the tax year. It is important therefore, to ask the scheme administrator to provide you with an estimate as early as possible.
What are the implications in actual financial terms?
Under the new tapered system, for every £2 of taxable income in excess of £150,000 an individual’s annual allowance is reduced by £1. Therefore anyone with income in excess of £210,000 will see their annual allowance reduced to £10,000 per tax year. Any excess above the available annual allowance is taxed at 55%.
Complexities arise because a large pension contribution will often be made by a person’s “employer” – which could be their own company. When calculating the maximum contribution allowed, the individual’s taxable income has to be estimated for the current tax-year and it’s difficult sometimes to do this accurately since it can change – for example, when bonuses and dividends are paid, the amounts of which are often not known in advance.
How should financial advisers navigate these new waters?
The first important thing is to try and utilise annual allowances where possible, while balancing this against trying to avoid incurring a Tapered Annual Allowance tax charge. To do the best job they can, advisers need to know the full picture. That is to say, they need to know every source of taxable income and must also have accurate figures.
If you’d like to find out more about this topic, or any other personal finance issue, you can contact Chartered Financial Planner and Director of Midland Financial Solutions, Kevin Edwards, on 01332 345 370, via firstname.lastname@example.org or by visiting www.midlandfinancialsolutions.co.uk