Income calculations complicate tapering

Unfortunately, as with all things tax, working out if you are affected and by how much means a number of calculations. One thing is certain, the more sources of income clients have, the harder it will be to get to a definitive number when contributions need to be paid.

The actual tapering of the annual allowance is quite simple. The complex part is in relation to working out what income should be used for the calculations and knowing what someone’s income will be for the tax year, before the end of that tax year.

For someone with earnings of more than £150,000, their annual allowance will be reduced by £1 for every £2 they earn over this figure. So someone with earnings of £170,000 will have their annual allowance reduced by £10,000.

The reduction is capped so that it can’t reduce the annual allowance below £10,000, so for those earning more than £210,000, they will not see any additional reduction over the maximum of £30,000.

The way this is worded in the legislation is interesting because it takes account of future reductions to the standard annual allowance, with an emphasis on the £10,000 being a minimum, rather than the amount of the total reduction.

The complexity in all this is the income calculation; it isn’t just earnings from employment or self-employment, but calculated in a number of stages.

First, you need to know net income – total taxable income (chargeable to income tax) – which includes, for example, income from employment, interest on savings, dividend income, rental income from properties, reduced by deductions listed in section 24 of the Income Tax Act 2007, which are reliefs such as trading and share loss relief.

You will need to add back in reliefs claimed under net pay arrangements, excess claims also made in relation to net pay arrangements and personal contributions made under net pay arrangements (these shouldn’t already be included in the net pay figure).

If the individual is not UK domiciled and is paying contributions to overseas schemes and receiving tax relief, this will need to be added back in. The last addition is employer pension contributions, which, again, need to be looked at in more detail.

You can, however, deduct payments received from lump sum death benefits that will be subject to income tax by next year.

The complexity in all this is the income calculation; it isn’t just earnings from employment or self-employment, but calculated in a number of stages. Claire Trott, Talbot and Muir

However, if you are looking at a final salary scheme then it becomes more complicated because the total pension input amount needs to be calculated.

For this, you will need pensionable salary at the beginning and end of the year, scheme accrual rates and the CPI rate from the previous September to calculate the amount of accrual for the year. Then multiply that accrual amount by 16 and deduct actual contributions paid by the member.

Threshold income is a little simpler. Where someone’s threshold income is less than £110,000 then there is no need to calculate the adjusted income and taper won’t apply, unless there is thought to be actual avoidance occurring.

To calculate someone’s threshold income, start with the net income, less any pensions contributions paid from taxed income (relief at source contributions) and payments received from lump sum death benefits that will be subject to income tax, then add back in any new salary sacrifice arrangements increased or started on or after July 9 2015.

Adding back in the salary sacrifice payment is part of the anti-avoidance measures and includes any new salary sacrifice arrangements as well as those that have to be opted into each year, so if an arrangement is not continuous it will need to be taken into account. If it is continuous and there is an increase in the amount sacrificed, then only the increase has to be added back in.

There are also anti-avoidance measures to ensure income isn’t artificially moved from one year to another to gain a higher annual allowance in a certain year. The regulations will look back as well as forward so taking more income this year to reduce it next year and benefit from a full annual allowance isn’t possible.

While you cannot adjust income or set up new salary sacrifice arrangements, it is possible to ensure clients use up all of their carry forward allowance. If they don’t have earnings to support personal contributions it is still possible to maximise contributions using employer contributions, which aren’t linked to earnings.

Claire Trott is head of pensions technical at Talbot and Muir