At the start of the 2017/18 tax year, it still only feels like days since the tapered annual allowance (TAA) was introduced. In truth, we are now a year in. The allowance isn’t something that gets easier to deal with as time goes by, but more complicated the more cases you see.
The theory is quite simple and, if you have all the information, the calculations are also pretty straightforward. Getting all the information into a useable format can be the most complex part of the whole process.
In addition, the way in which the tapered annual allowance is calculated means external factors and legislation that don’t directly relate to the purpose of the taper impact on individuals, removing their ability to plan appropriately.
Defined benefit schemes
On paper, it is quite simple to calculate the pension input amount that is needed to establish the employer contributions for a defined benefit (DB) scheme. But in some schemes the definition of pensionable salary can be so complicated that being able to establish this before the end of the tax year, when the scheme is able to tell you, is virtually impossible.
The pension input amount isn’t something that can be controlled very easily, either. One factor is CPI inflation; this is determined in advance: the September in the year before the tax year in which it is applicable, to be precise.
This has had a massive impact for the year 2016/17 because the rate was effectively zero. Therefore the pension input amount for the exact same increase in benefits would be more for the tax year 2016/17 than those preceding and following it. Those impacted by the taper would have been worse off in 2016 than in this year.
Career-averaged schemes are becoming more prevalent and taking over from final salary schemes in many cases. This means that each year the benefit earned in each previous year is up-rated, so the increase in benefit at the end of the period relates not only to that in question, but to all previous years, too.
This means estimating the closing value for a pension input amount calculation is even more difficult, so accurate calculations should be left to the scheme.
Rental income
The issues with the tapered annual allowance being linked to income tax and not pension legislation will continue to develop as that legislation evolves.
Net income is determined by the first two stages of the income tax calculations, which use rental profit after expenses rather than the actual income received. This means some expenses incurred in renting the property out can be used to reduce the amount that is subject to income tax.
This year the amount of expenses that can be deducted from rental income is being reduced. It will be cut further over the next few years; this will mean the net income figure will increase for this income from properties with mortgages on them.
The expenses aren’t actually being ignored and, for many, the amount of income tax they pay on the rental profits will remain the same: the expenses are being moved to a later part of the calculation and an allowance will be given for them. However, this doesn’t help those people impacted by the tapered annual allowance because it means the reduction they would have seen in net income is no longer there.
This may mean some are now going to be over the threshold income limit, pushing them into the taper. Those already in the taper zone will have their annual allowance reduced further, which seems to be an unintended consequence. The calculations are clear – if you understand them.
Confusing terminology
There are many areas of the tapered annual allowance rules that are confusing, especially with regards to inclusions and exclusions. But on top of that the information provided to us to do the calculations can be very confusing, too.
Often a pay slip or a pension statement is provided to give details for income. The payslip should show enough detail if the individual doesn’t have any variable income, and pension contributions are clearly detailed with regards to when and how they are paid: either ‘net pay’ or ‘relief at source’, before or after tax is taken.
If there is salary sacrifice this would need to be carefully detailed, especially if there have been any changes in the agreement or increases since 2015.
What the payslip is unlikely to show is any P11d earnings such as cars or private medical insurance, which will need to be included as they are taxable.
When looking at a pension statement you may be able to understand the contributions paid, but again it may not show exactly how they are paid, whether salary sacrifice is used, and what the split between employer and personal is.
Any salary quoted should be checked because pensionable salary can differ dramatically between employer and even between schemes under the same employer.
Crystal ball gazing
What will become of the annual allowance, tapered annual allowance and money purchase annual allowance all remains to be seen. The next budget, in the autumn, has again been billed as a potential time for change, especially with regards to pension tax relief.
It has been mooted that pensions may again be targeted by the Treasury as a means of recouping money, particularly in light of the U-turn on self-employed national insurance contributions.
Suggestions have been made that a flat rate of relief on pension contributions would be an option, but, as discussed before in Money Management, this is something that would be incredibly difficult and costly for all schemes as well as the Treasury to monitor and administer.
In my opinion, it’s more likely that a lower annual allowance would be easier and bring in more money.
The most difficult schemes to deal with under a flat rate tax-relief regime would be DB schemes; they are also generally the schemes that have higher pension input amounts that the individual has little or no control over.
Many more of those in DB schemes would be caught simply by reducing the annual allowance to even £30,000.
This could mean schemes have to reduce individual retirement benefits to pay HM Revenue & Customs the annual allowance charge, or else the member pay through their own self-assessment.
The employer would have been the one to have really benefitted in the first place, through allowable business expense rules, which reduce the tax they pay.
Variable complexities
The complexities of a variable annual allowance cause confusion and may well mean that some individuals don’t understand that they are being affected.
Therefore, they may inadvertently not report pension contributions in excess of the amount they are entitled to make. With a standard annual allowance there would be no reason to be confused.
All the variables that need to be taken into account when trying to establish if, and by how much, an individual is affected by the tapered annual allowance.
You can’t cut corners because everything has an impact. In cases where finances are complicated, liaising with the individual’s accountant seems to be the easiest and clearest way to establish the clients ‘net income’ for this purpose.
Net income is the starting point for the threshold and adjusted income calculations, so it needs to be accurate before pension contributions are even considered. If this is wrong there is little point in going any further.
Claire Trott is head of pensions strategy at Technical Connection
