An individual’s annual allowance is the maximum pension input amount they can accrue in a tax year without incurring a tax charge.
For a money-purchase pension – also known as defined contribution (DC) – this is simply the total of tax relievable and employer pension contributions received into pensions.
For defined benefit (DB) pensions – such as final salary – the input amount is broadly the additional pension benefits that have accrued in the tax year.
The standard annual allowance for 2017-18 and 2018-19 is £40,000. Subject to various conditions, unused annual allowance can be carried forward from up to three previous tax years.
There is also a money-purchase annual allowance for those who have flexibly accessed their pension on or after 6 April 2015, which is £4,000 for 2017-18 and 2018-19.
The charge is calculated by treating the annual allowance excess as the top slice of income and taxing it according to the band in which it falls.
Cutting pension tax relief for high earners
In the 2015 summer Budget, the government announced its intention to effectively cut pension tax relief for those with incomes over £150,000. The tapered annual allowance (TAA) was subsequently introduced from 6 April 2016.
An individual’s annual allowance is reduced by £1 for every £2 of adjusted income over £150,000 in the tax year, unless their threshold income for the tax year is £110,000 or less. The maximum reduction currently possible is £30,000, resulting in an annual allowance that cannot be lower than £10,000. See Box One.
It is still possible to carry forward unused annual allowance to, and from, a tax year in which the annual allowance has been reduced by the taper. The only difference is that where the TAA applies in a tax year, it is this allowance that is used instead of the standard annual allowance. See Box Two.
In an attempt to reduce the number of people having to calculate their adjusted income, the TAA does not apply to those with threshold income below £110,000.
Threshold income is defined as adjusted income minus the annual allowance. This means that, for example, if the standard annual allowance were to be reduced to £30,000, then threshold income would increase to £120,000.
Threshold income is all taxable income minus relief at source pension contributions, plus any salary sacrificed for relevant pension provision on or after 9 July 2015. See Box Three.
Salary sacrifice/flexible remuneration
It was necessary to add in these salary sacrifice pension contributions as otherwise circumventing the taper would be relatively easy. This also included ‘flexible remuneration arrangements’, where an employee and employer agree that pension is to be provided instead of employment income.
Relevant pension provision is an increase in pension provision, or new pension provision, that is effective on or after 9 July 2015.
Although salary sacrifice agreements generally continue until they are changed, it is also possible to have a salary sacrifice agreement that needs to be renewed each year. It is possible that renewing an existing salary sacrifice could count as making a new salary sacrifice agreement.