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.
Carry forward
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.
Threshold income
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.
Relevant pension provision therefore probably includes an increase or renewal of an existing salary sacrifice arrangement, but probably not a decrease. It will depend on the precise terms of the salary sacrifice or flexible remuneration arrangement.
Adjusted income
The annual allowance starts to taper once adjusted income has reached £150,000 (assuming threshold income is also above £110,000).
Adjusted income is all taxable income plus net pay pension contributions – which would otherwise reduce taxable income – plus employer contributions, plus DB and cash balance pension input amount, minus employee contributions to DB and cash balance pension schemes. See Box Four.
Anti-avoidance
There are anti-avoidance provisions to catch those who reduce adjusted/threshold income in one or two years and increase it in another. The provision only applies if it is “reasonable to assume” this is being done to increase an annual allowance that would otherwise be tapered.
It also only applies if the reduction in adjusted/threshold income in a year is redressed by an increase in a different year.
The main grumble
It is unlikely that those restricted from making the pension contribution they wish will be happy with the restriction – that’s almost a given. The difficulty with the TAA is that you can only be certain whether or not you are affected by the taper once you know your taxable income for the tax year.
For many, this will not be known until after 5 April, at which point it is too late to make a pension contribution for that tax year.
Unable to carry forward
Most of those who do not use their full annual allowance, tapered or not, will be able to carry forward the unused amount to the following tax year.
This ability to carry forward will not help those unable to make a pension contribution in the following year. This could include those who have left employment and therefore do not have relevant UK earnings and those who have accessed flexible pension income and so are restricted by the £4,000 money-purchase annual allowance.
It is possible to insist your pension scheme pays the annual allowance charge from your pension fund. To do so, the annual allowance tax charge should be at least £2,000 and the pension input amount, for example contributions, to that pension scheme should exceed the standard annual allowance, which is £40,000 for 2017-18 and 2018-19.
It’s all a bit of a hassle, way too fiddly and the sooner it is abolished the better.
Phil Warner is head of technical at Hargreaves Lansdown
