How to help clients affected by the tapered annual allowance

Adjusted income is: 

• Taxable income for the tax year less any allowable reliefs under section 23 ITA 2007, plus:
• The value of any employer pension contributions made in the tax year
• Any employee contributions made under the net pay arrangement
• Any relief claimed by non-domiciled individuals for contributions to overseas pensions;

less:

• The amount of any taxable lump-sum pension death benefits paid to the individual during the tax year that can be deducted from the threshold income. 

Again, for example, that might be a lump sum paid:

• On death of a scheme member after age 75.
• On death before age 75, when the lump sum was not paid within the required two-year period.

Adjustments are made for employer contributions and those made to net pay arrangements because they are excluded from taxable income. Contributions under relief at source schemes are made from taxable income.   

The adjustments mean there is no benefit to be gained from choosing one form over another if the tapered annual allowance applies. 

For those members who only have defined benefit pension provision and employment income, you can calculate the adjusted income by simply adding the annual allowance used in the scheme to the P60 earnings.

What is the tapered annual allowance?  

The pension annual allowance is the annual limit on the level of contributions paid to, or benefits accrued in, a pension scheme before the member has to pay tax. The annual allowance is currently set at £40,000. 

For tapered annual allowance to apply, the limits on threshold income and adjusted income must both be exceeded.

For every £2 of adjusted income over £240,000, an individual’s annual allowance is reduced by £1. The maximum reduction is £36,000 and the minimum tapered annual allowance is £4,000.

The tapered annual allowance rules result in the standard annual allowance being available for those with an adjusted income of less than £240,000.

Individuals have a responsibility to report any annual allowance tax charge at the end of every tax year.

A reducing pension annual allowance applies for those with adjusted incomes between £240,000 and £312,000 and an annual allowance of £4,000 for those with an adjusted income over £312,000.

It is important to be aware that before the 2020-21 tax year, lower limits applied for threshold and adjusted income.

For tax years 2016-17 to 2019-20, the tapered annual allowance reduces an individual’s annual allowance by £1 for every £2 of adjusted income over £150,000, with a maximum reduction of £30,000 for adjusted income over £210,000.

That meant everyone had an annual allowance of at least £10,000.

What about carry forward? 

Any individuals subject to tapered annual allowance will still be able to carry forward unused relief from previous tax years.