A look at the changes to the pension Tapered Annual Allowance rules that were announced by the Chancellor, Rishi Sunak, in the Budget on 11th March 2020.
Are you a high earner looking for ways to reduce the tax you pay? Are you in a position to pay large contributions to pensions each tax year? Were you previously restricted to paying less into pensions than you would have liked? Then this article will be of interest to you.
The recent Budget introduced changes to pension contribution rules for high earners which means that you may have more flexibility to benefit from additional tax relief than you previously had.
Why were the pension contribution rules changed?
Doctors and GPs were one of the main groups affected by the Tapered Annual Allowance rules. An increase in earnings due to taking on extra work was causing an increase in accrual under their NHS Pension Scheme. The knock-on effect was that Doctors were turning down additional work rather than be penalised with tax bills via their pension schemes. This was a major concern given the pressures the NHS were already under.
What were the previous rules?
Pension contributions are allowed up to £3,600 regardless of what you earn. Contributions above this level are allowed to a maximum of 100% of relevant UK earnings, subject to an overall maximum of £40,000, known as the Annual Allowance. This allowance includes the total amount paid into defined contribution schemes such as personal pensions, and any increase in a defined benefit scheme in a tax year. This Annual Allowance is reduced to £4,000 if you start to draw an income from a money purchase pension arrangement. Unused Annual Allowance from the previous 3 tax years can be carried forward to off-set against any pension contributions that exceed the £40,000 limit.
Employer’s pension contributions are paid gross and are eligible for corporation tax relief but are not capped by your earnings. The employer contributions are however included in the calculations for the Annual Allowance along with personal contributions. This may mean that you could be affected by these rules without knowing about it or making any personal payments to pensions.
The Tapered Annual Allowance was announced in the 2015 Summer Budget and affects high earners by restricting the amount they can pay to pensions in a tax year to obtain tax relief and avoid penalty. This came into effect from 6th April 2016 for individuals with Threshold Income (total taxable income) in excess of £110,000 and who have Adjusted Income (total taxable income plus the value of any pension contributions) of over £150,000. The Tapered Annual Allowance reduced the Annual Allowance by £1 for every £2 of income in excess of £150,000. The reduction was capped at £30,000 and hence the maximum reduction was from £40,000 to £10,000.
If you made contributions over the Annual Allowance or Tapered Annual Allowance, you would not receive tax relief on the excess contributions and would be subject to an Annual Allowance Charge based on your income tax position. If you exceed the Annual Allowance or Tapered Annual Allowance in the tax year, you need to include this excess amount in your Self-Assessment Tax return.
What are the changes?
At the 2020 Budget in March the Chancellor announced an increase in the Tapered Annual Allowance limits for Threshold Income and Adjusted Income. From 6th April 2020 the Adjusted Income limit increased to £240,000 and the Threshold Income limit increased to £200,000. This means that that high earners now have more scope to pay higher pension contributions than before and enjoy additional income tax relief.
Another change is the Tapered Annual Allowance’s maximum reduction of the Annual Allowance falling to £4,000 (previously £10,000). This will only affect those earning over £300,000 including pension accrual. Careful planning is required if your total earnings is near this level to ensure you do not have additional tax charges to pay.
Will the new Tapered Annual Allowance affect me?
If in the 2020/21 tax year your Threshold Income is over £200,000 and your adjusted income is over £240,000, you will be subject to the Tapered Annual Allowance.
These changes have been welcomed as they will address the situation with regards to the NHS pension scheme as well as providing all high earners with a greater ability to use pension contributions to save for retirement tax-efficiently going forward.
If you would like to explore whether you can benefit from the additional flexibility that these changes provide, please contact your Wealth Manager who will be able to talk this through with you.