You may be in line for unexpected income tax if pension contributions are made and your total annual income and employer pension payments add up to more than £150,000.
Since 6 April 2016 tax relief on pension contributions is subject to a Tapered Annual Allowance that reduces the normal £40,000 Annual Allowance to as low as £10,000 for certain individuals.
The purpose of the Tapered Annual Allowance is to reduce the amount of tax relief that higher earners can claim on pension contributions by reference to their income.
For those with an ‘adjusted income’ of over £150,000 the Annual Allowance is tapered by operating a £1 reduction for every £2 of adjusted income above £150,000, subject to a £10,000 floor. These rules apply to individuals who have ‘adjusted income’ over £150,000 and have ‘threshold income’ of over £110,000.
In simple terms;
‘adjusted income’ means all taxable income and benefits plus all pension contributions
‘threshold income’ means all taxable income and benefits, less personal pension payments, and without adding back in any employer pension contributions.
Income given up under salary exchange agreements set up after 8 July 2015 are added back for this purpose.
Peter received salary and dividends in 2016/17 of £130,000. He made gross pension contributions of £15,000 and his employer also contributed £25,000, a total of £40,000.
His threshold income is £115,000 (£130,000 less £15,000)
His adjusted income is £155,000 (£130,000 plus £25,000)
Peter’s threshold income exceeds £110,000 and his adjusted income exceeds £150,000. His Annual Allowance is therefore reduced by £2,500 to £37,500 ((£155,000 less £150,000)/ 2). Peter is liable to pay income tax of £1,000 (40%) and must report this on his 2017 Tax Return.
Carry Forward Relief
If pension contributions for the current year exceed the Tapered Annual Allowance then any unused Annual Allowances from the three prior tax years may be used.
Even where income is not expected to exceed £150,000 p.a. on average, a number of variables can make it difficult to predict when planning pension payments, such as;
- Timing of bonuses
- Share Awards (vesting or option exercise)
- Self Employed Profit fluctuations
- Investment income
- Employer pension contributions
- Accruals under Defined Benefit arrangements
- Salary exchange agreements
The rules are complex and there will be those already caught by them but have yet to realise.
Be proactive. Seek professional advice if needed to ensure that your income tax and pension planning are fully co-ordinated, consistent with your financial objectives, and avoid unexpected pitfalls.
If you would like to discuss your pension tax planning please contact Lynn Gracie, Tax Senior Manager (firstname.lastname@example.org) or your usual AAB contact.