Tapered annual allowance - could high earners contribute more this tax year?
19 February 2021
Despite perennial pre-Budget rumours of cuts to pensions tax relief, the 2020 Spring Budget actually increased the scope for many high earners to make a bigger pension contribution this year. The annual allowance income limits went up by £90,000, taking many out of the tapered annual allowance trap, maybe for the first time in several years.
The availability of a full £40,000 annual allowance provides an opportunity for some to boost pension savings and receive a fourfold increase in the amount of tax relief before the tax year end.
However, entitlement to the full annual allowance depends on two key measures - 'adjusted income' and 'threshold income'. Our new practical guide breaks down the various sources of income to look at what is included, and what can be deducted.
What has changed for 2020/21?
This year, the adjusted income limit has risen to £240,000 (up from £150,000 last year), and the threshold income limit to £200,000 (previously £110,000).
Compared to 2019, this means an individual with adjusted income of £210,000 in 2020 has the full £40,000 annual allowance instead of £10,000.
At the same time, however, very high earners could see their funding opportunities cut further. Those with threshold income over £200,000 and adjusted income over £312,000 will get less tax relief, as the minimum annual allowance now drops to £4,000 (previously £10,000).
How the tapering works
Tapering reduces the standard £40,000 annual allowance (AA) by £1 for every £2 of adjusted income over £240,000. The minimum annual allowance is £4,000 for anyone with adjusted income of £312,000 or more.
Example
Theo is an additional rate taxpayer. His taxable income is £210,000, all from self-employed earnings. His 'adjusted income' is therefore £210,000. He pays the maximum tax relievable contribution into his pension each year.
In 2019/20, his annual allowance was tapered down to the minimum £10,000. The maximum pension contribution he could make with tax relief was therefore £10,000. He received tax relief of £4,500 on this contribution.
This year, as his adjusted income is below the £240,000 limit, there will be no tapering, and therefore the maximum he can pay into his pension with tax relief is £40,000. This time he receives tax relief of £18,000, i.e. four times more than last year.
However, it may be possible to reinstate the full £40,000 allowance by making use of carry forward. The taper won't apply if threshold income is £200,000 or less. Threshold income is broadly total income less individual pension contributions.
How to counter tapering
Those with adjusted income above £240,000 may still be able to re-instate their annual allowance this year if they are able to keep threshold income below £200,000. This can be achieved by making a personal contribution as this is an allowable deduction from threshold income.
Unused annual allowances carried forward from the last three tax years can be used to ensure that the contribution is not subject to the annual allowance tax charge. But remember that these allowances may also be tapered if adjusted income and threshold income was above £150,000 and £110,000 respectively in those earlier years.
Example - personal contributions restore full annual allowance
Alina is a high flyer and this year her earnings have risen to £220,000. She also has other taxable income of £5,000. Her employer pays 10% of earnings (£22,000) into the company scheme, while she contributes (£11,000) under the net pay arrangement.
Her adjusted income for the year is £247,000, so she thinks her annual allowance will be cut by £3,500 down to £36,500.
However, when calculating her threshold income, her own £11,000 pension contributions are deducted from her actual income of £225,000. This gives her threshold income of £214,000. By making a further gross contribution of £15,000 (£12,000 net) this will take her threshold income to £199,000 and restore her £40,000 annual allowance for this year.
The total pension input amount for Alina in 2020/21 is £48,000, so carry forward is needed to avoid an annual allowance charge. But as the allowance wasn't tapered, only £8,000 unused allowance is needed.
Summary
Although the increase in the adjusted income and threshold income limits could be read as a pension tax give-away for high earners, the measure was introduced primarily to solve an issue around annual allowance tax charges that existed amongst NHS doctors.
For those who normally have a reduced annual allowance, this may be a window to boost their pension savings with maximum tax relief.
Our new practical guide 'The tapered annual allowance - adjusted income and threshold income' will help clients gauge how much headroom they have to maximise tax efficient contributions.
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