Tapering the Annual Allowance
by on 13·09·2016
This recent measure restricts pension tax relief by introducing a tapered reduction in the amount of the annual allowance for individuals with an adjusted income of over £150,000 and a threshold income over £110,000. Sounds simple but, as always, its more complex than need be.
This new tax-gathering strategy has been introduced to fund the cost of the new residence nil rate band for inheritance tax that is to be phased in gradually from 2017.
Since 6 April 2016, individuals who have taxable income for a
tax year of greater than £150,000 will have their annual allowance
for that tax year restricted. It will be reduced, so that for every
£2 of income they have over £150,000, their annual allowance is
reduced by £1. Any resulting reduced annual allowance is rounded
down to the nearest whole pound.
The annual allowance can reduce to a minimum £10,000.
The danger is thinking that this cutback only applies if "earnings" are £150,000 or more, as it is "adjusted income" that is the important term, comprising:
- All taxable income less any reliefs available under section 24 ITA 2007 except those in respect of pension contributions.
- All employer pension contributions.
- All employee pension contributions made under the net pay system.
This definition captures a lot more people than would be the case if the £150,000 threshold were linked solely to earnings. Even if the adjusted income exceeds £150,000, an individual can be excluded from the reduction in the annual allowance if their "threshold income" is less than £110,000.
Threshold income is all taxable income less any reliefs available under section 24 ITA 2007 (relief in respect of pension contributions made personally is deducted) with employer contributions being ignored except under an anti-avoidance provision, which adds back any pension salary sacrifice made on or after 9 July 2015. Generally, for threshold income, all member pension contributions need to be deducted and you wouldn't add in employer contributions. This threshold income provision may help some to avoid the annual allowance tapering.
Whilst the threshold income of £110k means that less people will be caught by the tapering annual allowance rules, it certainly complicates the issue and makes the requirement for sound financial advice, all the more pressing.
Other implications arising from the tapering annual allowance rules are:
Anti-Avoidance rules - Introduced to avoid individuals entering into a salary exchange or a flexible remuneration arrangement after 9 July 2015 so they received additional pension contributions but reduce their adjusted or threshold income anti-avoidance rules have been put in place.
The anti-avoidance rules apply if:
- It is reasonable to assume that the main purpose for the change to the salary exchange or flexible remuneration agreement is to reduce the individual's adjusted or threshold income (this includes any reductions to nil).
- The change affects their income in either the current tax year or two or more tax years, including the current tax year.
- In return for the income being reduced the individual receives an increase in their adjusted or threshold income in a different tax year.
If the anti-avoidance rules do apply, then the income used to calculate the reduction to the annual allowance for that tax year is the one before any adjustments were made.
Carry Forward - On the bright side, clients can still carry forward unused annual allowance from the three previous years, with the proviso that if you carry forward from a year when tapering applied, the carry forward will be based on the tapered amount of unused annual allowance.
Flexible Access Drawdown - Clients who have drawn income from FAD will continue to be subject to the Money Purchase Annual Allowance of £10,000 but, where this applies, the Alternative Annual Allowance (normally £30,000) against which DB savings are tested, will be restricted by tapering. Therefore, those with incomes of £210,000 or more will have a zero Alternative Annual Allowance.