Beware of the tapered pension Annual Allowance

If you’re a busy professional, finding time to dedicate to pension planning can be difficult. But, with the new tax-year, there could be a number of people receiving an unwelcome tax bill after unintentionally overfunding their pensions.

Whilst there is no actual maximum you can pay into a pension, the Annual Allowance is the cap for receiving tax relief on what you contribute. Currently, it’s the equivalent of your earnings, up to a maximum of £40,000 each tax year.

Despite the Government’s enthusiasm for us to plan appropriately for retirement, the allowance has been heavily reduced over time, previously peaking at £255,000 in 2010/11. However, things get worse if you are a high-earner, as your Annual Allowance could be as little as £10,000.

Tapering of the Annual Allowance

Anyone earning an ‘adjusted income’ over £150,000 and a ‘threshold income’ of £110,000 will be subject to a tapering. This means your Annual Allowance will be reduced by £1 for every £2 your income exceeds £150,000, up to a maximum reduction of £30,000. In effect, if you have an income of £210,000 your Annual Allowance could be just £10,000.

The definitions of ‘adjusted’ and ‘threshold’ income are important:

Adjusted income includesall taxable income from earnings, investments and benefits in kind, plus employer pension contributions, minus any taxed death benefits received. Pension contributions are included to stop salary sacrifice arrangements being used to circumvent the restriction. If this figure is more than £150,000, you’ll need to define your threshold income.
Threshold income is your adjusted income minus your gross Personal Pension contributions. This is intended to protect people with fluctuating income or pension contributions. If it’s less than £110,000, you are not subject to tapering, but you might have exceeded the Annual Allowance in the process.

In addition to tapering, it’s also worth mentioning something called Money Purchase Annual Allowance (MPAA). That is just 10% of the usual allowance at £4,000 and is triggered if you make a pension withdrawal beyond your tax-free cash entitlement.

Given that since 2015 you are able to withdraw and spend your entire pension from age 55, it might be tempting to use it to repay your mortgage or fund a large purchase. But, doing so you will restrict the amount you are able to pay in even further.

Carry Forward

There is a potential opportunity to contribute above your Annual Allowance and not attract tax penalties, called Carry Forward. If you were a member of a pension scheme and didn’t use your entire Annual Allowance in the previous three years, you are able to roll over the unused amount to the current tax year. If you’ve unknowingly used Carry Forward in the past, it may have been your saving grace!

The Annual Allowance has remained at £40,000 for the last few years. If, in the rare circumstance you haven’t made any pension contributions in the previous three years, using Carry Forward the maximum potential Annual Allowance could be £160,000, assuming tapering isn’t involved.

Carry Forward might be especially beneficial if your income is irregular, you’ve received a large bonus recently or have taken a sabbatical.

Preventative measures

The issue with the complexity surrounding the Annual Allowance, however much yours may be, is that it is your responsibility. There are no warnings you might be getting close to or have exceeded it; the first sign is likely to be a tax bill from HMRC.

In an ideal world, your employer or pension scheme trustees would warn you about tapering and any contribution restrictions that might affect you. Sadly, this isn’t the case, as often various sources of income and the likelihood of having multiple pensions confuse matters.

As a higher earner, often the most tax-efficient way to make pension contributions is unique to you, making advice essential. To ensure you are not overfunding your pension, we are here to help. We offer a one-hour meeting to discuss your requirements and our services on a no fee or obligation basis.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.