Tapered Annual Allowance
A new tapered annual allowance was introduced on 6 April 2016 to meet the government’s objective of controlling the cost of pensions tax relief and help make sure that pensions tax relief is fair and affordable.
In this bulletin we will explain the rules of the tapered annual allowance and identify who is affected by the changes. Please note that in order to implement the tapered annual allowance there were changes to pension input periods which are covered in a separate bulletin.
Facts and analysis
From 6 April 2016, individuals who have income for a tax year of greater than £150,000 have their annual allowance for that tax year restricted. For clarity, this means that the application of the tapered annual allowance is applied each tax year separately and hence an individual may have a tapered annual allowance in one tax year, and a full annual allowance in the following tax year depending on their income.
The definition of income for the £150,000 figure is ‘adjusted income’. A full definition of adjusted income can be found below. Please note that the inclusion of employer pension contributions in the definition of adjusted income means that it is not possible to use salary exchange to reduce income below £150,000.
There will also be an income floor of £110,000, called the ‘threshold income’. This figure has been included to try to give some certainty to both scheme administrators and to individuals about who may be affected by the tapered annual allowance and also to ensure that lower paid individuals are not affected as a result of a large pension contribution. Again a full definition of the threshold income is below.
Where an individual has threshold income of £110,000 or less, they will not be subject to the tapered annual allowance even if their adjusted income is greater than £150,000.
The way that the tapering works is that for every £2 of income that exceeds £150,000, £1 of annual allowance will be lost. There is a cap to the tapering of £30,000, which means that the minimum tapered annual allowance is £10,000.
Carry forward can still be used by an individual who is subject to a reduced annual allowance, and for 2014/15 and 2015/16 this will be based on the unused annual allowance of £40,000 (assuming the money purchase annual allowance does not apply). For the tax years 2016/17 on onwards the amount of carry forward available will be based on the unused tapered annual allowance.
The tapered annual allowance applies to individuals with adjusted income of £150,000 and over and threshold income of over £110,000. So let’s look at the definitions of adjusted income and threshold income.
The technical definition of this is –
- the individual's net income for the tax year as calculated under steps 1 and 2 of section 23 of the Income Tax Act 2007, plus,
- the amount of any relief under section 193(4) of Finance Act 2004 (a claim for excess relief under net pay) and section 194(1) of Finance Act 2004 (relief on making a claim) deducted at step 2, plus,
- the amount of any pension contributions made from any employment income of the individual for the tax year under net pay, under section 193(2) of Finance Act 2004, (to ensure fairness between those who have contributions deducted via net pay and those through relief at source), plus,
- where non domiciled individuals make contributions to overseas pension schemes, any relief claimed under Chapter 2 of Part 5 of the Income Tax (Earnings and Pensions) Act 2003 for the tax year, plus,
- the value of any employer contributions* for the tax year, but less,
- the amount of any lump sum death benefit that accrues to the individual in the tax year mentioned in section 636A(4ZA). That is those that were previously subject to the special lump sum death benefit charge but will, from April 16, be taxed at the recipient’s marginal rate.
In plainer English this is-
- the total amount of income for the tax year on which an individual is subject to income tax, which will include salary, bonus, profits from self-employment, benefits in kind, pension income (including uncrystallised funds pension lump sums), income from property, savings, dividends and taxable lump sum death benefits (post 5 April 2016)
- less certain allowances and reliefs, e.g. excess tax relief under net pay pension schemes (where full tax relief not available through payroll), pension scheme tax relief upon making a claim (RACs), gifts to charities and trade losses
- plus any pension scheme tax relief deducted in the previous bullet-point
- plus any employee pension contributions deducted from gross salary (net pay arrangements) in the tax year the payment is made
- plus the value of any employer contributions* (which includes any employer contributions as a result of a salary exchange arrangement) for the tax year
- less any lump sum death benefits paid to individuals in the tax year which were taxable at the individuals marginal rate (ie taxable lump sum death benefits received on or after 6 April 2016)
*For Defined Benefit arrangements, this will require working out the actual pension input amount for the tax year, using the normal annual allowance rules, and then subtracting from this figure the total of any member contributions to that arrangement paid in the tax year.
For example, Fiona has the following income in 2018/19 –
- Income less allowable reliefs and deductions £130,000
- Dividend income of £10,000
- Interest of £2,000
- She is a member of her employer’s pension scheme, with employee pension contributions of £10,000 (paid through the net pay arrangement) and employer contributions of £15,000
Fiona’s adjusted income is therefore £167,000 and she will be subject to the tapered annual allowance. She loses £1 of allowance for each £2 in excess of £150,000, hence her annual allowance is reduced by £17,000/2 = £8,500. Her new tapered annual allowance is therefore £31,500 for 2018/19.
The definition of threshold income is somewhat simpler as follows –
- the total amount of income for the tax year on which an individual is subject to income tax, which will include salary, bonus, profits from self-employment, benefits in kind, pension income, income from property, savings, dividends and taxable lump sum death benefits (post 5 April 2016)
- less certain allowances and reliefs, e.g. excess tax relief under net pay pension schemes (where full tax relief not available through payroll), pension scheme tax relief upon making a claim (RACs)
- less any contribution made by an individual to a relief at source pension (e.g. the gross amount of a contribution to a personal pension)
- less any lump sum death benefits received in the tax year which were taxable at the individuals marginal rate (ie taxable lump sum death benefits received on or after 6 April 2016)
- plus the amount of any employment income given up for pension provision as a result of any salary sacrifice or relevant flexible remuneration arrangement made on or after 9 July 2015.
The threshold income will be important for many. For example if an individual’s total income amount less deductions is £100,000 (after an employee pension contribution to a net pay arrangement scheme of £80,000) it would mean that the £150,000 adjusted income is breached, but because the threshold income of £110,000 is not breached the tapered annual allowance will not apply.
The legislation included anti-avoidance measures for anyone entering into an arrangement on or after 9 July 2015 to avoid or reduce the impact of the tapered annual allowance. An arrangement will include –
a salary sacrifice arrangement under which the individual gives up the right to income in return for the making of a relevant pension contribution, and
a relevant flexible remuneration arrangement under which the individual and the employer agree that relevant pension provision is be made rather than the individual receiving some description of employment income.
An arrangement will be caught by the anti-avoidance provisions where -
it is reasonable to assume that the main purpose, or one of the main purposes, is to reduce the impact of the tapered annual allowance, and
the arrangement has the impact of reducing either or both the adjusted income or threshold income figure, and
the reduction in either or both adjusted income or threshold income is redressed by an increase in the individual’s adjusted income or threshold income for a different tax year.
Where an arrangement is caught by the anti-avoidance measures it will be ignored for the purpose of calculating the tapered annual allowance.
Money Purchase Annual Allowance
You could be forgiven for thinking that the taper annual allowance will not apply where someone is subject to the money purchase annual allowance, but unfortunately this is not the case.
The reason for this is that even where an individual has triggered the money purchase annual allowance, any contributions to a defined benefits pension scheme are not limited to £4,000 and hence could be caught by the tapered annual allowance.
Therefore, where an individual is subject to the money purchase annual allowance –
- contributions to a money purchase arrangement will be limited to £4,000 (without any carry forward).
- contributions to a defined benefits scheme (which will be a maximum of £36,000 where £4,000 is paid to a money purchase arrangement) will be restricted under the taper.
- hence if the adjusted income is £210,000 or above and the threshold income of £110,000 is exceeded, the individual will have a tapered annual allowance of £10,000, and assuming that they made a money purchase contribution of £4,000, a £6,000 taper annual allowance (although carry forward from previous tax years can still be utilised) is available for any contributions to the defined benefits arrangement
Maggie has the following income and benefits in the tax year 2018/19–
- Salary £100,000
- Company car £5,000
- Dividends £4,000
- Employer pension contribution £50,000 (including £10,000 from a salary exchange arrangement set up in 2012)
- Maggie is using the annual allowance of £40,000 plus carry forward of £10,000 from a previous tax year
Adjusted income is £159,000 with all of the income and benefits being included in this definition.
Threshold income, however, is only £109,000 because the employer pension contribution is not included and because the salary exchange was set up before 9 July 2015 it means that this is not included either.
Maggie will therefore retain the full annual allowance of £40,000 for the 2018/19 tax year.
2. Nick has the following income and benefits in the tax year 2018/19–
- Salary £6,000
- Dividends £70,000
- Employer pension contribution of £150,000 using carry forward
Adjusted income is £226,000 with all of the income and benefits being included in this definition.
Threshold income is £76,000 because the employer pension contribution is not included.
Nick with therefore retain the full annual allowance of £40,000 for the 2018/19 tax year.
3. Kevin has the following income and benefits in the tax year 2018/19 –
- Salary £100,000
- £10,000 employee pension contribution to a net pay arrangement scheme
- Dividends £10,000
- Interest £5,000
- Company car £10,000
- Employer pension contribution £25,000
Adjusted income is £160,000. Please note that where an individual makes a pension contribution from net income this is deductible from the ‘salary’ figure, but is then added back in (under the definition of adjusted income).
Threshold income is £125,000.
This means that the tapered annual allowance will apply, and this will be £10,000/2 = £5,000. The tapered annual allowance is therefore £35,000.
4. Sally has the following income and benefits in the tax year 2018/19 –
- Salary £145,000
- Dividends £5,000
- Employer pension contribution £20,000
- Employee contribution through a net pay arrangement scheme of £100,000 using carry forward
Adjusted income is £270,000
Threshold income is £150,000
This means that the tapered annual allowance will apply, and because adjusted income is in excess of £210,000 it will be £10,000. If Sally does not have carry forward of £110,000 (i.e. total contribution of £120,000 less tapered annual allowance of £10,000) from the previous 3 tax years she will incur an annual allowance charge.
The tapered annual allowance requires additional checks for high earners before a pension contribution is made by either employer or employee to ensure that an annual allowance charge is avoided.
For those who exceed the threshold income of £110,000 there is very little that can be done to avoid the tapered annual allowance. Example 2 for Nick illustrates that individuals who have their own small business are in a slightly better position because they may be able to manipulate their income levels (remembering of course that it makes no difference whether profits from the business are taken as salary or dividends for this purpose). They can, however, within limits, take profits from the business as a pension contribution to keep income within the threshold income of £110,000 because pension contributions are not included in this definition of income. Care need to be taken with such planning to make sure that the anti-avoidance measures are not triggered.
The last example for Sally also highlights that although an individual may still have the full carry forward from earlier tax years, the use of this carry forward can impact on the annual allowance available in the year of payment.
This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2019. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice.