Tapered Annual Allowance
Tapering of the 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 tapering, and by the changes in March 2020. 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.
On 11 March 2020, the Chancellor of the Exchequer announced an increase of £90,000 in both the threshold and the adjusted income from 6 April 2020. The fully tapered annual allowance was also reduced to £4,000. These changes are not retrospective, so figures for carry forward purposes from 2016/17 to 2019/20 inclusive continue to be calculated based on the rules and values that applied to the relevant tax year.
Both sets of figures are given below, but the focus is on the current position throughout. The figures which applied from 6 April 2016 to 5 April 2020 are also given, for reference when calculating the amount of annual allowance available to carry forward from those years.
Facts and analysis
From 6 April 2020, individuals who have income for a tax year of greater than £240,000 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 £240,000 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 £240,000.
There is also an income floor of £200,000, 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, or a significant increase in salary for a Defined Benefit scheme member, that still leaves their pay below this level. Again, a full definition of the threshold income is below.
Where an individual has threshold income of £200,000 or less, they will not be subject to the tapered annual allowance even if their adjusted income is greater than £240,000.
The way that the tapering works is that for every £2 of income that exceeds £240,000, £1 of annual allowance will be lost. There is a cap to the tapering of £36,000 which means that the minimum tapered annual allowance is £4,000.
The amount of carry forward available is based on the unused tapered annual allowance where an individual was subject to tapering in the carry forward year. If the money purchase annual allowance applies, that carry forward can only be used against benefits accrued in Defined Benefits schemes.
The tapered annual allowance applies to individuals with adjusted income of £240,000 and over and threshold income of over £200,000.
Figures which applied from 6 April 2016 to 5 April 2020 (2016/17 to 2019/20 tax years inclusive)
Adjusted income £150,000
Threshold income £110,000
Maximum tapering £30,000
Minimum tapered annual allowance £10,000
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), trust 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), 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 (i.e. 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.
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 individual’s 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 taxable income amount (less deductions) is £190,000 (£100,000) following an employee pension contribution to a net pay arrangement scheme of £80,000, it would mean that the £240,000 (£150,000) adjusted income is breached, leading to the expectation that the annual allowance will be tapered, but because the threshold income of £200,000 (£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 to 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.
This principle did not change on 6 April 2020. Because this remains the case, new sacrifice schemes to reduce the Threshold Income below £200,000 will not be effective. This applies to arrangements to sacrifice both regular salary and bonus. The Threshold Income is the relevant measure in this scenario because employer contributions are included as part of the Adjusted Income calculation in any case.
Money Purchase Annual Allowance
You could be forgiven for thinking that the tapered 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 by the MPAA and hence could have triggered the tapered annual allowance.
From 6 April 2020, as the fully tapered annual allowance is £4,000 for those with threshold income over £200,000 and adjusted income over £312,000, this now matches the Money Purchase Annual Allowance (MPAA). Therefore, the relationship between tapered (standard) annual allowance and MPAA works differently. The only remaining distinction between the two measures of pension input affects those who are accruing benefits in both money purchase and defined benefits schemes. Up to their full £4,000 allowance can be used to support input to a money purchase scheme, and the remaining balance of the standard AA (tapered as necessary) can be used to support benefits accrued in defined benefit schemes, as can any available carry forward of standard annual allowance from previous years, also tapered as necessary. Unused money purchase annual allowance cannot be carried forward from previous tax years.
The effect of the MPAA - 6 April 2016 – 5 April 2020 version
An individual subject to the money purchase annual allowance in the 2016/17 to 2019/20 tax years is subject to the following limits:–
contributions to a money purchase arrangement will be limited to £4,000 (without any carry forward).
benefits accrued in a defined benefits scheme (which will be a maximum of £36,000 where £4,000 is paid to a money purchase arrangement) will be subject to the standard Annual Allowance, tapered where necessary.
Hence, in tax years 2016/17 to 2019/20 (inclusive) 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, the remaining £6,000 of tapered annual allowance in the current tax year is available for any contributions to the defined benefits arrangement, although carry forward from previous tax years can still be utilised to support any excess defined benefits accrual.
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 2020. 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.