High Earners & the ‘Pension Funding Trap’
Since the introduction of the Tapered Annual Allowance, planning pension contributions has become much more complex for high earners.
In our article we detail how the tapered annual allowance works and how to determine if you have breached or are likely to breach the thresholds.
The annual allowance
Current UK legislation allows you to contribute up to 100% of your UK earnings each tax year and receive tax relief, up to the annual allowance of £40,000 gross. Any payments into your pension will be paid net of basic rate tax, whereby the pension provider will claim basic rate tax relief (20%) directly from HMRC. In the event you are a higher/additional rate tax payer, you can additionally claim the difference between the lower and higher tax rate (currently 20%/25%) yourself, via self-assessment. This relief can be particularly beneficial for individuals with earnings over £100,000 as it can have the added benefit of restoring your personal allowance.
In the event you are in breach of the annual allowance, a tax charge will apply.
What is tapered annual allowance?
Since 6 April 2016, the pension ‘taper’ has been in place to restrict the tax relief for higher earners. Two tests, based both on the level of taxable income and the level of pension contributions in the year of assessment, are applicable and high earners are defined as those with:
- ‘Adjusted income’ of over £150,000 for the tax year
- ‘Threshold income’ of over £110,000
Adjusted income – is all income (salary, bonus, dividends, rental income, taxable benefits) plus all pension contributions (employer and personal) less personal pension contributions. If this is under £150,000 then you do not need to test against ‘threshold income’.
Threshold income – is all income (as before) less personal pension contributions.
Those exceeding the adjusted income and threshold income levels, will lose £1 of the Annual Allowance for every £2 of adjusted income above £150,000. This is subject to a minimum Annual Allowance of £10,000 for those with adjusted income in excess of £210,000.
This table provides an example of the reductions associated with high levels of income:
| Adjusted income | Reduction | Tapered annual allowance |
|---|---|---|
| £160,000 | £5,000 | £35,000 |
| £192,125 | £21,062 | £19,938 |
| £220,000 (over £210,000) | £30,000 (max) | £30,000 (max) |
A large problem associated with this type of planning is that many people will not know how much they will earn until the end of the tax year; making it even more difficult to know how much to contribute in the tax year. Further complications arise for members of Defined Benefit pension schemes (e.g. the NHS) where the level of pension accrual cannot be controlled and is not known in advance.
Carry Forward
It is important to note that if you have any unused allowances for the previous 3 tax years and were a member of a pension scheme in that period, you may be able to carry forward the unused allowances.
A big advantage of carry forward is that it is based on the individual’s allowance in the year carried forward from, rather than the tapered allowance in the current year. For example, if an individual had a pension but made no contributions for input periods relating to 2017/18, £40,000 could be carried forward and added to the tapered allowance for 2018/19.
In the event an individual had an unused tapered allowance of £30,000, only £30,000 could be carried forward to future years, regardless of their income in future years.
What can I do?
As you can see, there is considerable complexity for high earners wishing to maximise their pension provisions. Action can be taken to mitigate or manage the impact and options including: utilising carry forward allowances; transferring income producing assets to a spouse (reducing adjusted income); making personal contributions (thereby reducing threshold income); or negotiating with your employer to reduce their contributions.
If you are restricted to the £10,000 maximum after these options, you may wish to reroute your pension contributions to other tax efficient investments such as ISAs (£20,000 p.a. each) or consider Venture Capital Trusts (VCTs) or Enterprise Investment Schemes (EISs) which offer income tax relief at 30% (though these are higher risk investments and certainly not suitable for everyone). If you believe that you may be impacted by the tapered annual allowance rules, we suggest that you discuss this with your financial adviser, who can then establish whether a taper issue exists and if so explore options to mitigate the problem.