Financial adviser David was looking at some of his higher earning clients to ascertain the effect of the annual allowance taper due to start on 6 April. In some ways this sort of work annoyed him – complexity for the sake of it from the last Budget. And there is still a chance the forthcoming Budget will change things yet again.
The task that faced him was to work out the adjusted income and the threshold income for each client before deciphering any taper and any new annual allowance. He had devised a method of working through this.
First, figure out the client’s adjusted income. This is total gross income from all sources, so includes investment income as well as salary. Now add all pension contributions including any deductions under net pay arrangements. Then deduct personal contributions and any lump sum death benefit where the recipient is liable to tax.
If the total is £150,000 or less then the tapered annual allowance will not apply. If the total is more than £150,000 then a check against the client’s threshold income is also required. Note that sacrificing salary or bonus payments for employer contributions purely to reduce the client’s adjusted income for this purpose will be ineffective.
If the client’s net income (total income less personal contributions entitled to relief at source) is less than the £110,000 threshold, then they will not normally be subject to the tapered annual allowance. Any new salary sacrifice arrangements set up on or after 9 July 2015 will need to be included.
So the calculation would be: Total gross income from all sources including investment income + any new salary sacrifice/flexible earnings set up on or after 9 July 2015 – personal contributions entitled to relief at source = net income.
Julian runs his own PR agency and for the current year (2016) has taxable income, made up of salary and dividends, of £115,000.
Julian is keen to retire as early as he can and he maximised his pension contributions in 2013/14 and 2014/15.
In 2015 he had not made a contribution due to a business expansion opportunity. In 2016/17 he wants to maximise his contribution from the business, making use of his carry forward from 2015/16.
David looked at the figures:
If the employer contributes the maximum available contribution of £80,000 his situation is:
Adjusted income £195,000 (£115,000 income chargeable to income tax + £80,000 total pension input).
Threshold income £115,000 (£115,000 income chargeable to income tax).
As both the adjusted and threshold income are above the relevant thresholds, Julian would be subject to the taper. The £45,000 excess adjusted income reduces Julian’s 2016/17 annual allowance by £22,500 to £17,500.
The excess of £22,500 would be subject to the annual allowance charge.
David had a bit of a think. Is there any advantage to be gained by splitting the contribution between employer and employee? He realised that salary sacrifice and/or flexible salary arrangements would not avoid the taper but a small business might have scope to amend the source of the contribution, which might assist. He re-did the numbers.
Julian could make a personal contribution of £5,000, and his company make an employer contribution of £75,000. In this scenario the situation would be as follows:
Adjusted income £190,000 (£115,000 income chargeable to income tax + £80,000 total pension input – £5,000 personal contribution).
Threshold income would be £110,000 (£115,000 income chargeable to income tax – £5,000 personal contribution).
As the threshold income no longer exceeds £110,000, Julian’s annual allowance would not be tapered, so no annual allowance charge would apply.
So with just a slight tweak to the numbers, David is able to help Julian avoid the taper, allowing him to maximise his pension contributions and to catch up on the year that he missed out on.
Mike Morrison is head of platform technical at AJ Bell