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The tapered annual allowance and pension savings

Are personal or employer contributions best?

tapered annual allowanceI want to kick off 2018 by looking at the tapering of the annual allowance. This measure for pension savings came into effect from 6 April 2016 and affects high income individuals. A high income individual is defined by two measures: threshold income and adjusted income.

If the individual’s threshold income is £110,000 or less for the tax year then they are not a high income individual in that tax year. Alternatively, if their threshold income exceeds £110,000 and their adjusted income for the tax year exceeds £150,000, they lose £1 of annual allowance for every £2 of adjusted income in excess of £150,000.

The extent of tapering is limited to £30,000, meaning worst case scenario would see the annual allowance reduce from £40,000 to £10,000.

Both income measures are set out in legislation and the impact on these where the certain events occur in isolation is illustrated in Table 1.

Table 1

Event Threshold income Adjusted income
Employer contribution to an other money purchase arrangement No change Increases
Contribution made by member Reduces No change
Benefit enhancement under defined benefit or cash balance arrangement No change Increases
Increase in member’s salary Increases Increases

To understand the pension planning issues that could arise, let’s look at a case study.

Case study

Nicola is the major shareholding director in a company she started from scratch 20 years ago. Her pension saving in past years has been erratic and her income and pension savings estimates for the 2017/18 tax year are as follows:

  • Threshold income: £122,000
  • Adjusted income: £162,000
  • Annual allowance: £34,000
  • Pension input amount: £40,000
  • Unused annual allowance from 2016/17: £10,000
  • Unused annual allowance from 2015/16: £14,000
  • Unused annual allowance from 2014/15: £6,000

Her £6,000 unused annual allowance from 2014/15 would cover the £6,000 excess in 2017/18, leaving £24,000 unused annual allowance available for 2018/19.

Table 2 shows the impact if Nicola makes the following additional gross personal contributions to her Sipp before the end of 2017/18:

A – £10,000
B – £12,000
C – £30,000

Table 2

A B C
Threshold income £112,000 £110,000 £92,000
Adjusted income £162,000 £162,000 £162,000
Annual allowance £34,000 £40,000 £40,000
Pension input amount £50,000 £52,000 £70,000
Unused AA available for 2018/19 £14,000 £18,000 Nil

Looking at B in more detail, if Nicola makes an additional contribution of £12,000 gross before the end of 2017/18, her threshold income would reduce to £110,000 and no tapering of the annual allowance would apply.

Her pension input amount for 2017/18 would increase to £52,000 compared to her annual allowance of £40,000. The £12,000 excess would be covered by £6,000 unused annual allowance from 2014/15 and the remainder from 2015/16, leaving £18,000 unused annual allowance (£8,000 from 2015/16, £10,000 from 2016/17 and nil from 2017/18) available for 2018/19.

Table 3 shows what would happen if the additional contributions were made by the company/employer instead:

E – £10,000
F – £12,000
G – £30,000

Table 3

E F G
Threshold income £122,000 £122,000 £122,000
Adjusted income £172,000 £174,000 £192,000
Annual allowance £29,000 £28,000 £19,000
Pension input amount £50,000 £52,000 £70,000
Unused AA available for 2018/19 £9,000 £6,000 Nil

Consider G in more detail. If an additional employer contribution of £30,000 is made before the end of 2017/18, Nicola’s adjusted income would increase to £192,000 and, as her threshold income exceeds £110,000, her annual allowance for that year would be tapered further.

Her pension input amount for 2017/18 would increase to £70,000, compared to her annual allowance of £19,000. There would not be enough unused annual allowance from previous tax years to cover the £51,000 excess, meaning she would be liable for an annual allowance charge for 2017/18 on a surplus of £21,000 (£51,000 – £30,000) and there would be no unused annual allowance available for 2018/19.

No increase in Nicola’s salary or other taxable benefits will be forthcoming in the tax year. The additional pension funding will be through the Sipp and her pension fund will increase by the same amount regardless of the funding source.

From an annual allowance perspective, the personal contribution route is best. However, personal contributions, subject to the appropriate level of tax relief, will come from Nicola’s own income/savings, which is not the case if funding comes from the employer.

Also, subject to the wholly and exclusively criteria being met, employer contributions would attract corporation tax relief.

So, where high net worth individuals have spare resources due to a redundancy or bonus payment, for example, then using these to boost their retirement pot will be an option for consideration.

The impact of the tapering of the annual allowance, especially where the boost comes on top of already healthy pension funding, needs to be understood if retirement planning is to remain tax efficient. And let’s not forget the small matter of individuals completing their self assessment tax returns accurately.

Neil MacGillivray is head of technical support at James Hay

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  1. Best article I`ve seen explaining this.

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