The annual allowance is the greatest sum that can be paid into a pension without recovery tax charges. For those with higher levels of income this allowance can be reduced, known as tapering.
The tapered annual allowance is often reported as affecting those “earning” over £150,000 and “contributing” to a pension.
These two terms are too general and can lead to incorrect conclusions, as explained below.
Firstly, earnings specifically relate to employment income but the legislation on the tapered annual allowance is far broader. The key threshold is usually £110,000 of total income, but many reports fixate on the higher adjusted limit of £150,000. The difference between these two terms (threshold vs. adjusted) is important as described below.
Here the risk is that taxable benefits, rent received, dividends, trust distributions and other income must be figured into the equation – missing any one of these can lead to an erroneous conclusion.
Secondly, “contributions” is far too specific to be useful. The test is based on the pension input amounts. For individuals in defined contribution schemes (which is a majority of those in the public sector) both employer and employee contributions are relevant (though the two are treated differently as below); for those in defined benefit schemes the increase in the value of those benefits is important (with an allowance made for inflation). Both defined contribution and defined benefit schemes should be able to issue a statement confirming the pension input amount.
A common “trap”, is that a small number of schemes may have broken a link to future added years of service, but still retain a link to earnings. The confusion is that members may feel that they may not be building up benefits in this scheme, but they are. Examples include the NHS 1995 scheme, in the public sector and, at the time of writing, Siemens, though this is likely to change. The problem is exacerbated for those with fluctuating earnings who see zero (not negative) pension input amounts when the definition of “earnings” the scheme uses falls, but when it rises the gain may be significantly positive (using up their annual allowance).
Tapering in Action
For those with income under £110,000 tapering is unlikely to be an issue and therefore the normal annual allowance should apply – this £40,000 (there are some exclusions for those who have drawn benefits from certain pension schemes).
For those earning over £110,000 individuals should add their relevant pension input amount (usually the defined benefit calculation as above plus any employer contributions to defined contributions schemes). Where personal contributions have been made under the “relief at source” method (most personal pensions) then these can be deducted and if an individual on this basis is under £110,000 (known as threshold income) tapering should not apply.
If the total of this calculation, (known as adjusted income) is above £150,000, then an individual is likely tapered; every £2 of adjusted income reduces their pension allowances by £1 to a minimum of £10,000 worth where this figure is above £210,000 (again different terms apply where an individual has accessed pension savings).
The key message, is that it is not sufficient just to look at earnings, or contributions in assessing if one is tapered. There is also a difference between the treatment of employee and employer contributions in defined contribution schemes.
Defined benefit schemes that appear to be “frozen” may actually affect annual allowance calculations.
My concern is that misreporting on this topic is causing individuals to make bad choices – the tapered annual allowance is not good tax policy, but a good adviser can help.
All these areas are complicated and therefore if you feel that any of the issues above affect you then please do not hesitate to get in contact.