High earners who save into a pension will need to beware of penalties from April.
High earners in the private and public sectors, including managers, GPs, civil servants, academics, long-serving teachers and senior police officers, risk being caught out by a complicated new ruling that could see their ability to build a sufficient pension restricted.
From April, the amount that can be contributed to a pension each year will be gradually reduced when income exceeds £150,000. In basic terms, the more you earn over this income threshold, the weaker will be your ability to put funds into a pension.
Lest you were in any doubt about the intention behind the reform, the ‘annual allowance taper’ is designed to ease the burden of tax relief being paid to the wealthiest by the Exchequer.
The annual allowance is not to be confused with the lifetime allowance. Both rein in the availability of tax relief, but whereas the lifetime allowance is an overall limit on pension wealth, the annual allowance is the most that can be put away in a pension tax-free each year. Contributions in excess of the allowances don’t just lose tax relief on the way in; they themselves attract a tax penalty.
The annual allowance is currently £40,000 for most high-earning individuals, but from 6 April 2016, this figure will be whittled away by £1 for every £2 of income over £150,000. Mercifully, the annual allowance will fall no further than £10,000; which is the level for those earning in excess of £210,000.
To add more twists to an already tangled scenario, what will be tested against the annual allowance is ‘adjusted income’, which isn’t as simple as just ‘salary’. Adjusted income includes the value of employer pension contributions as well as income from sources unrelated to employment, such as savings and property. It is estimated that those with salaries of £90,000 or more could be affected.
“Identifying who is in the ‘taper zone’ will require a lot of homework,” says Steve Moy, wealth management consultant at St. James’s Place. “Advice is going to be absolutely crucial to avoid unwanted tax bills.”
Tackling the issue
For anyone contributing to a defined contribution (money purchase) pension themselves, Moy says the action required is arguably quite simple. “Your total contributions should always stay within your allowance,” he says.
Anyone who benefits from an employer contribution has a potentially more challenging scenario. If your overall pension contributions are greater than that permitted by the taper, then a discussion with your employer is needed. “You need to decide whether to stop contributions or be remunerated in a different way, for example a bigger salary in lieu of employer contributions,” says Moy.
Members of a final salary scheme have arguably the greatest challenge of all. “Most members don’t know how much their ‘pension input amount’ is for the year,” explains Moy. Moreover, it’s far from simple to work out accurately. A factor of 16 is applied to the promised pension at the start of the year. Once adjusted for inflation, the figure is subtracted from the equivalent closing value 12 months later. This can then be used to compare against the individual’s annual allowance.
“It’s tremendously complicated, so I don’t recommend anyone makes a decision without getting advice first,” says Moy. He points out that unused allowance from the previous three years could counter any breach, but eventually an individual may run out of unused allowance, thereby triggering a tax charge of 40% for overpayment.
“Anyone with a money purchase or final salary pension who earns close to, or over, £100,000 a year should seek advice before April to determine how much can be put away in a pension tax-efficiently. If the annual allowance taper is an issue, then there could be other tax-efficient ways to save for retirement,” says Moy.
Meanwhile, a limited opportunity exists for high earners to maximise their £40,000 annual allowance before the end of the 2015/16 tax year and carry forward any unused annual allowance from 2012/13.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are dependent on individual circumstances.