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There have recently been a number of articles in the press about the reduction in pension contributions that high earners can make from the next tax year (2016/17), without receiving a tax charge.  Whilst it’s great that the financial press are making people aware of the changes, I haven’t come across an article on this topic that has been particularly accurate.

So, I have taken it upon myself to try and write one.  You’ll have to bear with me though, as the rules are overly complicated and a little confusing.  But then again, what would you expect!

This tax year (2015/16) the annual allowance is £40,000.  This is the total amount that can be contributed into a pension scheme without the owner suffering a personal tax charge (I’m ignoring carry forward relief for this purpose).

The press have concentrated on ‘adjusted income’ of £150,000.  Adjusted income is total income from all sources, plus the value of pension contributions.

For individuals who have an adjusted income of over £150,000, the £40,000 annual allowance reduces by £1 for every £2 of income above the threshold.  So someone with an income of £210,000 would see their annual allowance cut to £10,000.  Anyone lucky enough to have an adjusted income over £210,000 would still be able to contribute £10,000.

There is another test, however, called ‘threshold income’ that needs to be taken into account.  An individual’s annual allowance won’t be cut if their ‘threshold income’ is £110,000 or less for the tax year.

An individual’s ‘threshold income’ is again their total income from all sources, any new salary sacrifice arrangements (started after 8 July 2015) less any individual pension contributions.  Care needs to be taken as to whether personal pension contributions have been made via a net pay arrangement or relief at source.

As ever, the best way of illustrating the above is by way of examples.  These have been amended from a technical document that Standard Life produces for advisers and I think they illustrate the changes quite well.

Example 1 – an employer pension contribution triggers the annual allowance cut

Suzy has a total income of £150,000 and, as a business owner, also makes a pension contribution of £40,000 into her SIPP during the 2016/17 tax year.

Her adjusted income for the tax year is £190,000.  As this is £40,000 over the £150,000 cap it will reduce her annual allowance from £40,000 down to £20,000 for the 2016/17 tax year.

This means she’ll be liable to pay a personal tax charge of 45% on the £20,000 (£9,000) she has contributed above her new annual allowance figure.

graph 1

Example 2 – an employer contribution doesn’t affect the annual allowance

Shona runs her own business and has an income of £100,000 for the 2016/17 tax year.  Her company has had a successful year and she decides to make an £80,000 employer pension contribution into her SIPP by using carry forward of unused annual allowance from previous tax years.

Her ‘adjusted income’ is £180,000.  As this is £30,000 above the £150,000 cap, it would normally cut her annual allowance by £15,000 (to £25,000).

However, as her ‘threshold income’ of £100,000 is below the £110,000 limit, Shona keeps her full £40,000 annual allowance.

graph 2

Example 3 – personal contributions restore the full annual allowance

Mark earns £120,000 in the tax year 2016/17 and has minimal other taxable income of £2,000.  He’s a member of his employer’s occupational pension, contributing 15% (£18,000) which his employer tops up on a 2 for 1 basis (£36,000).

His adjusted income for the year is £158,000, so he thinks his annual allowance will be cut.

However, to calculate his ‘threshold income’, his £18,000 pension contribution must be deducted from his actual income of £122,000.  This gives him ‘threshold income’ of £104,000, meaning he keeps his full £40,000 annual allowance.

graph 3

Individuals in occupational final salary schemes won’t have the ability to adjust their funding levels to remain below the reduced annual allowance, so they’ll need specific advice on what their options are next year.

What is clear is that planning between your accountant, financial planner and yourself is vital so you don’t get caught out.

If you’re concerned about your pension planning going forward please get in touch with Paul Darley on 01782 279615.