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Pension contributions: act now to maximise tax efficiency

Phil Smithyes, Partner, Head of Financial Planning
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The annual allowance for pension contributions reduces for those with 'adjusted' income over £150,000, potentially to a minimum level of just £10,000 (or £4,000 if the money purchase annual allowance (MPAA) has been triggered – see table below).

What is the annual allowance?

The maximum amount you can contribute to a personal pension or stakeholder pension plan, on which you can receive tax relief, is 100% of your earnings or £3,600 gross, whichever is greater. This is capped at the annual allowance which, for the 2019-20 tax year, is £40,000.

From April 2016, pensions tax relief for high earners was cut by introducing a tapered annual allowance for those with incomes of over £150,000. For every £2 of adjusted income over £150,000, the annual allowance is reduced by £1 to a minimum of £10,000 i.e. where income exceeds £210,000 the maximum annual allowance is just £10,000. 

Annual Allowance summary

Income 2016-17 2017-18 2018-19 2019-20
£150,000 £40,000 £40,000 £40,000 £40,000
£210,000 £10,000 £10,000 £10,000 £10,000
 MPAA £10,000 £4,000 £4,000 £4,000

Key points

High earners retain the ability to carry forward any unused annual allowances from the previous three tax years and so larger contributions can still be made, which will attract income tax relief of up to 45% (46% in Scotland).

Planning Opportunity: what is carry forward?

You are allowed to carry forward any unused annual allowances from the previous three tax years, starting with the earliest year, in order to make a pension contribution in excess of the annual allowance.

It is still possible to use this carry forward even if you are subject to a tapered annual allowance. The maximum available amounts of unused relief remain at £40,000 tax years 2016-17, 2017-18, and 2018-19 meaning that it may be possible to make a maximum pension contribution of up to £160,000 in tax year 2019-20. However, if income has exceeded £210,000 in all four tax years, the maximum pension contribution would be £40,000 (see table above). This is subject to the MPAA not having been triggered.

The amount that can be carried forward from any tax year to which the taper applied is the balance of the tapered annual allowance.

If you do not use your annual allowance entitlement from 2016-17 by 5 April 2020, then this allowance will be lost.

What action can I take?

You must use up your annual allowance for the current tax year first. Any outstanding annual allowance can then be carried forward from 2016-17 (the earliest of the three carry forward years available). Please be mindful that you must have been in a pension arrangement in an earlier year to have unused annual allowance to carry forward, although you don't need to have contributed.

If you haven’t paid any contributions to a PPP since 2015-16 and are subject to the maximum taper in 2016-17, 2017-18, 2018-19 and 2019-20, the maximum potential contribution in this tax year (without suffering a tax charge) is £10,000 + £10,000 + £10,000 + £10,000 = £40,000.

Assuming you cannot afford to fund the maximum amount this year and only pay £5,000 in contributions in 2019-20, then in 2020-21 with a tapered annual allowance again of £10,000, the maximum contribution is £10,000 + £10,000 + £5,000 + £10,000 = £35,000.

Therefore, there is an excellent opportunity for high earners to make use of the unused allowance from the tax year 2016-17 before it is lost (after 5 April 2020).

Will I be affected by the reduction in the annual allowance?

The definition of income for the £150,000 figure is ‘adjusted income’ which is total taxable income from all sources including earned income. All pension contributions are included in annual allowance calculations (though the calculations of the amounts to be included differ between defined contribution and defined benefit arrangements).

If adjusted income is more than £150,000, the taper will only take effect if the ‘threshold income’ limit (of £110,000) is also breached.  This test is intended to help protect those with spikes in earnings or contributions. If an individual’s net income is less than the £110,000 threshold, then they will not normally be subject to the tapered annual allowance. Care is needed here with any new salary sacrifice arrangement (set-up on or after 9 July 2015), which may be included in the calculation. If in doubt, please speak to us for guidance.

Interaction with the money purchase annual allowance

This can be quite a complicated area. The MPAA is currently set at £4,000 and is triggered when an individual flexibly accesses their pension benefits.

For high-income individuals, the taper applied to the ‘alternative annual allowance’ against which any defined benefits savings are tested (currently £36,000).  This means that individuals with incomes of £210,000 or more will have an alternative annual allowance of £6,000.  Their annual allowance (for money purchase and defined benefits savings combined) will be £10,000. 

It is not possible to carry forward unused MPAA; however, when an individual who has triggered the MPAA has a tapered annual allowance of £10,000, they can carry that allowance forward for defined benefit savings purposes.

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

Next steps

The aspects of pensions are complicated, so seeking advice is essential.

To discuss this, or other pension issues in more detail, please contact us.

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Phil Smithyes
Phil Smithyes
Partner, Head of Financial Planning
Thames Valley