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Tapered annual allowance for higher earners 

Technical Update - November 2017

The calculation of adjusted and threshold income causes a great deal of confusion, particularly when deciding whether particular types of income need to be included. The position on carry forward when the taper applies also creates a number of queries. In this update we give a bit more clarity on these issues.

From 2016/17 tax year onwards, people with ‘adjusted income’ over £150,000 will have their annual allowance reduced for that tax year. Unless a person’s income stays below the relevant thresholds year on year or stays at £210k or above year on year, they could find their annual allowance changing each tax year.

The definition of income for the £150,000 figure is ‘adjusted income’ which is basically total taxable income including all pension contributions (which means that it isn’t possible to sacrifice salary for employer pension contributions to reduce income below £150,000).

The income floor of £110,000 is called ‘threshold income’ – which is defined in the same way as adjusted income but without including any pension contributions. This figure is to ensure that individuals aren’t affected by the taper purely as a result of a large pension contribution. Where an individual has threshold income of £110,000 or less, they will not be subject to the tapered annual allowance even if their adjusted income is greater than £150,000 (some people may be able to make a personal contribution to a pension in order to reduce threshold income to £110k or less and thus avoid their annual allowance being tapered).

The way that tapering works is that for every £2 of income that exceeds £150,000, £1 of annual allowance will be lost. The maximum taper is £30,000 to give a minimum annual allowance of £10,000 (which is reached at an adjusted income level of £210,000 plus).

Definition of adjusted income

The total amount of income for the tax year on which an individual is subject to income tax - which includes salary, bonus, profits from self-employment, benefits in kind, pension income (including UFPLS), profits from renting out property, savings income (even if falling within the personal savings allowance), dividend income (even if falling within the dividend allowance), taxable elements of redundancy payments, chargeable gains (before top-slicing). NB. It may be the case that employee pension contributions made via the net pay method (occupational schemes including some auto enrolment schemes but not GPPs) have already been deducted from this figure as these are deducted from income before tax is applied (however they do need to be included in the final figure)

Less certain allowances and reliefs, e.g. gifts to charities and trade losses

Plus any employee pension contributions deducted from gross salary (net pay arrangements) if these aren’t already included in the income figure at bullet point 1

Plus the value of any employer contributions*

Less any taxable lump sum death benefits

*For DB pensions, this will require working out the actual pension input amount for the tax year, using the normal annual allowance rules (broadly 16 times the increase in benefits over the tax year), and then subtracting from this figure the total of any member contributions to that arrangement paid in the tax year.

Definition of threshold income

The total amount of income for the tax year on which an individual is subject to income tax, as described above (any ‘net pay’ employee contributions must not be included in this figure)

Less certain allowances and reliefs, e.g. gifts to charities and trade losses

Less any contribution made by an individual to a relief at source pension (e.g. the gross amount of a contribution to a GPP, PPP or SIPP)

Less any taxable lump sum death benefits

Plus the amount of any employment income given up for pension provision as a result of any salary sacrifice or relevant flexible remuneration arrangement made on or after 9th July 2015.

Carry forward

Unlike the Money Purchase Annual Allowance which can't be increased using carry forward, it is still possible to use carry forward if subject to a tapered annual allowance. The maximum available amounts of unused relief remain at

£50,000 for 2013/14 (can be used in respect of 2016/17 contributions/funding but not later tax years) and

£40,000 each for 2014/15 and 2015/16 (transitional provisions apply for 2015/16).

The standard annual allowance for 2016/17 is also £40,000 but if a person was subject to the tapered annual allowance in that year they can only carry forward the balance of the unused tapered AA figure.

From 2017/18 onwards, the amount that can be carried forward from any tax year in which the taper applied is the balance of the tapered annual allowance amount.

So, if Brian hasn’t paid any contributions to his PPP since 2011/12 and is subject to the maximum amount of tapering in 2017/18, in that tax year his maximum contribution (without suffering a tax charge) is £40k + £40k + £40k + £10k = £130k.

Assuming he can’t afford to maximum fund that year and only pays £5k in contributions in 2017/18, then in 2018/19 with a tapered annual allowance again of £10k, his maximum contribution is £40k + £40k + £5k + £10k = £95k.

Money purchase annual allowance

Anyone who has flexibly accessed their DC pension savings (and is therefore subject to the £4,000 money purchase annual allowance) and who is also an active member of a defined benefit scheme, can have their £36,000 alternative annual allowance reduced by the taper rules. This means that for those with incomes of £210,000 or more, they will have an alternative annual allowance of zero although any available used annual allowance can be carried forward and added to this.

One final caveat – adjusted income has nothing to do with a similar-sounding definition we already have for ‘adjusted net income’ (thanks HMRC!) – adjusted net income (which was formerly known as net statutory income) is the income calculation that determines whether someone loses their personal allowance, suffers a child benefit charge and whether they are eligible for the Personal Savings Allowance and at what level. In contrast to adjusted income, adjusted net income allows employee/personal contributions made to pensions to be deducted. Adjusted net income has nothing to do with the tapered annual allowance.

In Summary

With regard to the tapered annual allowance and the adjusted income and threshold income figures, the easiest way to look at it is that adjusted income is total taxable income and it also includes personal and employer pension contributions. Threshold income is the same but without including any pension contributions (NB: any income given up to provide employer pension contributions from a post 8th July 2015 salary sacrifice agreement must be added in as part of threshold income as an anti-avoidance measure). Some people may not know what their final earnings and other income will be until after the tax year has ended and therefore won't know where they fall within the taper range (unless their income is such that they know they will definitely be above or below the range). This means it is difficult to know how much their maximum tax relievable pension contributions can be for that year.

The value of investments can fall as well as rise and past performance is not a guide to the future. This information contained within this document is for guidance only and is not a recommendation of any investment or a financial promotion and individual advice is always recommended. The value of any tax relief depends on your individual circumstances. This is our understanding of current tax legislation and this can change.  The Financial Conduct Authority does not regulate tax advice.