A week ago I wrote about the Money Purchase Annual Allowance (MPAA) you can read that here Should I Cash In My Pension? This week we are talking about the Tapered Annual Allowance, the thorn in the flesh of high earning professionals and pension advisers alike.
What is the tapered annual allowance?
It is a relatively new piece of legislation which lowers the annual pension contribution allowance available to high earning individuals. In most cases, you have an annual pension contribution allowance of £40,000. This is how much you can put into your pension and receive tax relief.
The tapered annual allowance effects those on a “threshold income” of over £200,000 and “adjusted income” of over £240,000. Broadly speaking, for every £2 of adjusted income over £240,000, an individual’s annual allowance is reduced by £1. This tapers your annual allowance all the way down to £4,000. There are a whole host of income streams that are included for the purposes of this calculation, you can find out more here.
How will I be effected?
Not everyone has £40,000 to put into a pension each year and most hold off until their income allows, but it’s a bit of a catch 22. Why? You’ve probably heard the phrase “learn in your 20s and earn in your 30s” and that’s quite typical of those in professional careers. You spend the majority of your 20s learning your craft, gradually increasing your earnings potential and then salary increases can occur quite rapidly.
Promotions come and your income jumps. (Quick note here, often, especially in US based companies’ senior individuals are awarded “RSUs”, it’s a little complicated to go into here, but for the purposes of tapered annual allowance calculations, they are included and can reduce your annual allowance)
After a few years of living on baked beans, wearing 2 jumpers to bed in December and doing all you can to save, you’ve finally got some spare cash to
lease a sportscar start paying into your pension! You’ll likely be nowhere near the pension lifetime allowance limit and want to start making some serious contributions.
Hold on a moment!
Unless alerted by their employer, many find themselves unexpectedly in the position where their pension contributions are limited. Many of our clients come to us with this issue and quite often their pensions are well below the lifetime allowance and they’re paying a fair chunk of income tax. So what are they to do?
Whilst you may be limited to how much you can put in for this tax year, you could well have some unused allowances from previous tax years that you can “carry forward” and make a large contribution.
You can do this up to three years prior to the current tax year. So, if you’ve got some allowance remaining from 3 tax years ago, you could use it (or if you don’t, lose it) this tax year and when the next tax year rolls around you could carry forward some allowance from the year after.
Of course, after 3 years you’ll have caught up to where you are now, but it makes sense to at least use these remaining years now because your income is likely to increase and so contributions are going to be limited. If you are young, any additional monies that are being paid into your pension will have years to compound and could result in a significant amount of money.
If you are an additional rate tax payer, which you will be if you are effected by the taper, each £1.00 contribution is only costing you c55p – a no brainer.
Consider using your spouses pension
If you have a partner and they don’t have a tapered allowance (and sufficient allowance available), you could look to fund their pensions, even if a basic rate tax payer a £32,000 contribution could result in £40,000 in their pension. If you are selling down RSUs as they vest this could give you the capital you need.
It’s also worth noting, whilst not necessarily as commonplace with the new generation we often see pensions skewed in favour of the higher earner. Naturally if you earn more, then you are likely to have a bigger pension, but it’s always worth considering evening it up a little as when you come to draw the income in retirement, if the bulk of the wealth is held in one individuals pension, they could be paying more tax than needed. If you both make withdrawals, then you have two sets of tax allowances to use.
Reducing your threshold income
Finally, you could look to do some planning to reduce your threshold income and regain your allowance. This is a meaty subject and one best discussed on its individual merits.
There are a number of other options that you could consider, such as VCT’s etc. With tax year end approaching, you should give it some serious thought. It’s a use it or lose it scenario.
If you’ve been wrestling with the calculations and would like independent pension advice, get in touch. Our first meeting is always on us.
T: 01268 944122
To find out more please visit About us – Sterling & Law – Rayleigh