As the chancellor finalises his Autumn Statement, there are calls for him to bin the tapered annual allowance on pensions.
Last month, the government scrapped George Osborne’s blueprint for a second-hand annuity market following concerns about consumer protection. Now there are calls for the new chancellor, Philip Hammond, to overturn some of his predecessor’s other pet projects, such as the tapered annual allowance.
The annual allowance is the maximum amount anyone can save into a pension tax-efficiently each year. For the vast majority of working people it is currently £40,000. However, a measure introduced in April this year by the former chancellor means that some top earners can fall foul of a taper, which gradually restricts pension saving by as much as £30,000 a year.
Put simply, if your income from all sources is more than £110,000 a year, you could be affected by the tapered annual allowance.
The problem with the taper is that it’s an incredibly complex and confusing way to curb pension tax privileges at a time when the government itself is aiming for greater simplicity. Recently departed pensions minister Baroness Altmann has branded the rule “fiendishly complicated”, and her predecessor Steve Webb has even called it “absurd”.
The government remains tight-lipped about the contents of this year’s Autumn Statement, but there are no current plans to abolish the tapered annual allowance, so it’s vital that you seek advice to help understand what it means for you.
Doing the maths
The tapered reduction does not apply if your ‘threshold income’ (broadly speaking your taxable income from all sources including property and investments, minus the value of pension contributions you make personally) is £110,000 or less.
If threshold income is more than £110,000, a second test determines your ‘adjusted income’. In summary, adjusted income includes your taxable income plus the value of any pension contributions made by your employer, including any paid as a result of salary sacrifice.
If adjusted income is more than £150,000 and threshold income is more than £110,000, then the tapered annual allowance kicks in.
The £40,000 annual allowance is reduced by £1 for every £2 of adjusted income over £150,000. The annual allowance reaches a base level of £10,000 once adjusted income hits £210,000.
Any pension savings in excess of the annual allowance are taxed at the individual’s highest marginal rate. Individuals with a high income caught by the restriction may therefore have to reduce the contributions paid by them or their employer, or accept an annual allowance charge.
Back to basics
Many experts claim that the taper is unworkable and are calling for it to be revoked as part of the measures announced in the Autumn Statement on 23 November.
“The taper is far too complicated for most individuals to fully understand,” says Ian Price, Divisional Director at St. James’s Place. “It is especially tortuous for the self-employed who typically don’t know their income until after the end of the tax year. Furthermore, most members of final salary schemes do not know how much, in monetary terms, is being added to their pension each year,” he adds.
“Funding for retirement should be simple and straightforward, so [St. James’s Place] would support an axing of the annual allowance taper. An annual individual limit on pension contributions of £40,000, irrespective of income, seems both fair and realistic,” says Price.
Those affected by the taper could potentially ‘carry forward’ unused annual allowance, but only from the previous three tax years. The annual allowance was £40,000 in 2015/16, £40,000 in 2014/15 and £50,000 in 2013/14. As the taper rule did not apply in these years, there’s an opportunity to add £130,000 to their pension immediately, and claim tax relief at their highest marginal rate.
Doing so while current rates of tax relief are available could make all the difference to retirement, especially as there is renewed speculation over whether the government will also take the opportunity to review pension tax relief on 23 November.
The levels and bases of taxation and reliefs from taxation can change at any time and are dependent on individual circumstances.