The pensions annual allowance places a cap on tax relieved contributions, which can be made to a registered pension scheme for the pension input period. From 2016/17, the pension input period is aligned with the tax year.
The pensions annual allowance is set at £40,000 for 2016/17. However, some higher earners are only entitled to a reduced annual allowance as the allowance is tapered where income exceeds certain thresholds.
The taper is only applied if the individual has both threshold income in excess of £110,000 for 2016/17 and adjusted net income in excess of £150,000.
Threshold income is basically taxable income after pension contributions made either by deduction from salary or to a personal pension plan where basic rate relief is given at source. Where a salary sacrifice arrangement was entered into after 8 July 2015 under which salary is given up in exchange for employer pension contributions, the salary given up needs to be added back. Any salary sacrifice arrangements before 9 July 2015 can be ignored.
If threshold income is less than £110,000 the reduction in the annual allowance does not apply.
Adjusted net income
Adjusted net income is basically taxable income before deducting pension contributions, plus any employer contributions.
If adjusted net income is less than £150,000 the reduction in the annual allowance does not apply.
The taper only applies where both threshold income is more than £110,000 and adjusted net income is more than £150,000. Where this is the case, the annual allowance is reduced by £1 for every £2 by which adjusted net income exceeds £150,000, subject to a maximum reduction. Thus, an individual who has threshold income of more than £110,000 and adjusted net income of more than £210,000 will only be entitled to the minimum pensions annual allowance of £10,000 for 2016/17. The maximum taper of £30,000 applies.
Hannah has a gross salary of £160,000 in 2016/17. She contributes £20,000 into a registered pension scheme. Her employer also makes a contribution of £20,000.
Her threshold income is £140,000 – her salary of £160,000 after her pension contribution of £20,000.
Her adjusted net income is her £180,000, being her salary before her pension contributions of £160,000 plus the pension contributions made by her employer of £20,000.
As her threshold income is above £110,000 and her adjusted net income is above £150,000, the taper applies.
Her annual allowance is reduced by 50% (£180,000 – £150,000) = £15,000.
Her annual allowance for 2016/17 is £25,000 (£40,000 - £15,000).
Don’t forget brought forward allowances
Even where the taper applies, it is possible to make tax-relieved contributions in excess of the reduced allowance if allowances have not been fully used in the previous three years. The taper did not apply before 2016/17 and unused allowances can be carried forward for up to three years.
Get in touch with Inform if you need further advice on reduced pensions annual allowance for high earners or any other tax related matter.
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