If your total income is greater than £110,000 and you pay into a pension plan, you need to be aware of changes to the pension annual allowance for high earners. You may find that your ability to make pension contributions is reduced by up to £30,000, and this could mean you must pay additional tax at up to 45%.

The tax rates in this article have been updated to reflect the 2018/19 tax year.

Key points

  • If your ‘adjusted income’ of taxable income plus pension contributions is greater than £150,000 then your annual allowance will be reduced gradually to a minimum of £10,000.
  • This tapered annual allowance for high earners reduces your annual allowance for £1 for every £2 earned between £150,000 and £210,000, to a maximum annual allowance loss of £30,000
  • Payments to pensions which exceed the tapered annual allowance are taxed at 45%
  • You cannot use salary exchange to reduce your income below £150,000
  • You can still use carry forward for unused pension annual allowance for up to 3 tax years
  • Examples of the tapered annual allowance for high earners in practice

Changes to the pension annual allowance for high earners

Currently, everyone has an annual allowance, which permits you to pay up to £40,000 into your pension schemes, from all sources, per pension input period (aligned to the tax year from April 2016). Any payments over this figure are subject to tax at your marginal rate of income tax – 20%, 40% or 45%, depending on your earnings. The annual allowance has reduced dramatically in recent years, from £255,000 in 2011/12 to its current level of £40,000. If you are using flexible drawdown then your annual allowance is reduced to £4,000.

Carry forward

If you have not used your full annual allowance in the past 3 years, and were a member of a pension scheme during that period, then you may be allowed to carry forward unused annual allowance for these 3 years. Therefore, it may be possible to pay pension contributions in excess of the standard annual allowance in certain circumstances without incurring tax. The tax relief provided on your pension contributions is paid at source, and you must account for any excess contributions over the annual allowance in your tax return.

The new tapered annual allowance for high earners

From April 2016, if your ‘adjusted income’ is over £150,000 you may find that your ability to make pension contributions. It is quite possible that your current pension contributions would incur additional tax at 45%. Adjusted income over £150,000 will reduce your pension annual allowance by £1 for every £2 above this figure. The annual allowance for pensions will reduce to a minimum of £10,000 per tax year if you earn more than £210,000. Each tax year will be treated differently, so your earnings in one year might reduce your annual allowance, but in other years you might have the full annual allowance.

What is adjusted income?

If your adjusted income is greater than £150,000 you will start to lose your annual allowance. Adjusted income includes:

  • Employment income – salary, bonus, benefits in kind
  • Profits from self-employment
  • Pension income
  • Property income
  • Dividends
  • Savings income
  • Taxable lump sum death benefits
  • Employer pension contributions
  • Salary exchange contributions
  • Individual pension contributions under a ‘net pay’ scheme – usually from an occupational pension scheme or retirement annuity contract

If you pay into a personal pension, then your individual pension contributions usually come out of net pay, and therefore do not need to be added back to adjusted income. Employer pension contributions do count in adjusted income.

Any pension contributions which may be made to reduce your taxable income, such as salary exchange, are now taken into account when determining your adjusted income for your pension annual allowance if you are a high earner.

You can use some allowances to reduce adjusted income, such as gifts to charities.

An exception – threshold income below £110,000

If your ‘threshold income’ is not greater than £110,000 in a tax year, the annual allowance is not tapered for that tax year. These rules are designed to protect lower earners.

What is threshold income?

If your threshold income is less than £110,000 then you cannot be subject to the tapered annual allowance, even if your adjusted income is greater than £150,000. Threshold income includes:

  • Income from employment- salary, bonus, benefits in kind
  • Profits from self-employment
  • Pension income
  • Property income
  • Dividends
  • Savings income
  • Taxable lump sum death benefits
  • Salary exchange contributions to pensions since 9th July 2015
  • Individual pension contributions under a ‘net pay’ scheme – usually from an occupational pension scheme or retirement annuity contract

Importantly, this definition does not include employer pension contributions. If a salary exchange arrangement was set up before 9th July 2015 this amount is not included in your threshold income.

Example 1 – adjusted income over £150,000

Julie earns a salary of £140,000. She also gets employer personal pension contributions of 10% of salary per year, or £14,000. The employer pension contributions take her adjusted income to £154,000. Since this takes Julie over the £150,000 threshold, the additional £4,000 means a £2,000 reduction in the pension annual allowance to £38,000. Since Julie’s pension scheme benefits from tax relief at source, her personal contributions are not added back in to the calculation.

Example 2 – threshold income below £110,000

Tim runs a business and pays himself a salary of £8,000, plus dividends of £72,000. He also owns 2 rental properties, providing a total income of £10,000. His taxable income is therefore £90,000, which is below the threshold income figure of £110,000. If he pays a company contribution using carry forward of £100,000, this will not reduce his annual allowance, since his threshold income is below £110,000. The fact that his adjusted income is now £190,000 is not relevant.

Example 3 – adjusted income and threshold income breached

Mark earns £150,000 before tax, and pays 8% into his employer’s occupational pension scheme, which his employer matches (£12,000). He gets a on-off bonus of £40,000. This takes his total adjusted income to £150,000 + £12,000+ £12,000 + £40,000 = £214,000. Therefore, his annual allowance is now reduced by £32,000 to £8,000. If Mark is not able to use carry forward of unused annual allowances from any of the previous 3 tax years, he will be subject to additional tax on excess contributions over £8,000 at his marginal income tax rate (45%). In this case, the excess pension contributions are £16,000, and Mark would pay additional tax of £7,200.

Anti-avoidance measures

The draft legislation includes anti-avoidance measures to stop you trying to avoid the impact of the tapered annual allowance.

Therefore, you could be caught within these measures if:

  • You use salary sacrifice to give up the right to income in return for the making of a relevant pension contribution; or
  • You manipulate your remuneration so that your employer  agrees that pension contributions are made instead of other employee benefits.

Any arrangement will be caught by the anti-avoidance measures if:

  • it is reasonable to assume that the main purpose, or one of the main purposes, is to reduce the impact of the tapered annual allowance; and
  • the arrangement has the impact of reducing either or both the adjusted income or threshold income figure; and
  • the reduction in either or both adjusted income or threshold income is redressed by an increase in the individual’s adjusted income or threshold income for a different tax year.

Where an arrangement is caught by the anti-avoidance measures it will be ignored for the purpose of calculating the tapered annual allowance.

What can you do to avoid the tapered annual allowance for high earners?

If your income exceeds the £110,000 threshold income level then there is little you can do to avoid the tapered annual allowance. If you own a business you may be able to adjust your income levels to bring your total income below the threshold income level, but you should take care not to fall foul of the anti-avoidance measures. Because pension contributions are not included in the definition of threshold income you may be able to use a pension contribution to take profits from the business if your threshold income is below £110,000.

In practice, employees will find it very difficult to avoid the additional tax payable on pension contributions. This will be especially true if you receive bonuses at the end of the tax year. Pension contributions already made throughout the tax year may now attract additional tax purely because of a large bonus which reduces your annual allowance.

The only alternative will be to use carry forward wherever possible.

What to do if you are a high earner

The best solution is to contact us to examine the figure so that you fully understand your tax position.

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Dan Woodruff

Certified Financial Planner & Chartered Wealth Manager at Woodruff Financial Planning
Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.

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