Pension Contributions for High Earners | Blog | UnaVida Wealth Management Ltd

Pension Contributions for High Earners

If you earn over £200,000 per year, you need to take particular note of the thresholds and adjusted income, as your annual pension contribution allowance may be reduced or (tapered).

The annual allowance for a tapered person is less than that of a regular person. Any member may be subject to this lower limit depending on their amount of taxable income for the tax year.

Important Points

  • On 6 April, 2016, the tapering annual allowance was introduced.
  • Both the threshold income and adjusted income caps must be surpassed for the taper to take effect.
  • For every £2 in adjusted income over £260,000, a person’s annual allowance decreases by £1. The yearly minimum grant will be £10,000.
  • Between the tax years 2020–2021 and 2022–2023, lower restrictions were in effect. An individual’s annual allowance was decreased by £1 for every £2 in adjusted income that exceeded £240,000. With £4,000 serving as the minimum annual allowance.
  • From the 2016–2017 tax year until the 2019–2020 tax year, lower restrictions were in effect. An individual’s annual allowance was decreased by £1 for every £2 in adjusted income that exceeded £150,000. With a £10,000 annual minimum allowance.

Why was the annual allowance created with a taper?

Depending on the member’s level of taxable income for the tax year, a reduced yearly allowance may apply to all pension deposits made by them or on their behalf starting in the tax year 2016–2017. This will help to ensure that pension tax relief is equitable and reasonable while also controlling costs.

The government launched the Tapered Annual Allowance on 6 April, 2016, for people who have both an ‘adjusted income’ and a ‘threshold income’ of over £150,000.

The Tapered Annual Allowance will be available to anyone with an ‘adjusted income’ of over £240,000 and ‘threshold income’ above £200,0000 as of 6 April, 2020.

The Tapered Annual Allowance will be available to anyone with an ‘adjusted income’ of over £260,000 and ‘threshold income’ of above £200,000 as of 6 April, 2023.

What is the income threshold?

One of two criteria used to assess whether a member is eligible for a tapered annual stipend is threshold income.

An individual is not subject to the tapered annual allowance and is not required to calculate adjusted income if their ‘threshold income’ is £200,000 or less. The amount of any tapering yearly allowance must be determined by calculating adjusted income if the threshold income exceeds £200,000.

For those with lower incomes who can experience sporadic increases in the value of their employer-sponsored pension contributions, the threshold income measure serves to provide some predictability. Individuals who have net (taxable) incomes of no more than £200,000 are often exempt from the tapering annual allowances. However, salary sacrifices made for pension savings established on or after 9 July,  2015, will be included in the threshold income calculation due to anti-avoidance regulations.

The general definition of ‘threshold income’ is ‘the individual’s net income for the year’. This will cover all forms of taxable income, including:

Profit from certain alternative financing arrangements, government or corporate bonds issued at a discount or repayable at a premium, and other sources of income less the amount of any taxable lump sum pension death benefits paid to the individual during the tax year that can be subtracted from the threshold income.

Any taxable lump sum pension death benefits that are accruing throughout the tax year (section 636A-4ZA of ITEPA 2003) in addition to salary sacrificed for pension payments made by employees under agreements established on or after 9 July, 2015.

The gross amount of any relief at source pension contributions (such that any contributions paid under net pay, which are subtracted to arrive at taxable income, and relief at source are equalised for computing threshold income).

Adjusted Income: What Is It?

The other metric used to assess whether a member is eligible for a tapering annual allowance is adjusted income.

To stop people from getting around the restriction by trading their pay for employer contributions, the definition of ‘adjusted income’ includes the value of all employer pension contributions. The yearly allowance approach will be utilised to determine the employer contribution value for individuals in cash balance or defined benefit plans.

That is, the employer contribution will be equal to the entire pension input amount for the plan, less any money that the member may have contributed during the tax year.

The method by which adjusted income is determined is:

1. Determine the income levels for which the person is required to pay income tax throughout the tax year. All the sums add up to ‘total income’. Every one of those sums is a ‘component’ of total income (which will comprise all the previously discussed taxable income). This is the first step in the Income Tax Act of 2007’s computation section.

2. Subtract from the components the amount of any reliefs under a Section 24 provision that the taxpayer is eligible for the tax year and is listed about the taxpayer. For additional information about the deduction of various reliefs, refer to Section 25. ‘Net income’ is the total of the amounts of the components that remain after this stage. This completes step 2 of the Income Tax Act of 2007’s computation section.

3. Include any sum contributed to a pension:

  • Under agreements for net pay
  • Achieving tax relief in the UK, while contributing to foreign pension plans
  • Making use of the net pay provision excess relief
  • The provision utilising relief while filing a claim

4. Include the employer’s contribution value, which is:

  • Cash Purchase equals Contribution Value
  • The defined benefit is equal to the pension input amount less member contributions (although this is more straightforward and requires adding the entire pension input amounts and subtracting the member contributions).

5. Deduct any taxable lump sum pension death benefit that was given to the person during that tax year.

Note: The yearly allowance utilised in the scheme can be added to the P60 earnings to determine the adjusted income for members who solely have defined benefit pension provision and employment income.

 

The Taper Process

How annoying if you are facing reductions in your annual allowance, as it will be is reduced by £1 for every £2 that the adjusted income surpasses £260,000 in cases where both the adjusted income and the threshold income have been exceeded. This decrease can reach a maximum of £50,000 and a minimum tapering annual limit of £10,000.

As a result, individuals with adjusted incomes under £260,000 are eligible for the regular annual allowance; those with adjusted incomes between £260,000 and £360,0000 are eligible for a declining annual allowance; and those with adjusted incomes exceeding £360,000 are only eligible for an allowance of £10,000.

Both the defined contribution and defined benefit pension input amounts are subject to the tapered annual allowance restrictions. Although it is more difficult to identify the value of ‘contributions’ in defined benefit schemes,. Nonetheless, the Annual Allowance for Pension Savings article explains the DB calculation process. It is the cumulative sum of all pension ‘contributions’ that must be considered when comparing against the limits.

It is still possible for individuals who are subject to a tapered annual allowance to carry forward any unused amount from prior tax years.

Carry Forward and Tapered Annual Allowance

From the time of its launch in the 2016–2017 tax year to the 2019–2020 tax year, the tapered yearly allowance was subject to various caps. The minimum tapered yearly allowance was £10,000 (i.e., the minimum taper applied from adjusted income of £210,000 and higher), the threshold income limit was £110,000, and the adjusted income limit was £150,000.

The threshold income limit was £200,000 for the 2020–2021 tax year, while the adjusted income limit was £240,000 for the 2022–2023 tax year.

When calculating a member’s carry forward status, it is crucial to be aware of these limitations because, even if no pension contributions have been made, the tapering annual allowance will still apply for those tax years.

Planning for Tapered Annual Allowance

If the taper impacts clients, planning may be done to mitigate such an impact. Our earlier blog, Tapered Annual Allowance: Planning Ideas and Potential Pitfalls, goes into great length on this subject.

Think about using carry-forward to lessen or absorb the excess yearly allowance amount if clients have exceeded the tapering annual limit. Only the amount of the Tapered Annual Allowance (TAA) that is not used in a given tax year may be carried forward. You are not automatically carried forward with the entire normal yearly allowance if your pension input amount is zero. Before calculating the potential carry-forward of unused yearly allowance, you must still determine any TAA limits for high-income clients.

If there is still an excess, our article, Annual Allowance for Pension Savings, provides more details on the appropriate tax charge’s calculation, reporting and payments.

A Dilemma for Employees on High Salaries

The regulations may pose a problem for employees on high salaries who may have failed to maintain a proper level of pension contributions historically.

Sacrificing the contributions that would otherwise be allowable (due to the accumulation of a yearly allowance) would be limited to a maximum of £10,000. This would happen if the contribution was paid in the form of salary sacrifice.

The best way to take advantage of the annual allowance carry-forward is for them to make a personal net contribution. If this is within their means, they would benefit by paying less personal income tax at their top rate.

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A pension is a long-term investment that typically cannot be accessed until age 55 (57 from April 2028). The level of pension benefits offered could change depending on the value of your investments (and any income they may generate).

The interest rates in effect at the time you begin receiving benefits may also have an impact on your pension income. The tax consequences of pension withdrawals will depend on your unique situation. In later Finance Acts, tax rates, tax bases, and tax relief may change.

The opinions expressed by Ray Best are meant to inform and educate. Before making any investment decisions always take advice that is pertinent to your investment personality and financial situation.

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