Will I be caught by the annual allowance tax taper?
I’m trying to figure out if I am going to be caught by the annual allowance tax taper both this tax year and next. I’m going to have taxable earnings of £150,000 this year, and have used up the full £40,000 annual allowance (50% my contributions, 50% from my employer). My earnings and pension contributions should be the same next year.
Tom Selby, AJ Bell Senior Analyst says:
For most people the annual allowance (inclusive of tax relief) on all pension contributions is £40,000, with an additional cap of 100% of UK earnings on the contributions you pay personally.
There are two major exceptions – where someone has flexibly accessed taxable income from their pension, triggering the £4,000 ‘money purchase annual allowance’, or where they have breached both annual allowance ‘taper’ income thresholds.
At the moment, the pension tax taper kicks in when someone’s ‘threshold’ income is above £110,000 and ‘adjusted’ income is above £150,000.
Threshold income is broadly taxable income (so earnings plus investment income) minus personal pension contributions. Adjusted income is taxable income (again earnings and investment income) plus employer contributions.
Threshold income also needs to include any salary sacrifice or flexible earnings arrangements set up after 8 July 2015, while lump sum death benefits are deducted to reach both income measures.
Where both limits are breached, the annual allowance reduces by £1 for every £2 of adjusted income earned above £150,000, to a minimum of £10,000 for those with adjusted income of £210,000 or more.
So in your case, assuming you have no investment income, recent salary sacrifice or lump sum death benefits, your threshold income this year will be £130,000 (£150,000 - £20,000 personal pension contribution) and your adjusted income will be £170,000 (£150,000 + £20,000 employer pension contribution).
In the 2019/20 tax year you will therefore trigger the taper, reducing your annual allowance from £40,000 to £30,000.
As your total pension contribution in the tax year is £40,000, unless you have unused allowances from the last three tax years that you can ‘carry forward’, you’ll be subject to an annual allowance tax charge on £10,000. As the contribution would have benefitted from 40% tax relief, you will face a charge of £4,000 (£10,000 x 40%).
Chancellor Rishi Sunak has announced a big increase in both the threshold and adjusted income measures used with the annual allowance taper. From 6 April this year, threshold income will rise to £200,000 and adjusted income will increase to £240,000.
The taper will be applied in the same way as previously – so your annual allowance will reduce by £1 for every £2 of adjusted income earned above £240,000 – but the annual allowance floor has been lowered to £4,000 for those with adjusted income of £312,000 or more.
Assuming your earnings and pension contributions remain the same in 2020/21, you will benefit from the full £40,000 annual allowance and therefore face no annual allowance charge.
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