As the tax year-end approaches, Neil MacGillivray provides a brief reminder of the tapered annual allowance, and how advisers can ensure their clients retirement planning remains tax efficient
As we approach the end of the tax year, we are receiving quite a number of queries on tapering of the annual allowance (AA) and how it affects high income individuals, so I thought it would be worth sharing a brief reminder of how it works.
A high income individual is defined by two income measures; threshold income and adjusted income.
From 6 April 2020, if an individual's threshold income is £200,000 or less for the tax year, then they are not a high income individual in that tax year. Alternatively, if their threshold income exceeds £200,000 and their adjusted income for the tax year exceeds £240,000, they lose £1 of annual allowance for every £2 of adjusted income in excess of £240,000. The extent of tapering is limited to £36,000 meaning that worst case scenario, they would see their annual allowance (AA) reduce from £40,000 to £4,000.
Both income measures are defined in legislation and the impact on these, where certain events occur in isolation, is as follows:
To help understand the pension planning issues, consider the following case study.
Nicola is the major shareholding director in a company she started 20 years ago. Her pension saving in past years has been erratic and her income and pension savings estimates for the 2020/21 tax year are:
The £6,000 unused AA from 2017/18 would cover the £6,000 excess in 2020/21 leaving £24,000 unused AA available for 2021/22.
The impact of Nicola making the following additional gross personal contributions to her SIPP before the end of 2020/21, is shown in the table below:
Looking in more detail, if Nicola makes an additional contribution of £12,000 gross before the end of 2020/21, her threshold income would reduce to £200,000 and no tapering of the AA would apply. Her PIA for 2020/21 would increase to £52,000 compared to her AA of £40,000.
The £12,000 excess would be covered by £6,000 unused AA from 2017/18 and the remainder from 2018/19, leaving £18,000 unused AA (£8,000 from 2018/19, £10,000 from 2018/19 and nil from 2019/20) available for 2021/22.
If the additional contributions were made by the company/employer instead, then the position would be as shown in the table below:
If an additional employer contribution of £30,000 is made before the end of 2020/21, Nicola's adjusted income would increase to £282,000 and as her threshold income exceeds £200,000 her AA for that year would be tapered further. Her PIA for 2020/21 would increase to £70,000 compared to her AA of £19,000.
As there would not be enough unused AA from previous tax years to cover the £51,000 excess then she would be liable for an AA charge for 2020/21 on a surplus of £21,000 (£51,000 - £30,000) and there would be no unused AA available for 2021/22.
From an AA perspective the personal contribution route is best. However personal contributions, subject to the appropriate level of tax relief, will come from Nicola's own income/savings which is not the case if funding comes from the employer. Also, subject to the wholly and exclusively criteria being met, employer contributions would attract corporation tax relief.
Where high net worth individuals have spare resources, then using these resources to enhance their retirement savings will be appealing. The impact of any enhancement, where tapering of the AA is an issue, needs to be understood if retirement planning is to remain tax efficient.
Not forgetting an important factor that it's the client's responsibility to declare any annual allowance charge within their self-assessment tax return. Failure to do so could mean penalties and an unhappy tax year for the client.
Neil MacGillivray is head of technical support at James Hay