Making the Tapered Pension Allowance a Little Clearer

This week, we look at the tapered pension annual allowance for high earners.  Anyone studying AF3, R04 or J05 may wonder how they’re going to remember how it works if/when it’s tested; the definitions for income look confusing to say the least. 

This article is relevant to examinable tax year 2016/17

Let’s have a closer look: firstly it applies to people who have adjusted income over £150,000 and threshold income of less than £110,000.  The reduction follows a familiar £1 reduction for every £2 (over £150,000) pattern.

Before we calculate what adjusted income and threshold income is though we need to start with the client’s ‘net income’; this is worked out as gross income (eg earnings, rental income, pension income, interest, dividends) less deductions with the most relevant deduction being pension contributions made by an employee using the net pay method (whether a defined benefit or money purchase scheme). For someone with a £100,000 salary who pays 10% into their employer’s occupational money purchase scheme (before tax is deducted under PAYE), their net income is worked out as £90,000.

Calculating Threshold Income

To calculate threshold income:  from the net income figure, deduct gross pension contributions paid by the member or on their behalf by someone other than their employer (unless these are the ones we’ve already accounted for in the net income figure).  To this figure, add any salary sacrifice figure set up after 9 July 2015, and finally, deduct any lump sum death benefits that were taxed as income (as they are taken into account in the ‘net income’ figure).  If the threshold income figure you are left with now is below £110,000, there is no taper.

Calculating Adjusted Income

Adjusted income starts with the same net income figure as before.  To this, we add all employer pension contributions and any employee contributions paid via the net pay method.  We can also again deduct any lump sum death benefits that were taxed as pension income.  This gives you the adjusted income figure.

The most important thing to remember is that ‘adjusted income’ includes both employer and employee pension contributions and ‘threshold income’ doesn’t.

We hope this makes tapering the annual allowance a little clearer; remember too that the maximum reduction is £30,000, so anyone with income of £210,000 or more will still have a £10,000 annual allowance.

Grab the resources you need!

If you’re studying for your CII R04 exam, and you’re wanting to do well on exam day, you’ll need to be well prepared. Grab our free taster to try out one of Brand Financial Training’s mock exam papers for yourself.  Click the link to download the R04 mock exam taster now!

Alternatively, you can download the taster for AF3 or J05 if one of those exams is causing you some anxiety.

Over to You…

Did this help you to more fully understand tapered pension allowance? Let us know in the comments!