Tapering the Annual Pension Allowance for High Earners
Last updated on February 23rd, 2021 at 9:02 am
In the 2020 budget, the rules for tapering the pension annual allowance changed. Read on to help your revision for the CII AF1, AF2, AF5, AF7, J05, R04 or R06 exams.
THIS ARTICLE IS RELEVANT TO THE 20/21 EXAMINABLE TAX YEAR
Before we look at these, let’s remind ourselves what the tapered annual allowance is.
What is the tapered annual allowance?
It was introduced in 2016 to try and control the cost of tax relief on pension contributions, and it applied to those with threshold and adjusted income above certain limits.
The formula for reduction was is – £1 reduction in the allowance for every £2 of income above a threshold.
Before 6 April 2020, it affected those people with ‘adjusted income’ of £150,000 or more; the maximum amount of reduction was £30,000, so anyone with an income of £210,000 or more would still have had an annual allowance of £10,000. The tapered reduction didn’t apply to anyone with ‘threshold income’ of £110,000 or less.
From 6 April 2021 the rules changed and the annual allowance is now tapered for those with a threshold income of more than £200,000 and an adjusted income of £240,000 of more and the maximum amount of reduction has been increased to £36,000.
Distinguishing Between ‘Adjusted Income’ and ‘Threshold Income’
The key to understanding any of this is the distinction between ‘adjusted income’ and ‘threshold income’.
Both definitions include all of someone’s taxable income – so savings as well as non-savings income.
The difference is that the ‘adjusted income’ definition includes pension contributions (this is both employee AND employer contributions), and the definition of ‘threshold income’ doesn’t.
Both definitions start with ‘net income’, which used to mean income after tax, but in this context, means taxable income less certain allowable deductions – one of which could be your CII subscription.
When calculating ‘threshold income’, the member’s pension contributions are deducted, and the employer contributions are not added in.
As stated above from 6 April 2020 the tapered annual allowance applies to those people with ‘threshold income’ of more than £200,000 and ‘adjusted income’ of more than £240,000. The maximum amount of reduction is £36,000 so giving a minimum tapered annual allowance of £4,000.
If someone’s threshold income is less than £200,000, then they are not subject to the taper, and there is no need to work out adjusted income.
If, however, threshold income is more than £200,000, then adjusted income needs to be calculated to then work out the amount of the taper.In the budget, the rules for tapering the pension annual allowance changed. Read on to find out more. Click To Tweet
Let’s take an example:
Steve is the sole shareholder/director of his building company. He has a taxable income of £190,000 and pays an employer pension contribution of £60,000.
His adjusted income is £250,000, so it looks as if his annual allowance will be tapered, as this is clearly over £240,000. However, to work out his threshold income, we don’t include the employer contribution, so his threshold income is £190,000, and the taper does not apply after all.
The minimum amount of £4,000 will apply to anyone with adjusted income over £312,000 i.e. £312,000 – £240,000 = £72,000/2 = £36,000.
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