19th April 2018

Prudential: Tapered Annual Allowance

We’re now in the second year of the Tapered Annual Allowance and while since the introduction of this, the legislation has not been altered, but can still be a tricky path to navigate.  Mark Devlin, Technical Manager at Prudential explores.

It’s important when looking at clients’ financial affairs that the taper situation is checked for 2016/17 and 2017/18 as this will affect carry forward usage. Prior to this, the standard AA of £40,000 will be in effect. The tapered AA will reduce the full AA by £1 for each £2 over the adjusted income limit of £150,000 (as long as threshold income is also above £110,000). It’s also important to remember that for those with adjusted income over £210,000 the minimum they will have for this year’s Annual Allowance will be £10,000. 

To highlight how this works we’ll look at a short case study. Michael has an employment contract that states that his salary is £165,000. His employer has a net pay money purchase scheme, Michael contributes £6,000 to this and his employer contributes £12,000. 

As the scheme is a net pay arrangement, Michael’s total income (for the taper calculation purposes) is actually £159,000 as net pay contributions are deducted before tax becomes payable. So, his tapered AA is £26,500, with total inputs so far of £18,000. Therefore, Michael has £8,500 of AA left for the tax year. 

At the end of the year Michael’s employer makes a pension contribution for him of £8,000.

The issue here is the new employer contribution is included in the taper calculation, changing Michael’s adjusted income to £185,000. The knock-on effect on his tapered AA, reduces this to £22,500. However, his total AA usage is now £26,000, so an excess of £3,500 exists. There’s no carry forward available, resulting in an AA charge of £1,575.

A further complication in this is that mandatory scheme pays can’t be used to pay the charge. 

You can only call upon mandatory scheme pays if your tax charge is above £2,000 and your scheme inputs for the tax year are above £40,000. So, Michael has £8,000 extra in his pension from his employer but it has cost him an extra £1,575. If he extracts this at higher rate tax (including the Pension Commencement Lump Sum (PCLS) and factoring in the AA charge), he will receive £4,025 in his bank account.

Read full article here

Pensions, Tax, Trust & ISA