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Tapered Annual Allowance

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Phone icon Last updated 9 December 2020

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Tapered Annual Allowance

From 6 April 2016 a tapered annual allowance was introduced so that individuals with income above £150,000 have their standard annual allowance reduced on a tapered basis. The annual allowance of £40,000 was reduced by £1 for every £2 of income above £150,000, subject to a minimum reduced annual allowance of £10,000.

From April 2020 the amount of the threshold where the allowance is tapered has increased to £240,000 so that anyone with both an ‘adjusted’ income of over £240,000 and ‘threshold’ income of £200,000 will have their allowance reduced accordingly.

Adjusted Income

For the purpose of the tapered annual allowance the income definition is known as 'adjusted income'.  This definition is based on the individual’s total taxable income, including any investment income, after allowing for certain reliefs plus the value of their pension savings during the tax year. If this total falls below £240,000 then the tapered annual allowance does not apply.

Total gross income from all sources including income, benefits in kind and investments income less any available reliefs
+
Any employer contributions, including personal payments under a net pay arrangement
-
Any taxed lump sum death benefits received
=
Adjusted income

Threshold income

If the adjusted income is more than £240,000 the taper will only take effect if an additional limit – known as ‘threshold income’ – of £200,000 is also breached. The definition of threshold income is the individual’s taxable income after allowing for certain reliefs plus the value of certain pension-related salary sacrifice type arrangements. If threshold income is less than £200,000 then the tapered annual allowance will not apply.

Total gross income from all sources including income, benefits in kind and investments income less any available reliefs
+
Any salary sacrifice arrangement set up on or after 9 July 2015
-
Deduct any gross personal contributions regardless of the method of relief
-
Any taxed lump sum death benefits received
=
Threshold income


In brief summary, the differentiating feature between Adjusted income and Threshold income is pension contributions. The formula for Adjusted income includes all pension contributions while the formula for threshold deducts all member pension contributions and employer contributions are not taken into account.

Both definitions of income include all forms of taxable income so in addition to earnings other items including benefits in kind, investment income and rental income need to be factored in. Deductions against this total will include items such as trading losses and charitable gifts – the full list is included in the Income Tax Act 2007.

Examples

Client A

  • Client A has self employment income of £240,000 and dividend income of £5,000. 
  • There are no trading losses or any other deductions. 
  • Client A is self employed so there are no employer contributions but a personal contribution has been paid £56,000 this tax year using carry forward
Adjusted Income is calculated as follows:
Income of £240,000 + £5,000 less reliefs £0 plus
Employer contributions £0 less 
Taxed death benefits £0
= £245,000

Threshold Income is calculated as follows:
Income of £240,000 + £5,000 less reliefs £0 less
Pension contributions £56,000 less
Taxed death benefits £0
= £189,000

Client A’s adjusted income is over the £240,000 limit but as threshold income is less than £200,000 then tapering will not apply. 
 
Client B
  • Client B has earned income of £250,000 with benefits in kind of £10,000 and investment income of £5,000. 
  • The employer pays £12,000 into the workplace pension plan
  • Client B makes personal contributions of £20,000. 
Adjusted Income is calculated as follows:
Income of £250,000 + £10,000 + £5,000 less reliefs £0 plus
Employer contributions £12,000 less 
Taxed death benefits £0
= £277,000

Threshold Income is calculated as follows:
Income of £250,000 + £10,000 + £5,000 less reliefs £0 less
Pension contributions £20,000 less
Taxed death benefits £0
= £245,000

Client B will be subject to tapering as the adjusted income is in excess of £240,000 and threshold income is in excess of £200,000.

The reduction in the annual allowance is calculated as a £1 reduction for every £2 of income over the £240,000 limit:-
(£277,000 - £240,000) / 2 = £18,500
£40,000 - £18,500 = £21,500

As Client B has made £32,000 of pension inputs for the year she will need to rely on carry forward to ensure no annual allowance charge will apply. 
 

Money Purchase Annual Allowance (MPAA)

Tapering will reduce the alternative annual allowance for anyone who is subject to the MPAA. The alternative annual allowance is the standard allowance, currently £40,000, less the MPAA giving an alternative allowance limit of £36,000.

Anti avoidance

Anti-Avoidance rules apply to the tapering rules to prevent anyone entering into a salary sacrifice arrangement after 9 July 2015 from reducing their adjusted or threshold income. If the rule applies then the income used to calculate any reduction is based on the total prior to the deductions – in effect adding back in the value of the sacrifice.

Important Information

The information provided is based on our current understanding of the UK legislation and may be subject to amendments as a result of changes in legislation.

All references to taxation are based on our understanding of current UK taxation law and may be affected by future changes in legislation, the individual circumstances of the investor and pension scheme conditions.

The information provided in this article is not intended to offer advice.

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