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calculation of additional contributions and Tapered AA

Much has been written about the tapered annual allowance and the income considerations that need to be accounted for as part of this calculation. Please see tapered annual allowance and high earners for further information. It has also been made clear in other articles when and which type of pension contribution needs to be taken into consideration. Please see tapered annual allowance examples for further information.

However, when looking at the tapered annual allowance calculations little has been written on the impact of making additional contributions when the client is close or is already impacted by the tapered annual allowance. Although there are calculators that can be used there are few simple explanations of the impact of any such contributions.

This is a short summary of the calculation with examples that may be of use as a quick reference. This summary is made in relation to any additional personal contributions being made via the Net Pay Arrangement method and employer contributions only.

As you will see, small changes to figures can create significant differences to the funding available. In all cases remember that the tapered annual allowance only affects the annual allowance in the specific tax year and not others, this means that there is potential for carry forward of unused annual allowance from the previous 3 tax years based on the full annual allowances applicable in those years.

Scenario; Failing threshold income calculation and approaching adjusted income limits to trigger tapered annual allowance

In this scenario the client has income calculated which is in excess of the threshold income limit of £110,000 but is currently below the adjusted income level for taper to apply (£150,000). If an employer is looking to make a contribution you need to be aware of the impact this may have on the client’s annual allowance and if there will be scope available. This is not as simple as just saying you will add in the contribution as this contribution will vary 2 elements of the calculation; the level of annual allowance available under taper rules and the available annual allowance after a contribution has been made.   

In simple terms the calculation can be done by;

1. Looking at the difference between the adjusted income calculation and £150,000. Take this from the proposed pension contribution
2. Taking the residual proposed contribution (the part which will reduce down the tapered annual allowance over £150k) and dividing by 2 and multiplying the result by 3.
3. From the full annual allowance of £40,000 take away the result from 2.
4. Take away from this figure any amount deducted from the proposed contribution under point 1.
5. This will give you the position after making the proposed contribution. If this is a negative figure, this will be in excess of the available annual allowance when recalculated to take into consideration the new pension contribution.

Example A

  • Client has initial adjusted income of £140,000 and their employer is proposing to make a pension contribution of £35,000 and the client wishes to know if they have scope to do this.
  • From the £35,000 remove £10,000 to take the client’s income up to the taped limit, leaving £25,000 of proposed contribution.
  • Divide the £25,000 by 2 to get £12,500 and multiply by 3 to get £37,500.
  • From the full annual allowance of £40,000 take away £37,500 to get £2,500.
  • Take £10,000 (difference between proposed contribution and £150,000) from £2,500 = -£7,500
  • This shows the client will have exceeded the available tapered annual allowance by -£7,500 after making the proposed contribution.
  • The adjusted income level will now be seen as £175,000

Example B

  • Client has initial adjusted income of £140,000 and their employer is proposing to make a pension contribution of £45,000 and the client wishes to know if they have scope to do this.
  • From the £45,000 remove £10,000 to take the client’s income up to the taped limit, leaving £35,000 of proposed contribution.
  • Divide the £35,000 by 2 to get £17,500 and multiply by 3 to get £52,500.
  • From the full annual allowance of £40,000 take away £52,500 to get £-12,500.
  • Take £10,000 (difference between proposed contribution and £150,000) from -£12,500 = -£22,500
  • This shows the client will have overfunded the tapered annual allowance by -£22,500 after making the proposed contribution.
  • The adjusted income level will now be seen as £185,000

Scenario; Within the £150,000 adjusted income limits and proposing to invest up to £60,000, so altering the amount of tapered annual allowance

This scenario is similar to the first scenario but rather than having to consider contributions that do and do not affect the tapered annual allowance, this is slightly simpler where the proposed contribution will fall within the scope of the annual allowance. This calculation will have to consider the amount of the contribution proposed and also the effect this has on the adjusted income and therefore the tapered allowance. If the adjusted income is greater than £150,000 this excess will simply be removed before the final part of the calculation

Example A

  • Client has initial adjusted income of £155,000 and the employer is looking to make a pension contribution of £20,000 (in reality this figure could be any between £1 and £60,000 and the process is the same).
  • Divide the total in excess of the £150,000 threshold (£25,000) by 2 to get £12,500 and multiply by 3 to get £37,500.
  • From this figure take away the existing excess over the £150,000 threshold (£5,000) = £32,500
  • From the full annual allowance of £40,000 take away £32,500 to get £7,500
  • This shows the client will have unused tapered annual allowance of £7,500 after making the proposed contribution
  • The adjusted income level will now be seen as £175,000.

Example B

  • Client has initial adjusted income of £160,000 and the employer is looking to make a pension contribution of £25,000 (in reality this figure could be any between £1 and £60,000 and the process is the same).
  • Divide the total in excess of the £150,000 threshold (£35,000) by 2 to get £17,500 and multiply by 3 to get £52,500.
  • From this figure take away the existing excess over the £150,000 threshold (£10,000) = £42,500
  • From the full annual allowance of £40,000 take away £42,500 to get -£2,500
  • This shows the client will have overfunded the tapered annual allowance by £2,500 after making the proposed contribution.
  • The adjusted income level will now be seen as £185,000.

Step by step summary for the application of additional contributions

 

Existing adjusted income £150,000 or below.

Add the proposed pension contribution to the adjusted income. Record the excess pension contribution over £150,000
£______

Divide by 2 and then multiply by 3

£______

Add difference between adjusted income and £150,000 (if adjusted income already greater than £150,000 ignore this step)
£______

Take answer above from full annual allowance (£40,000)

£______

Result
£______ = remaining annual allowance if proposed contribution is made.

 

Existing adjusted income at £150,000 or above.

Add the total adjusted income excess over £150,000 plus the proposed contribution
£______

Divide by 2 and then multiply by 3

£______

minus existing adjusted income excess over £150,000

£______

Take answer above from full annual allowance (£40,000)

£______

Result
£______ = remaining annual allowance if proposed contribution is made.

 

Created: May 2017


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

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown on the title page. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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