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Tapered annual allowance – examples

We have put together some simple examples to help explain Tapered annual allowance and how the client may be affected.

You may have seen our article “Tapered annual allowance & high earners” describing the changes brought in from 6 April 2016 and amended in April 2020 affecting those with high earnings with the tests for those earning £200,000 (threshold income) or more and the potential for losing annual allowance for clients with adjusted income over £240,000.

Here we have put together some simple examples to explain a few of the different situations and how the client may be affected.

You will note that under examples B, C, E and J the clients have made pension contributions before the Threshold and Adjusted income levels have been calculated and in these cases the reduced annual allowance has meant that the client has now breached the lower annual allowance. This is a scenario that high earners will need to be aware of. 

Please note: these examples are designed to be read after you have read the Tapered Annual Allowance & High Earners article.

A.            £175,000 income made up of salary, p11D, pension income and savings. No pension contributions

  • Threshold income calculation

             - Total income subject to income tax of £265,000 with no reductions to make. So threshold income = £265,000

  • Adjusted income calculation

             - Adjusted income will have no elements removed or added so the adjusted income level is £265,000

             - Tapered annual allowance will be £265,000 - £240,000 = £25,000 / 2 = £12,500

             - £40,000 - £12,500 = £27,500

 B.            £360,000 income made up of rental income (£170,000), salary (160,000), and 5% bond withdrawal £30,000). Personal pension contributions of £20,000 made through relief at source (paid from net salary and grossed up by basic rate tax by the pension provider. Any higher rate tax can be reclaimed separately by the client via a stand-alone claim or self-assessment).

  • Threshold income calculation

             - Total income subject to income tax = rental income (£170,000) and salary (£160,000). Bond income within the 5% allowances is not subject to immediate income tax so discounted from this calculation. = £330,000.

             - Minus the personal pension contribution of £20,000 = £310,000.

  • Adjusted income calculation

             - Total income subject to income tax = £330,000 (again, 5% bond income excluded and individual pension contribution £20,000 made by relief at source ignored) = £330,000

             - Tapered annual allowance will be £330,000 - £240,000 = £90,000 / 2 = £45,000. However, tapering is capped to a maximum reduction of £36,000 to take the tapered annual allowance down to £4,000

 C.            £250,000 income made up of rental income (£120,000) and salary (£130,000). Personal pension contribution paid via net pay arrangement (pension contribution taken from gross pay by the employer and paid into the pension therefore giving immediate tax relief at highest marginal rate and no need to claim any tax back) and employer contribution based on 10% (£13,000 each) of adjusted salary each. Note, when calculating net income for tapered annual allowance calculations, always deduct personal contributions paid by the net pay arrangement.

  • Threshold income calculation

             - Total income subject to income tax = rental income (£120,000) and salary (£130,000) = £250,000

  • Adjusted income calculation

             - Total income subject to income tax = £250,000 plus employer pension contribution (£13,000) plus the employee contribution via net pay arrangement (£13,000) = £276,000

             - Tapered annual allowance will be £276,000 - £240,000 = £36,000 / 2 = £18,000

             - £40,000 - £18,000 = £22,000

D.            £250,000 income made up of rental income (£30,000) and salary (£220,000). Personal pension contributions paid of £10,000 via relief at source. However, this year the client has also paid an additional £45,000 personal contribution to use up some carry forward.

  • Threshold income calculation

             - Total income subject to income tax = rental income (£30,000) and salary (£220,000) = £250,000

             - Minus personal pension contributions (£10,000 + £45,000) = £195,000

As the personal pension contribution has reduced the threshold income down to below the £200,000 limit, there is no need to do an adjusted income calculation and the client will have a full annual allowance available.

E.            £250,000 income made up of rental income (£30,000) and salary (£220,000). Personal pension contributions paid of £15,000 via relief at source.

  • Threshold income calculation

             - Total income subject to income tax = rental income (£30,000) and salary (£220,000) = £250,000

             - Minus personal pension contribution (£15,000) = £235,000

  • Adjusted income calculation

             - Total income subject to income tax = £250,000

             - Tapered annual allowance will be £250,000 - £240,000 = £10,000 / 2 = £5,000

             - £40,000 - £5,000 = £35,000

 F.            Income made up of savings income (£100,000) and salary (£100,000). Employer pension contributions (£20,000) made up of salary sacrifice entered into from 2014.

  • Threshold income calculation

             - Total income subject to income tax = savings income (£100,000) and salary (£100,000) = £200,000

As the salary sacrifice took place prior to 9 July 2015 this is not taken onto consideration as part of the calculation and so can be ignored.

The total of the client's threshold income calculation is exactly £200,000 meaning it does not exceed the £200,000 limit so there is no need for an adjusted income calculation and the client will have a full annual allowance available.

 G.           Income made up of savings income (£5,000), rental income (£100,000) and salary (£120,000). Employer pension contributions (£20,000) made up of salary sacrifice entered into from August 2016.

  • Threshold income calculation

             - Total income subject to income tax = savings income (£5,000) plus rental (£100,000) and salary (£120,000) = £225,000.

             - As the salary sacrifice was entered into post 8 July 2015 this is not effective for these calculations and has to be counted, so £225,000 + £20,000 = £245,000

  • Adjusted income calculation

             - Total income subject to income tax = savings income (£5,000) plus rental (£100,000) plus salary (£120,000) and the employer contributions post 8 July salary sacrifice (£20,000) = £245,000

             - Tapered annual allowance will be £245,000 - £240,000 = £5,000 / 2 = £2,500

             - £40,000 - £2,500 = £37,500

H.          Income made up of £200,000 salary and £30,000 investment income. Employer makes a pension contribution of £30,000 and the employee makes a contribution of £5,000 (net pay arrangement). The client also makes a personal contribution (relief at source) of £30,000. Note, when calculating net income for tapered annual allowance calculations, always deduct personal contributions paid by the net pay arrangement.

  • Threshold income calculation

             - Total income subject to income tax = salary (£200,000) plus investment (£30,000) = £230,000

             - Minus personal contribution (£30,000) = £200,000

The total of the client's threshold income calculation is exactly £200,000 meaning it does not exceed the £200,000 limit so there is no need for an adjusted income calculation and the client will have a full annual allowance available.

I.            Income made up of £110,000 salary and 120,000 investment income. Employer makes a pension contribution of £30,000 and the employee makes a contribution of £5,000 (net pay arrangement). The client also makes a personal contribution (relief at source) of £20,000. Note, when calculating net income for tapered annual allowance calculations, always deduct personal contributions paid by the net pay arrangement.

  • Threshold income calculation

             - Total income subject to income tax = salary (£110,000) plus investment (£120,000) = £230,000

             - Minus personal contribution (£20,000) = £210,000

  • Adjusted income calculation

             - Total income subject to income tax = salary (£110,000) plus investment (120,000) plus personal pension contributions via net pay arrangement (£5,000), plus employer contributions (£30,000) = £265,000

             - Tapered annual allowance will be £265,000 - £240,000 = £25,000 / 2 = £12,500

             - £40,000 - £12,500 = £27,500

J.        Income made up of £40,000 dividends and salary of £170,000. Employer has made a contribution of £40,000.

  • Threshold income calculation

             - Total income subject to income tax =   dividends (£40,000) plus salary (£170,000) = £210,000.

  •  Adjusted income calculation

             - Total income subject to income tax =   dividends (£40,000) plus salary (£170,000) plus employer contribution (£40,000) = £250,000.

             - Tapered annual allowance will be £250,000 - £240,000 = £10,000 / 2 = £5,000

             - £40,000 - £5,000 - £35,000

Alternatively the client makes a personal contribution via relief at source of £10,000 therefore the threshold calculation is £40,000 + £170,000 - £10,000 = £200,000 – passes threshold income test so no adjusted income test is needed and they will retain their full annual allowance.

K.            £255,000 income made up of rental income (£120,000) and salary (£135,000). Personal pension contributions paid of £15,000 via relief at source.

  • Threshold income calculation

             - Total income subject to income tax = rental income (£120,000) and salary (£135,000) = £255,000

             - Minus personal pension contribution (£15,000) = £240,000

  • Adjusted income calculation

             - Total income subject to income tax = £255,000

             - Tapered annual allowance will be £255,000 - £240,000 = £15,000 / 2 = £7,500

             - £40,000 - £7,500 = £32,500

In addition to the current year’s annual allowance it should be remembered the client can still utilise carry forward from the previous year’s unused annual allowance.This would involve applying this taper calculation to any previous tax years where the client was a high earner. Please remember that the taper limits for both threshold and adjusted income levels were lower for tax years 2016/17 to 2019/20.

These examples all show how the client's current year’s pension contribution may be restricted for annual allowance purposes. It must be remembered that this amount may change every year depending on the level of income used for the adjusted income calculations.

 

Created February 2016 

For financial advisers only. Not to be relied on by consumers.


 

 

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