The government is generous when it comes to pensions. If you are a top rate taxpayer, HMRC will add 45% to your pension contributions in tax relief. It helps ensure that your pension is among the most rewarding investments you can make.
However, there are limits to this generosity, which prevent the seriously wealthy from abusing the system. The first is a limit on the lifetime pension contribution to £1.03 million. The second is the limit on the annual allowance.
Most people can save up to £40,000 into their pension pot each tax year and take advantage of the tax relief on it all. However, for some high earners this limit is reduced. They can still make contributions, but the taxman will limit the level of relief they can enjoy.
It is a complicated tax. We look at how it is applied, to help you see whether it will be costing you money this tax year.
Are you liable for Tapered Annual Allowance?
The government has not introduced a cut off point which spells an end to pension tax relief. Instead they introduce a tapered allowance, by which the tax allowance is reduced progressively in line with earnings.
People with an ‘adjusted’ income over £150,000 will have their annual allowance restricted. This means that for every £2 of income they have over £150,000, their annual allowance is reduced by £1. The reduction doesn’t apply to anyone with ‘threshold income’ of less than £110,000.
The maximum reduction will be £30,000. So, anyone with an income of £210,000 or more will see their annual allowance fall to £10,000. Critics, of which there are many, point out that this is a tax by stealth, while others complain that the complications involved seem deliberately designed to baffle anyone who is not a tax expert.
There are certainly some calculations to do. Obviously, the key to understanding these calculations is to know the difference between adjusted income and threshold income.
Both include all taxable income, and are not restricted to earnings. Investment income of all types and benefits such as medical insurance premiums paid by the employer must also be included.
In a nutshell, adjusted income includes all pension contributions while threshold income excludes pension contributions.
HMRC provide a detailed guide to work this out. The basic steps are:
1.Work out your net income
Add up your taxable income and deduct any tax reliefs paid before the relief was given.
2.Work out your threshold income
Start with your net income for the tax year and deduct the gross amount of your pension savings from all schemes.
Add any reduction of employment income for pension provision through any relevant salary sacrifice arrangements and any relevant flexible remuneration arrangements.
3.Work out your adjusted income
Start with your net income for the tax year. Add the amounts of claims made for tax relief on pension savings. If your permanent home is outside the UK, add any relief claimed on pension savings you made to overseas pension schemes.
Add the amount of pension savings your employer made for you.
Get some help
The calculations are complicated, and most people will need some help to work out what their charges will actually be under Tapered Relief. The good news is, that once you understand exactly what your current liabilities are there may be ways to help you mitigate them.
At Continuum, we will be happy to work with you to provide the solutions.
The value of investments can fall as well as rise and you may get back less than you invested.
Levels and basis of reliefs from taxation are subject to change and depend upon your personal circumstances.