How to help clients affected by the tapered annual allowance

These have got me thinking how these payments could impact a client’s annual allowance, for example, if a client’s income is more than £200,000.

This in turn reminded me of wonderful phrases, such as ‘threshold’ and ‘adjusted income’.

So I thought it would be useful to cover the detail behind the tapered annual allowance and who it may impact. 

The tapered annual allowance was first implemented in 2016-17 to restrict the cost of pension tax relief given to high earners.

It originally affected those that had both threshold income over £110,000 and adjusted income over £150,000.

In 2020-21 there were substantial increases in the income thresholds. That meant the tapered annual allowance now affects far fewer clients.

The limits are:

• amounts over £200,000 for threshold income, and 
• amounts over £240,000 for adjusted income. 

What is threshold income?  

Threshold income is one of two measures used to determine if an individual will be subject to a tapered annual allowance.

If an individual has a threshold income of £200,000 or less they cannot be subject to the tapered annual allowance and there is no requirement to calculate adjusted income. 

If however, the threshold income exceeds £200,000 you must calculate adjusted income to work out the amount of any tapered annual allowance.

Threshold income is:

• Taxable income for the tax year less any allowable reliefs under section 23 ITA 2007, minus 
• the gross amount of any pension contributions made using relief at source, plus  
• the amount of employment income given up for any pension contributions made by the employer (ie, salary sacrifice) under an arrangement made on or after 9 July 2015, minus
• the amount of any taxable lump-sum pension death benefits paid to the individual during the tax year that can be deducted from the threshold income.For example, that might be a lump sum paid:
• On death of a scheme member after age 75.
• On death before age 75 when the lump sum was not paid within the required two-year period.

The threshold income helps to provide a safety net for individuals with lower salaries who may have one-off spikes in the value of their employer pension contributions.

If the individual’s net (taxable) income is no more than £200,000, they will not normally be subject to the tapered annual allowance.

However, anti-avoidance rules were introduced so that any salary sacrifice for pension savings that have been set up on, or after, 9 July 2015 will be included in the threshold income calculation.

What is adjusted income?  

‘Adjusted income’ is the other measure used to determine if an individual will be subject to a tapered annual allowance.

If the threshold income exceeds £200,000, and the adjusted income exceeds £240,000, the tapered annual allowance will apply. 

In broad terms, adjusted income is the employee’s net taxable income, plus the value of all employer pension contributions and any employee pension contributions made under a net pay scheme. 

Adjusted income is: 

• Taxable income for the tax year less any allowable reliefs under section 23 ITA 2007, plus:
• The value of any employer pension contributions made in the tax year
• Any employee contributions made under the net pay arrangement
• Any relief claimed by non-domiciled individuals for contributions to overseas pensions;

less:

• The amount of any taxable lump-sum pension death benefits paid to the individual during the tax year that can be deducted from the threshold income. 

Again, for example, that might be a lump sum paid:

• On death of a scheme member after age 75.
• On death before age 75, when the lump sum was not paid within the required two-year period.

Adjustments are made for employer contributions and those made to net pay arrangements because they are excluded from taxable income. Contributions under relief at source schemes are made from taxable income.   

The adjustments mean there is no benefit to be gained from choosing one form over another if the tapered annual allowance applies. 

For those members who only have defined benefit pension provision and employment income, you can calculate the adjusted income by simply adding the annual allowance used in the scheme to the P60 earnings.