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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 recent article “Tapered annual allowance & high earners” describing the changes to be implemented from 6 April 2016 affecting those with high earnings with the tests for those earning £110,000 (threshold income) or more and the potential for losing annual allowance for clients with adjusted income over £150,000.

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 £175,000 with no reductions to make. So threshold income = £175,000

             - Adjusted income calculation

                - - Adjusted income will have no elements removed or added so the adjusted income level is £175,000

                - - Tapered annual allowance will be £175,000 - £150,000 = £25,000 / 2 = £12,500

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

 B.            £260,000 income made up of rental income (£70,000), 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 (£70,000) and salary (£160,000). Bond income within the 5% allowances is not subject to immediate income tax. = £230,000.

             - Minus the personal pension contribution of £20,000 = £210,000.

             - Adjusted income calculation

                - - Total income subject to income tax = £230,000 (again, 5% bond income excluded) plus individual pension contribution (£20,000) = £230,000

                - - Tapered annual allowance will be £230,000 - £150,000 = £80,000 / 2 = £40,000. However, tapering is capped to a maximum reduction of £30,000 to take the tapered annual allowance down to £10,000

 C.            £160,000 income made up of rental income (£30,000) and salary (£130,000). Personal pension contributions and employer contributions based on 10% (£13,000 each) salary each 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).

  • Threshold income calculation

             - Total income subject to income tax = rental income (£30,000) and salary (£130,000) = £160,000

             - Adjusted income calculation

                - - Total income subject to income tax = £160,000 plus employer pension contribution (£13,000) plus the employee contribution via net pay arrangement (£13,000) = £186,000

                - - Tapered annual allowance will be £186,000 - £150,000 = £36,000 / 2 = £18,000

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

D.            £160,000 income made up of rental income (£30,000) and salary (£130,000). 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 (£130,000) = £160,000

             - Minus personal pension contributions (£10,000 + £45,000) = £105,000

As the personal pension contribution has reduced the threshold income down to below the £110,000 limit, there is no need to do an adjusted income calculation and the client will have a full annual allowance available.

E.            £160,000 income made up of rental income (£30,000) and salary (£130,000). 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 (£130,000) = £160,000

             - Minus personal pension contribution (£15,000) = £145,000

             - Adjusted income calculation

                - - Total income subject to income tax = £160,000

                - - Tapered annual allowance will be £160,000 - £150,000 = £10,000 / 2 = £5,000

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

 F.            Income made up of savings income (£10,000) 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 (£10,000) and salary (£100,000) = £110,000

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 £110,000 meaning it does not exceed the £110,000 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 (£10,000) and salary (£120,000). Employer pension contributions (£20,000) made up of salary sacrifice entered into from August 2015.

  • Threshold income calculation

             - Total income subject to income tax = savings income (£5,000) plus rental (£10,000) and salary (£120,000) = £135,000.

             - As the salary sacrifice was entered into post 8 July 2015 this is not effective for these calculations and has to be counted, so £135,000 + £20,000 = £155,000

             - Adjusted income calculation

                - - Total income subject to income tax = savings income (£5,000) plus rental (£10,000) plus salary (£120,000) and the employer contributions post 8 July salary sacrifice (£20,000) = £155,000

                - - Tapered annual allowance will be £155,000 - £150,000 = £5,000 / 2 = £2,500

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

H.           Income made up of £110,000 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.

  • Threshold income calculation

             - Total income subject to income tax = salary (£110,000) plus investment (£30,000) = £140,000

             - Minus personal contribution (£30,000) = £110,000

The total of the client's threshold income calculation is exactly £110,000 meaning it does not exceed the £110,000 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 £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 £20,000.

  • Threshold income calculation

             - Total income subject to income tax = salary (£110,000) plus investment (£30,000) = £140,000

             - Minus personal contribution (£20,000) = £120,000

             - Adjusted income calculation

                - - Total income subject to income tax = salary (£110,000) plus investment (£30,000) plus personal pension contributions via net pay arrangement (£5,000), plus employer contributions (£30,000) = £175,000

                - - Tapered annual allowance will be £175,000 - £150,000 = £25,000 / 2 = £12,500

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

J.        Income made up of £40,000 dividends and salary of £80,000. Employer has made a contribution of £40,000.

  • Threshold income calculation

             - Total income subject to income tax =   dividends (£40,000) plus salary (£80,000) = £120,000.

             - Adjusted income calculation

                - - Total income subject to income tax =   dividends (£40,000) plus salary (£80,000) plus employer contribution (£40,000) = £160,000.

                - - Tapered annual allowance will be £160,000 - £150,000 = £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 + £80,000 - £10,000 = £110,000 – passes threshold income test so no adjusted income test is needed and they will retain their full annual allowance. If we take this a stage further and the client pays a £20,000 personal pension contribution via relief at source and not only do they then not reach the threshold level of income but they will also regain their personal allowance by reducing their adjusted net income figure to £100,000.

K.            £165,000 income made up of rental income (£30,000) 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 (£30,000) and salary (£130,000) = £165,000

             - Minus personal pension contribution (£15,000) = £150,000

             - Adjusted income calculation

                - - Total income subject to income tax = £165,000 plus personal pension contribution (£15,000) = £180,000

                - - Tapered annual allowance will be £180,000 - £150,000 = £30,000 / 2 = £15,000

                - - £40,000 - £15,000 = £25,000

In addition to the £25,000 current year’s annual allowance it should be remembered the client can still utilise carry forward from the previous year’s unused annual allowance. So, in this case, assuming the client or his employer had not made contributions in the previous three years but was a member of a registered pension scheme, they could pay up to £155,000. This would be made up of £25,000 for the current tax year (2016/17)(less the £15,000 already paid in this example), £50,000 carry forward from tax year 13/14 and £40,000 carry forward from both 14/15 and 15/16 tax years.  

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.

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

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

It is based on Old Mutual Wealth or Old Mutual International's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. We 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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