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Tapered Annual Allowance and Carry Forward – new rules examined

18 August 2020

Stephen McPhillips, technical sales director, Dentons Pension Management Limited looks at the new threshold and adjusted income definition amounts applicable from 6 April 2020.

Readers will no doubt already be familiar with the concepts of Annual Allowance (AA) and Carry Forward of unused AA in relation to tax relievable pension contributions. Those readers with clients whose annual earnings extend beyond six figures may also have had practical experience of the Tapered Annual Allowance (TAA) in action. The TAA came into operation on 6 April 2017.

The recent changes to the earnings figures for “threshold” and “adjusted” definitions will have brought some welcome relief for those previously impacted by the TAA, but how does this make a difference in practice, particularly when it comes to Carry Forward?

The new threshold and adjusted income definition amounts came into effect on 6 April 2020. The threshold income figure was increased from £110,000 to £200,000 and the adjusted income figure was increased from £150,000 to £240,000. Each of these changes will have positive effects for many high-earning pension savers who otherwise would have been impacted by an AA Tax Charge. Some senior NHS clinicians (and others) were amongst the groups of people who had been affected by the TAA at the previous levels.

In order to demonstrate the positive effects of the change, and in relation to Carry Forward, it may help to consider a case study:

Case Study

Kathy has been a member of a registered pension scheme since 2009 and therefore has potential capability to carry forward unused AA from the previous three tax years to the current tax year. Kathy’s adviser makes her aware that the current year’s AA must be used first before any unused AA can be carried forward from earlier years.

Kathy’s earnings in the tax year 2019/2020 were £200,000. This, in turn meant that her available AA for that year was scaled back by the TAA to £15,000. Kathy’s earnings in the earlier tax years meant that she was unaffected by the TAA, and she made pension contributions as shown in the table below.

Kathy’s earnings in the tax year 2020/2021 are also £200,000. However, because of the increase in threshold earnings from £110,000 to £200,000 for this tax year, Kathy is no longer subject to the TAA and has a full AA of £40,000 instead of it being tapered back to £15,000. In turn, this means that her available AA has increased by £25,000.

The tables indicate how Kathy’s carry forward position would have looked before and also after the changes to the TAA. From these, it is clear that Kathy’s maximum tax relievable contribution in the current tax year has increased from £55,000 to £80,000.

Kathy’s carry forward position, had there been no changes to TAA:

Year               Adjusted income        AA                 Employee Cont.     Unused AA

2020/21          £200,000                   £15,000         £0                           £15,000

2019/20          £200,000                   £15,000         £10,000                  £5,000

2018/19          £75,000                     £40,000         £20,000                  £20,000

2017/18          £65,000                     £40,000         £25,000                  £15,000

Kathy’s carry forward position, following changes to TAA:

Year                 Adjusted income      AA                Employee Cont.       Unused AA

2020/21            £200,000                 £40,000        £0                             £40,000

2019/20            £200,000                 £15,000        £10,000                    £5,000

2018/19            £75,000                   £40,000        £20,000                    £20,000

2017/18            £65,000                   £40,000        £25,000                    £15,000

The net effect of the changes to the TAA mean that Kathy can maximise her pension contributions in the current tax year in a highly tax-efficient manner. Given the level of her earnings, Kathy should obtain full tax relief on the pension contribution of £80,000 in the 2020/2021 tax year.

Technical notes:

  1. ‘Member’ means active member, pensioner member, deferred pensioner member or pension credit member.
  2. Tapered annual allowance reduces a pension scheme member’s annual allowance on a sliding scale for a tax year in which their ‘adjusted income*’ exceeds a certain figure. For the 2020/21 tax year, this is £240,000. Members with an adjusted income of £312,000 or more in the tax year 2020/21 will have a maximum tapered annual allowance of £4,000. The tapered annual allowance will not apply if a member’s ‘threshold income’ is £200,000 or less, even if they have adjusted income of £240,000 or more. The annual allowance was not affected by the tapering in tax years prior to 2016/17, although it may have been affected by the money purchase annual allowance from 6/4/2015.
  3. Adjusted income includes the member’s earnings, dividends, interest on savings and pension contributions (including those made as a result of a salary sacrifice or similar arrangement).
  4. Threshold income is broadly similar to adjusted income except that pension contributions that entitle the member to Relief at Source and employer contributions resulting from a salary sacrifice (or similar arrangement) made before 9 July 2015 are excluded.

 

 

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