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Tapered annual allowance causing ‘untold damage’ to pensions understanding, confidence and trust

20 May 2019

While much attention has focused on NHS staff being hit with an unwelcome tax bill as a result of the government’s tapered annual allowance, the “dastardly” pension tax affects many more workers across the public and private sector, and is having a negative impact on people’s confidence and trust in pensions at a time when they need them most, Tom Selby, senior analyst at AJ Bell, has warned. 

According to Selby, around 300,000 people are estimated to be affected by the taper.

As a result, someone who delayed contributing to a pension until age 40 could be restricted to saving £250,000 tax-free by age 65. This figure would equate to a pot of £537,000 even with real investment growth of 5% a year, resulting in an inflation-linked annuity worth less than £18,000 a year, Selby said.

Whether someone is affected by the taper depends on two elements: adjusted income and threshold income. The former includes all taxable income and employer pension contributions, while the latter is the total taxable income and any salary sacrifice arrangements set up since 9 July 2015, less any personal pension contributions. Lump sum death benefits, where the recipient is liable to tax, are also deducted from both income measures.

If an individual’s adjusted income exceeds £150,000 and their threshold income is above £110,000, they will be affected by the taper. Their annual allowance will be reduced by £1 for every £2 of adjusted income above the £150,000 threshold.

Selby said of the pension tax: “Tens of thousands of private sector workers are having their ability to save severely restricted by this complex policy. In fact, the vast majority of people hit by the taper will be in the forgotten generation of people in their forties and fifties who missed out on the glory years of defined benefits and for whom automatic enrolment has arrived too late.”

Selby said many will have little to no pension provision at all from their earlier careers, possibly because their wages were lower, their employer didn’t offer a scheme or they prioritised buying a house and raising a family.

“Whatever the reason, the taper acts as a monumental brake for people looking to make up for lost time saving for retirement,” Selby continued. “It cannot be right that someone who has delayed saving until their 40th birthday risks having their retirement aspirations constrained to a private pension income worth less than two-thirds of the average UK salary.”

Selby said the complexity of the system means it will be difficult for savers to know in advance whether or not they will be affected in any given tax year.

He added: “Measures such as the taper are causing untold damage to people’s understanding, confidence and trust in pensions and making it difficult to explain the benefits of saving in a clear and simple way. The government must now scrap the taper and consider whether the overall pension tax system is really fit for purpose. A move towards greater simplification – with an emphasis on encouraging higher levels of pension saving in the UK – could help cement the retirement revolution automatic enrolment has started.”

How it works in practice – case study 

Georgina earned a salary of £130,000 and investment income of £10,000 in the 2018/19 tax year. Her employer made a £30,000 contribution and she personally contributed £10,000. Her adjusted income is £170,000 – £140,000 income chargeable to income tax plus £30,000 employer pension contribution.

Georgina’s threshold income is £130,000 – £140,000 income minus the £10,000 personal contribution.

As both her threshold and adjusted income are above the government limits, Georgina is subject to the taper and her annual allowance is reduced by £10,000 to £30,000. As her total pension contributions were £40,000, she will be subject to a tax charge on the £10,000 excess unless she has carry forward available.

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