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Technical: Income and the Annual Allowance taper

3 July 2017

Net income, Threshold income, Adjusted income – What’s the difference? It’s all in the definition, says Fiona Tait, technical director, Intelligent Pensions

We always knew the Annual Allowance (AA) taper would be complicated. The taper itself is simple enough – “the annual allowance is reduced by £1 for every £2 of income above £150,000, subject to a minimum reduced annual allowance of £10,000”. Quite frankly the sums are the easy bit, the difficulty lies in calculating the correct income.

Guidance in the Pensions Tax Manual (PTM) on this subject includes three separate income definitions, all of which are new to pension specialists.

Net income

While pension geeks have been wrestling with “adjusted” and “threshold” income, net income has been largely overlooked, despite the fact that it is fundamental to both. This may be because it is not a new term and most people have an idea of what they think net income is. Unfortunately most people would be wrong. In this context net income is not “income after tax” as we might suppose, it is actually “total pre-tax income”, i.e. income before any tax is deducted.

This is not a pension term, and it is much wider than the usual income definitions familiar to pension advisers. In simple terms it must include every source of income which is assessable to income tax:

• Earned income, including P11D benefits

• Pension income, including State Pension

• Savings income, including interest and dividends even if it is below the relevant allowance

• Rental income (minus expenses)

• Income from trusts received as an individual

Once this data has been collected there are a number of allowed deductions as listed in section 24 of the Income Tax Act 2007. It’s a fairly long list which can be accessed in the legislation itself: http://www.legislation.gov.uk/ukpga/2007/3/section/24. It is notable however that it includes some obvious deductions such as for trading losses, and also any relief for pension contributions made under net pay arrangements.

If the client has an accountant this information should be relatively easy to access as it conforms to Step 1 and Step 2 of the standard income tax calculation. If not, it is essential that information is gathered against each source of income and each potential deduction.

Threshold income

While the amount of any taper is dependent on the adjusted income (more later) it is worth calculating threshold income first. If threshold income is below £110,000 then the taper will not apply, regardless of the level of adjusted income.

Threshold income is defined as:

• Net income (as defined above)
plus

• Any employment income given up under a salary sacrifice arrangement
less

• Any taxable lump sum death benefits received in the tax year (i.e. from a donor aged over 75 at the time of death)
less

• Gross pension contributions paid under a relief at source (RAS) arrangement (note contributions under net pay have already been deducted under net pay calculation)

Adjusted income

If threshold income exceeds £110,000 then it is necessary to calculate the adjusted income. Adjusted income is defined as:

• Net income
plus

• Gross pension contributions made under a net pay arrangement (as these are deductible under the net income calculation they must be added back in)
plus

• Any excess relief given under net pay arrangements (also deductible from net income)

plus

• Relief on pension contributions made by non-domiciled individuals to an overseas pension scheme

less

• Any taxable lump sum death benefits received in the tax year (i.e. from a donor aged over 75 at the time of death)

If adjusted income exceeds £150,000 then the Reduced Annual Allowance is equal to:

Full annual allowance (£40,000) – ([adjusted income -£150,000]/2), subject to a minimum of £10,000

Other factors

Some individuals are caught by both the taper and the Money Purchase Annual Allowance (MPAA). If this is the case money purchase contributions must be assessed against the MPAA and defined benefit contributions, against the alternative annual allowance (AA). The alternative AA will be the reduced annual allowance minus the MPAA.

It is possible to use carry forward from previous years, however if the taper was applied in any of these years the amount available to carry forward will be the reduced annual allowance minus any contributions made.

There is also an anti-avoidance clause which would discount the effect of any action where the “main purpose, or one of the main purposes, is to reduce the amount an individual’s annual allowance is decreased under the tapered annual allowance provisions”.

So, there you have it. I only need to add that of course many individuals will not actually know what their net income is until well after the tax year has ended, therefore any calculation must necessarily be an estimate. Just one of the reasons why this unnecessary complication should be scrapped.

 

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