Pension funding changes: How will your retirement be affected?

5 May 2017 

Since 6 April 2016, individuals who have ‘adjusted’ income for a tax year of greater than £150,000 have had their annual allowance for making pension contributions in that tax year restricted.

The reduction meant that for every £2 of income they have over £150,000, their annual allowance was reduced by £1.

The maximum reduction is £30,000, so anyone with ‘adjusted’ income of £210,000 or more will have an annual allowance of £10,000.

High income individuals caught by the restriction may therefore have to reduce the pension contributions paid by them and/ or their employers — or suffer an annual allowance charge.

However, the tapered reduction doesn’t apply to anyone with ‘threshold income’ of no more than £110,000.The definitions of the two incomes are crucial to understanding whether you are affected by the tapered reduction or not.

So what is ‘adjusted’ income and ‘threshold’ income?

Both definitions include all taxable income, so this is not restricted to earnings – investment income of all types and benefits in kind such as medical insurance premiums paid by the employer will also be included.

The difference being adjusted income includes all pension contributions (including any employer contributions) while threshold income excludes pension contributions.

Those with income expected to fluctuate around the higher rate income tax threshold could consider delaying contributions until a later year when higher rates of tax relief might be achieved.

However, those with income together with relevant pension inputs above £150,000 per annum must consider the restriction in the annual allowance.

Carry forward

It is possible to use brought forward relief where the tapered annual allowance applies in a tax year. So, any unused annual allowance from the three tax years prior to the tax year in question can still be carried forward as normal and are done so in consecutive order.

The conditions that must be met to be able to carry forward unused annual allowances are minimal. An individual must have been a member of a registered pension scheme in the tax year they wish to carry forward from and the current year’s annual allowance must have been ‘used up’ in full (so, an excess above the current annual allowance will trigger an automatic carry forward).

Of the previous years, earlier ones are used in preference to later years; this ensures that unused allowances remain available for up to three tax years.

Annual allowance for each tax year to date:

Tax year       Annual allowance 
 2014/15        £40,000
 2015/16       £40,000
 2016/17
      £10,000 - £40,000
 2017/18       £10,000 - £40,000

 

The 2015/16 tax year was split into two periods, based on 8 July, which can mean an annual allowance of up to £80,000.

What about self-employed?

Whilst personal contributions are granted relief in the tax year in which they are paid, the relevant UK earnings that support them don’t necessarily arise in the tax year; the self-employed must justify tax relief on their personal contributions by reference to their trade profits. Self-employed individuals can choose an appropriate period over which to compute their profits.

A 31 March year end, for example, will normally mean that profits are calculated over the period from 1 April to 31 March, (treated as coterminous with the tax year), though it is possible to have a period of account that is longer or shorter than 12 months and to change the year end date, where appropriate.

A 31 December year end, on the other hand, will mean profits calculated over the calendar year support pension contributions made during the tax year in which that accounting year ends.

Correct timing of contributions is essential, particularly towards the end of the tax year and especially for traders that make up their accounts to 31 March relying on projected figures.

As well as utilising relevant UK earnings for the year in question and generating tax relief by reducing the tax bill — well-timed contributions can reduce future balancing payments and payments on account under self-assessment; thereby providing cash-flow benefits whilst enabling adequate pension provision.

 

Act sooner rather than later…

It would be sensible to use pension funding allowances early in the tax year (cashflow permitting) so there is certainty about the tax relief position.

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Daniela Glover

Head of financial services London +44 (0)20 7131 4440

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