Modified on: June 2023
Tapered annual allowance – how to avoid it
Tapered annual allowance – how to avoid it
Caught by the tapered annual allowance? Here are 3 ways to get around it
For years, high earners in the corporate world have been able to stick their heads in the sand, knowing their large pension benefits will âsort them outâ later down the line. With the tapered annual allowance, that’s now coming to an end.
The relatively recent introduction of the Tapered Annual Allowance rules has resulted in several high earning employees âopting-outâ of their pensions for fear of hefty tax bills.
What is the tapered annual allowance?
Since April 2016, employees in the UK earning between Â£150,000 and Â£210,000 per year have been subject to a new pension tax rule called the Tapered Annual Allowance (TPAA). The TPAA gradually reduces how much you can put into your pension (whilst gaining tax relief),Â starting at Â£40,000 and âtaperingâ down to just Â£10,000.
That changed in April 2020…
The recent changes have resulted in only people with total earnings of over Â£240,000 per year need to be concerned.
So employees earning over Â£240k have a gradually reducing allowance and once earners hit Â£300k or above, they, or their employers, can only put in Â£4k per year (or face a tax charge).
Earnings over Â£200k?
You might be thinking âhang on, didnât you just say âearners over Â£240,000â?â, and youâd be right, I did. However, that doesnât tell the full storyâ¦
Even if someone is earning less than Â£240,000, they could still be affected.Â
This is due to the âtaper testâ, which measures 2 things:Â
- âThreshold Incomeâ = income (salary, dividends, other income) excluding pension contributions
- âAdjusted Incomeâ = income (as above) but including pension contributions
So put simply, the Tapered Annual Allowance rules have the potential to impact an employee with a threshold income above Â£200,000 per year and/or an adjusted income above Â£240,000 per year. Yes, thatâs as simple as it gets in our world!
But what if your allowance is reduced and you overpay into your pension?
This would classify as an âexcess contributionâ above the Tapered Annual Allowance and would result in an income tax charge based on the excess amount at the employeeâs marginal rate of income tax, currently 45% for top-rate taxpayers.
Salary in lieu of pension to avoid tapered annual allowance
The long and short of this is that higher earners need to be aware of the tapered annual allowance. If your income is above Â£200,000, be careful!
It is becoming increasingly common for employers to restrict the maximum pensions contributions to the âminimum Tapered Annual Allowanceâ which was Â£10,000 per year and is going even lower to Â£4,000 as of 6th April 2020. And remember, that includes employee and employer contributions.
Some employers offer an enhanced salary in place of would-be pension contributions. The good news is that its cash paid to you now, the bad news is that youâll pay tax & NI on it (meaning youâll lose around half of it). If your employer reduces your pension contributions, make sure to ask about this!
You need to sit down with a spreadsheet and work out your income and allowances. Once youâve figured out what your allowance is, you can plan to use it, without going over.Â But be careful of things that can trip you up, like company benefits, which can count towards your adjusted income.
Alternative investments to avoid the tapered annual allowance
Itâs clear that the Government wants to restrict the amount that higher earners can put into pensions. This makes sense, given how tax-efficient pensions are.
So if youâre âlocked out of pensionsâ, whatâs the alternative?
- Carry Forward – Unused Annual Allowance from previous tax years (up to 3 years) can be used to make further contributions into your pension without the prospect of tax charges.Â
- ISAs – while ISAs donât quite have the same tax benefits as pensions, they do provide a tax-free pot for your money to grow.
- Venture Capital Trusts – these are HMRC-approved investment vehicles that have several highly attractive tax benefits. They arenât for everyone though, as they invest in smaller UK companies that carry higher risks.Â
Hopefully, that gives you some food for thought.
As always, any questions, just drop me a line.
Tapered annual allowance pension consultation
If you’re concerned about breaching the tapered annual allowance, you can book in for a pension consultation.
We will use this meeting to check whether you are affected by the tapered annual allowance and discuss how we can work together.
All the best,
James Mackay, Independent Financial Adviser in Bristol
.** This article has been updated to reflect the 2020/21 tax year changes **
Financial Advisor Bristol and Pension Advisor Clifton
About us: Frazer James Financial Advisers is a financial advisor, based in Clifton, Bristol. As an independent financial adviser, weâre able to provide independent and unbiased financial advice. We provide independent financial advice, pension advice, investment advice, inheritance tax planning and insurance advice.
If you would like to speak to a Financial Advisor, we offer an Initial Financial Consultation without cost or commitment.Â Meetings are held either at our offices, by video or by telephone. Our telephone number is 0117 990 2602.
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