Changes for high earners
At the 2020 Budget, the Government announced increases to the threshold income and adjusted income limits that are used to calculate tapered annual allowance. From 6 April 2020, the adjusted income limit will rise to £240,000 (increased from £150,000) and the threshold income limit will rise to £200,000 (increased from £110,000). The Chancellor also lowered the minimum reduced annual allowance that you can have under the tapering rules from £10,000 to £4,000.
What is ‘threshold income’?
Threshold income is all of your earnings (not just your salary) and includes chargeable gains on investment bonds – the whole gain, not just the ‘top slice’ – which are subject to UK Income Tax.
However it is net of all pension contributions that you pay personally to UK registered pension schemes. Foreign earnings do not count towards threshold income as they are not taxed in the UK.
What is ‘adjusted income’?
Adjusted income is all of your earnings which are subject to UK Income Tax, including all pension contributions paid by you personally and by your employer. The difference between ‘threshold income’ and ‘adjusted income’ is that the former excludes pension contributions, but the latter includes all pension contributions.
What is the annual allowance?
The annual allowance is the maximum you can save in your pension schemes each year with the benefit of tax relief. For the 2020/21 tax year the annual allowance is £40,000, but if you have a high income your annual allowance may be lower than £40,000. This tapering of the annual allowance is applied depending on your level of income within the tax year and applies to all pension savings that you make or that are made on your behalf.
Will the tapered annual allowance apply to me?
To see if the taper annual allowance applies, you will need to work out your:
- net income* in a tax year
- pension savings in a tax year
- threshold income in a tax year
- adjusted income in a tax year
*net income is not the same as ‘income after tax’. It is all taxable income minus various deductions, the most important of which is the deduction of members contributions paid to occupational pension schemes. This is where the sponsoring employer of the pension scheme deducts employees contributions before tax under PAYE.
From 6 April 2020, you will have a reduced (‘tapered’) annual allowance if:
- your threshold income is over £200,000 (this was previously £110,000)
- your adjusted income is over £240,000 (this was previously £150,000)
You will not be subject to the tapered annual allowance if your pension savings for that year are £200,000 or less, no matter what your adjusted income is.
What effect does the tapered annual allowance have on my savings?
If you are subject to the tapered annual allowance, for every £2 your adjusted income goes over £240,000, your annual allowance for that year reduces by £1. From 6 April 2020 the minimum that this can reduce to is a tapered annual allowance of £4,000.
For the 2020/21 tax year, an individual with an adjusted income of £300,000 will exceed the adjusted income limit by £60,000. The individual’s annual allowance would be reduced by half of this – so by £30,000 – leaving them with a tapered annual allowance of £10,000, which is the standard annual allowance of £40,000 less the £30,000 reduction under the tapering rules.
For the 2020/21 tax year, another individual earns £330,000. Their income exceeds the adjusted income limit by £90,000. Their annual allowance should be reduced by £45,000, which is the standard annual allowance of £40,000 less the £45,000 reduction under the tapering rules.
However, the minimum that the annual allowance can reduce to under the tapered annual allowance rules is £4,000, so this individual will have a tapered annual allowance of £4,000.
Having said this, you must not forget that you can also carry forward any unused annual allowance from the previous three tax years and use this. Your available annual allowance is your reduced (or tapered) annual allowance plus any unused allowance from the previous three tax years.
Please note that examples of how tax or tax relief may apply are based on our understanding of current tax legislation. Whether any tax will be payable, at what level it is charged and whether you qualify for tax relief will depend upon individual circumstances and may be subject to change in the future.
What should I do if I have made pension savings over my available annual allowance?
If your pension savings made in the tax year are more than your available annual allowance, you should include the excess amount on your Self-Assessment return. This amount is added to your taxable income net of any pension contributions paid by you personally in the tax year, and you will pay Income Tax on it at the tax rate that applies to you.
Andy Brooks, Director, FPFS Cert CII (MP) Chartered Financial Planner & Fellow of the CII.