Big Income, Big Pension Changes! Will your pension contributions be restricted?07 April 2016
There is no surprise to learn that HMRC has been busy as we move into the new tax year 2016/2017, which brings with it a range of fresh annual allowances, one of which is the annual allowance for pension contributions. However, important changes have come into force in this new tax year which mean that higher earners (£150,000 pa +) could see their annual pension allowance reduced significantly. Are you one of them and, if so, what do you need to do about it?
This pension situation can get complicated, as you will see below, however, the 'headlines' are as follows:
- The current personal pension contribution position is as follows:
- The maximum contribution that can be made in this tax year is £40,000 gross from all sources (i.e.: including employer's contributions)
- HMRC Carry Forward may be used to increase this amount limit if appropriate
- Additional rate personal pension tax relief is granted for earnings above £150,000. However, if you have higher adjusted income* above £150,000 gross, the pension contribution limit of £40,000 gross would be reduced in 2016/2017 on a pro-rata basis. If you receive adjusted income in excess of £210,000 gross in the new tax year, your new pension contribution limit will be restricted to £10,000 gross from all sources.
To clarify the situation and calculation a stage further, we have looked at two example 'tests' below to help you (or your accountant/tax adviser) consider this.
* 'Adjusted income' includes net income for the tax year (e.g. earnings) and the value of any pension contributions or pension input during the tax year. This means that employer pension contributions are included in your adjusted income, as well as any personal pension contributions that reduce taxable income (e.g. salary sacrifice). Personal pension contributions that receive tax relief at source (i.e. tax relief is claimed back by the pension provider) are not added to your adjusted income as they are already included within net income.
We appreciate that no one likes tests, however there are two 'tests' which should determine whether a high income individual will see their annual allowance cut. These are as follows.
Test 1 – 'adjusted income'
Additional rate income tax relief is granted on personal pension contributions for earnings above £150,000 gross in this tax year. However, if you have higher adjusted income* above £150,000, the pension contribution limit of £40,000 gross would be reduced in 2016/2017 on a pro-rata basis, by £1 for every £2 of excess adjusted income above £150,000. If you receive adjusted income in excess of £210,000 gross in the new tax year, your new pension contribution limit will be restricted to £10,000 gross from all sources.
As a simple example, assume that an individual has total income of £140,000 gross in the current tax year and that their employer pays £30,000 into a pension plan on their behalf, again in this tax year. This individual's adjusted income for the tax year 2016/2017 is £170,000 (total income plus employer pension contribution). This is £20,000 over the £150,000 cap and therefore reduces the annual allowance by £10,000, meaning that the annual allowance for the tax year 2016/2017 for this individual would be £30,000 from all sources.
As a note, if you are subject to this reduced allowance because of your income levels, and total pension contributions on your behalf exceed this reduced allowance, the tax charge on the excess will be applied at your highest marginal tax rate (in this case 45%).
Test 2 – 'threshold income'
Not every individual who fails the 'adjusted income' test will experience a cut in their annual allowance. There are some situations in which the full annual allowance will be retained even if adjusted income exceeds £150,000 in this tax year. If an individual's 'threshold income' is £110,000 or less for the tax year, the full annual allowance of £40,000 is retained. Some individuals may be able to reduce their threshold income by making a personal pension contribution. This is a complex area and financial advice should be sought before proceeding with any pension planning.
Existing Planned Pension Contributions
With this noted, you may wish to review your existing employer/employee pension contribution levels to ensure that they meet with your requirements and this new tax rule change.
As you can see from the notes above, there is much to consider for those with higher incomes and you should check that existing agreed pension contributions do not by default exceed these limits, or at least be aware of the tax consequences. You may also want to consider this further with your tax adviser.
If you would like to review your pension and retirement planning arrangements further in the light of these changes then please contact the Chapters team at either our Guildford or Woking offices.
No individual advice is provided during the course of this Blog.
Keith Churchouse FPFS
Chartered Financial Planner
CFP Chartered FCSI
Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.