Understanding the pensions taper
September 14 marked the start of Pension Awareness Week in the UK.
The national event aims to get people thinking about their retirement savings and their life after work.
You have spent the best part of your career building a pension fund that will provide your desired lifestyle in retirement. Your pension is where most of your retirement income will probably come from and you won’t want to see it eaten up by tax charges.
But that’s exactly what could happen if you fall foul of the pensions taper.
The Chancellor amended the taper in his first Budget earlier this year. Here’s a reminder of what he changed and what the changes could mean for you.
What is the pensions taper?
The pensions Annual Allowance – the amount you can contribute to your pension in a tax year and still receive pension tax relief – is £40,000 for the 2020/21 tax year.
The Tapered Annual Allowance was introduced on 6 April 2016 and lowers the Annual Allowance for high earners, based on certain income thresholds.
Earn over the ‘threshold income’ amount and your Annual Allowance reduces by £1 for every £2 of income you receive. The reduction applies to your ‘adjusted income’.
For these purposes, your threshold income is your taxable income: salary, bonuses, pensions, income from Buy to Let properties. Your adjusted income is all the above, plus any employer pension contributions you receive.
Why did the Chancellor make the changes?
The taper has been controversial since its introduction.
The Chancellor intended his changes to alleviate the concerns of those affected, especially among NHS pension scheme members, whose opposition to the taper has been well-publicised.
For those in Defined Benefit (DB) pensions schemes – such as the NHS scheme – understanding the impact of the taper can be tricky.
The calculation relies on knowing your adjusted income and in certain professions, this isn’t always possible.
If you are a doctor, for example, you might work unpredictable, or additional hours. You might not know the income you will receive at the end of a given month.
Because both the threshold and adjusted incomes are ‘cliff-edge’ amounts, income that tips over a threshold by even a minimal amount could have massive tax implications.
What changes did he make?
Rishi Sunak used his first Budget to raise the thresholds for adjusted and threshold income.
He raised both limits by £90,000. He also lowered the minimum reduced allowance.
For the 2020/21 tax year, the pensions taper applies if your threshold income is over £200,000 and applies to adjusted income over £240,000. If you earn over £312,000 a year, this will reduce your Annual Allowance to £4,000.
The minimum allowance had previously been £10,000.
Source: Pru Adviser
The changes represent massive tax savings for thousands of high earners, including NHS consultants. But will they draw a line under the debate on the future of the tapered allowance?
Back in January, FTAdviser reported the views of Dr Vishal Sharma, Pensions Committee Chairman of the British Medical Association: “Simply raising the threshold income would not remove any of the complexity of the taper, nor the threat of a ‘tax cliff’ when income increases.”
Former Pensions Minister, Baroness Ros Altmann, has also argued against raising thresholds as a workable solution. She said: “The way the taper is designed needs to be thoroughly reformed as it does not provide people, especially in Defined Benefit schemes, with any certainty.”
What do higher threshold amounts mean?
If you were close to the previous threshold amounts, raising both the income limits by £90,000 should have a massive impact.
But for those earning more than £312,000, the news is not so good.
A reduction of the allowance to its new minimal level of £4,000 severely limits the future pension contributions you can make while still receiving tax relief.
For those on the threshold of the new limits, the issue of a so-called ‘tax cliff’ remains.
Understanding the impact for you
Controversy has followed the pensions taper since its introduction. The Chancellor’s changes went a long way to resolving the issue for many, but the system’s underlying complexity remains, and future changes can’t be ruled out.
If you need help in understanding the taper or its implications for your finances, get in touch.
With ‘cliff-edge’ limits still in place, you could find yourself caught out. The rules will affect everyone differently and it’s only by gaining a thorough understanding of your financial position that we can build a retirement plan that works for you.
The advice we give is based on up-to-the-minute knowledge of regulatory changes and proposals. We can help you make full use of available allowances and thresholds to help toward your long-term goals in a tax-efficient way.
Get in touch
Please get in touch if you have any questions about your retirement contributions or the changes to the Tapered Annual Allowance.
This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated.