Technical Connection examines the tapered annual allowance
The tapered annual allowance was introduced to restrict the amount of tax relief granted for high earners in 2016/2017. From 2020/2021, there were substantial increases in the income thresholds, meaning far fewer clients are now impacted, but for those calculating carry-forward allowances from the tax years 2016/2017 to 2019/2020, the lower thresholds still apply.
For tax year 2020/2021 onwards, the tapered annual allowance affects those who, in any tax year, have both threshold income over £200,000 and adjusted income of more than £240,000.
For tax years 2016/2017 to 2019/2020, the tapered annual allowance affects those who in any of these tax years had both threshold income over £110,000 and adjusted income of more than £150,000.
The starting point for the calculations is net income, which is broadly an individual’s taxable income left after deducting any reliefs due. For a full list of reliefs due, please see Section 24 and Section 24A ITA 2007. It should be remembered that this income is very different from ‘relevant UK earnings’ because it includes everything subject to income tax such as pensions, savings and rental income, as well as dividends.
Threshold income is:
- Net income for the year (taxable income minus allowable reliefs).
- LESS contributions made under relief at source.
- LESS payments received from lump sum death benefits.
- PLUS salary-sacrifice arrangements if started or increased on or after 9 July 2015.
Adjusted income is:
- Net income for the year (taxable income minus allowable reliefs).
- PLUS personal contributions made under net pay arrangements.
- PLUS contributions to overseas schemes, if non-dom and receiving tax relief.
- PLUS (deemed) employer pension contributions.
- LESS payments received from lump sum death benefits.
This looks simple enough but getting accurate data before the end of the tax year can be difficult. This is especially hard for defined benefit schemes. In the case of those, the personal contributions are what are paid to the scheme, but the deemed employer contributions are in fact the pension input amount for the scheme, less contributions paid by the individual. This means they bear no actual connection to the amount paid.
Generally, should there be no salary sacrifice to take account of, the difference between the two figures will be the Pension Input Amount for the year.
Once these two figures are established, and both exceed the relevant limits, then you simply take the excess over the adjusted income, divide by two and deduct from the £40,000. For the tax years 2016/2017 to 2019/2020, there was a minimum annual allowance of £10,000 for those with adjusted income of £210,000 or more. For subsequent tax years, this minimum is £4,000 for those with adjusted income of £312,000 or more.
It is worth noting that any changes to contributions paid will mean that the calculation needs to be redone. For example, additional personal contributions could bring an individual out of the tapered annual allowance by reducing their threshold income. However, extra employer contributions, or increases in salary sacrifice, could mean bringing someone into taper or a further reduced annual allowance.
