Pension Contributions & the New Annual Allowance

There have been numerous articles in the press regarding the reduction in pension contributions that high earners can make in the coming tax year (2016/17), without creating a personal tax charge.

It’s now been 10 years since we all rejoiced at the words ‘Pension Simplification’ and as we all know the intermittent years have been anything but simple with pension rules and contribution limits changing on a regular basis. For the new reducing annual allowance calculations, we seem to have hit a new level of complexity, confining the word ‘simplification’ to the bin for a little while longer.

The headline number many will focus on is the £150,000 ‘adjusted income’ figure. As a quick summary, adjusted income is the total income from all sources (salary, overtime, rental income, investment income etc.) plus the value of any pension contributions.

The finer details…

For individuals who have an adjusted income of over £150,000, the normal £40,000 annual allowance reduces by £1 for every £2 of income above the threshold so someone with an income of £190,000 for example, would see their annual allowance cut to £20,000. For those individuals with an adjusted income of £210,000 and above, their annual allowance would be reduced to just £10,000 although there is a carry forward facility which can be utilized.

There is another test, however, called ‘threshold income’ that needs to be taken into account. An individual’s ‘threshold income’ is again their total income from all sources, any new salary sacrifice arrangements (started after 8 July 2015) less any individual pension contributions.  An individual’s annual allowance won’t be cut if their ‘threshold income’ is £110,000 or less for the tax year but a word of caution, care needs to be taken as to whether personal pension contributions have been made via a net pay arrangement or relief at source.

Act now to avoid the headache later…

Employers may be advised to communicate the potential issue to staff who may be affected, bearing in mind they cannot be expected to know all of their employee’s personal details so might be unaware of additional income they receive from other sources such as share dividends or investments. Many employers will have more complex cases with senior staff or very high earners having the reduced annual allowance and may well be receiving an employer pension contribution that will actually trigger a personal tax charge.

Without proper communication, employers could find themselves facing a number of very disgruntled employees by the end of the tax year and if we also then add in the employer’s duties surrounding auto enrolment, including the rules regarding ‘no inducements’ to opt-out, it is very clear that early discussions between employers and employees with the support and guidance of company pension advisors is vital to avoid confusion and help with suitable planning.

Example – an employer pension contribution creates a tax charge

Harry has a total income of £190,000 and, as an employee, also receives an employer pension contribution of 10% (£19,000) into his Group Personal Pension (GPP) during the 2016/17 tax year.

His adjusted income for the tax year is £209,000.  As this is over the £150,000 cap it will reduce his annual allowance by £2 for every £1 over the threshold, from £40,000 down to £10,500 for the 2016/17 tax year.

This means he’ll be liable to pay a personal tax charge of 45% (£3,825) on the £8,500 he has contributed above his new annual allowance figure.

If he had been required to pay a personal contribution of 5% in order to receive his employers 10% then this would have exacerbated the situation and increased his tax charge to £8,100.

If you are an employer and concerned you may have staff who will be impacted by the new rules please get in touch.