The tapered annual allowance: how to protect your pension
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
How much could you put into your pension each year? For most British people in 2023-24, the annual “limit” for contributions (receiving tax relief) is £60,000 – or up to 100% of your relevant UK earnings for that tax year (whichever is lower). This is called the Annual Allowance.
However, for certain higher earners, there is a rule called the Tapered Annual Allowance (TPAA), which can catch them out if they are not careful. Below, our Grantham financial planners explain how the Tapered Annual Allowance works, how it can impact retirement planning, and some ideas for mitigating this legitimately.
We hope these insights are helpful to you. To discuss your own family financial plan with us, please get in touch to arrange a no-obligation financial consultation at our expense:
01476 855 585
info@casfin.co.uk
What is the Tapered Annual Allowance (TPAA)
In April 2016, the government introduced a new rule – the Tapered Annual Allowance (TPAA) – which tried to reduce abuses of the UK’s generous tax reliefs for pensions. Those earning between £150,000 and £210,000 per year would see their Annual Allowance “taper down” from £40,000 to just £10,000.
However, the rules changed in April 2020 when the government decided that the TPAA would only concern those with total adjusted income of over £240,000 per year. In April 2023, the government again increased the adjusted income limit to £260,000.
Once an individual reaches an adjusted income level of £360,000, they can only contribute £10,000 per year to pensions without a tax charge.
Overpaying into your pension – e.g. inadvertently exceeding your TPAA – is called an “excess contribution” and results in a tax charge equivalent to your highest marginal rate on the excess contribution amount. For Additional Rate taxpayers, this is 45% in 2023-24.
Earning under £240,000? Some could still be affected
The TPAA rules can still impact individuals if they earn over £200,000. This is due to the “taper test”, which measures two factors. Firstly, your “total taxable income” (e.g. dividends and salary) minus any pension contributions. Secondly, your “adjusted income” – which measures all of the aforementioned including pension contributions.
In short, you may be affected by the TPAA if your threshold income is above £200,000 per year and your adjusted income is above £260,000 per year.
It is easy for many people to get “tripped up” by these complex rules. For instance, when taxpayers sit down with a spreadsheet to work out their income and allowances, company benefits may count towards their adjusted income and could be missed (or misassigned).
For peace of mind, consider seeking independent financial advice.
How can I navigate the Tapered Annual Allowance?
Some high earners in the corporate world and NHS have found themselves caught out by the new TPAA rules – resulting in people “opting out” from their pensions to avoid hefty tax bills in retirement. This is quite a drastic action and requires serious thought (and professional guidance) beforehand. What can you do if you think you may be affected?
Employers are increasingly limiting maximum pension contributions to the TPAA (£10,000), with some offering enhanced salaries to workers to compensate. Many people will welcome a higher salary, but these earnings will be subject to income tax and National Insurance (NI). So, consider consulting your employer about how it approaches the TPAA.
Beyond your employer, there are three main tax planning “routes” for taxpayers to mitigate the impact of the TPAA. Firstly, there is your ISA. Each tax year, individuals can contribute up to £20,000 to their ISAs and receive tax-free interest, dividends and capital gains.
For those aged between 18 and 39, there is the “Lifetime ISA”, which can be a helpful investment vehicle for retirement savers. An individual can contribute up to £4,000 per year to the account and receive a 25% “bonus” from the government (up to £1,000).
This option is arguably less tax-efficient than a pension but can be a great alternative if you have maxed out your annual allowance or TPAA. However, investors should note that a 25% charge will apply if funds are withdrawn or transferred to another type of ISA before age 60. There are exceptions for circumstances such as purchasing a first home worth £450,000 or less.
Secondly, there are the “carry forward” rules for pensions. These allow an individual to “combine” any unused annual allowance from the previous three tax years with that from the present tax year (provided they had an eligible pension in the tax years in question). This can help certain higher earners “expand” their contributions without the prospect of tax charges.
Invitation
Concerned that the Tapered Annual Allowance may affect you? Our Grantham financial advisers are here to help you explore your retirement planning options.
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
