The pensions annual allowance of £40,000 is the maximum amount of pension savings that can be made tax efficiently each tax year. Since 2016/17 the annual allowance has been tapered by £1 for every £2 of ‘adjusted income’ over £150,000. This is subject to a minimum level of £10,000, which applies to those with income of £210,000 or more. Adjusted income is broadly taxable income from all sources before deduction of the individual’s own pension contributions and after adding back employer contributions to money purchase schemes. Accruals to defined benefit schemes are also added back to the extent that they exceed the member’s own contributions to the scheme.
The taper rules are switched off where the individual’s ‘threshold income’ is £110,000 or less. Threshold income is normally net taxable income after deduction of all member contributions, but after adding back employer contributions made by way of salary sacrifice arrangements entered into on or after 9 July 2015.
Following the Budget announcement, pension taper will only apply where adjusted income exceeds £240,000 and threshold income exceeds £200,000. Additionally, the minimum level of allowance will reduce from £10,000 to £4,000.
Individuals with adjusted income between £150,000 and £300,000, combined with threshold income exceeding £110,000, will have higher annual allowances as a result of the changes. Individuals with adjusted income of over £300,000 will have lower annual allowances, due to the reduction in the minimum level of allowance. Taxpayers with threshold income of £200,000 or less will not need to apply taper. The minimum allowance of £4,000 will apply to taxpayers with adjusted income of £312,000 or more.
The change will affect annual allowances for 2020/21 onwards.
The removal of many taxpayers from the taper regime is a welcome change. Although the threshold income rule was intended to give many taxpayers certainty that they were outside the rules, the relatively low level set created a cliff-edge for those with income close to it. A small amount of extra income could create tax charges that far exceeded the income. As personal allowance taper applies to incomes between £100,000 and £125,000, these individuals earning just over £110,000 were being subject to two tapering rules simultaneously.
Although the pensions annual allowance is reducing for those with income of more than £300,000, the minimum allowance was already fairly low at £10,000.
It would have been simpler to remove pension taper altogether but this would have come at a significant cost to the Exchequer. The regime remains complex, and care is needed for those with substantial savings.