The Times has reported that the Government is weighing up changes to the rules for the Tapered Annual Allowance. This is the system which reduces the Annual Allowance for pension contributions - currently £40,000 for most people - down to just £10,000 for very high earners.
It’s a complicated area of the pension system - which is already pretty complicated - and difficult for even those affected by it to plan for.
The prompt for action appears to be a crisis in the NHS, where high-earning doctors with generous final salary pension have been landed with huge tax bills as a result of working extra hours. In response, they have worked fewer hours or even retired completely.
Are you affected by the Annual Allowance Taper? Could you benefit from a change in the rules? Here’s what you need to know.
What is the Tapered Annual Allowance?
In 2017 the Tapered Annual Allowance was introduced. It was designed to save money by making the system of pension tax relief a bit less generous to high earners. In the simplest terms, it gradually reduces - or tapers - the Annual Allowance from £40,000 to £10,000 once a person hits some specified earning limits.
Who is caught by the Tapered Annual Allowance?
Anyone whose annual income is more than £110,000 could be affected - but not everyone will be. It depends on two measures of income - ‘Threshold Income’ and ‘Adjusted Income’. The limits for both of these have to be triggered before a person is affected by the Tapered Annual Allowance.
In broad terms, Threshold Income includes your income from all sources minus pension contributions you’ve made. Adjusted Income is a higher amount and includes all your taxable income plus any pension contributions made to a workplace pension by you and your employer.
Anyone whose Threshold Income is more than £110,000 and whose Adjusted Income is more than £150,000 will be subject to the Tapered Annual Allowance.
There’s a more detailed explanation of how these are worked out in our Tapered Annual Allowance guide .
What is the effect of the Tapered Annual Allowance?
For those affected, the £40,000 Annual Allowance is reduced by £1 for every £2 that their Adjusted Income exceeds £150,000. Reductions continue until Adjusted Earnings reach £210,000. At that point their Annual Allowance will be just £10,000.
Bear in mind that anyone who has accessed a pension flexibly, which can be done from age 55, may be subject to an even lower Annual Allowance. The Money Purchase Annual Allowance applies in these circumstances, and allows just £4,000 to be contributed each year. Read more on the Money Purchase Annual Allowance (MPAA) in our guide .
What happens if you breach the Annual Allowance?
If you pay too much into your pension in any one year your excess contribution (the amount above your annual allowance) may be added to your income. As a result this will be subject to Income Tax at your highest marginal rate.
There is some protection in these circumstances from a rule which allows you to use any unused Annual Allowance from previous years. This is called ‘Carry Forward’ and is subject to its own rules and limits. Read more on the Carry Forward allowance in our guide.
Who is most at risk of breaching the Tapered Annual Allowance?
Anyone whose earnings are close to the £110,000 limit for Threshold Income needs to be watchful.
Those in Defined Benefit pension schemes face a particular problem, including doctors and other high-earning employees in the public sector. These are the schemes where retirement income is guaranteed and calculated as a proportion of salary.
Working out annual pension contributions into these schemes is not straightforward and clinicians may not be able to predict their contributions because it will depend on any extra hours they work - a common scenario in the health system.
Many doctors found they had contributed too much and they had breached the Tapered Annual Allowance, triggering high tax charges. Some reacted to this by working fewer hours, or even seeking early retirement.
What can the Government do?
The Government has previously promised to look at ways to make the doctors’ pension scheme more flexible so that NHS employees can more easily avoid tax charges. The proposals include making NHS pension contributions more flexible, and encouraging employers to recycle contributions above the Tapered Annual Allowance back into doctors’ salaries.
The recent reports suggest that ministers could go further, and some have called for the Taper to be scrapped completely. Short of that, the limit of Threshold Income could be raised so that no-one earning below £150,000 is caught.
The value of investments and the income from them can go down as well as up so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment on pensions depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.