Reduction in pension allowances for high earners

Pensions Simplification was introduced in 2006 to make pensions simpler and more attractive and to enable people to save for a comfortable retirement. This was then reinforced by Auto-Enrolment in the workplace, so that everyone has the opportunity to receive pension contributions from their employers.

However, everything introduced recently has started to muddy the pension waters again, particularly for higher earners and those with significant pension pots.

In particular, legislation introduced in April 2016 has had potentially serious ramifications for those earning more than ￡150,000. Under the previous rules an individual could make annual contributions equal to their taxable income, subject to a limit of ￡40,000. 

Under the new rules anyone with ‘adjusted income’ of more than ￡150,000 has seen their annual allowance cut by ￡1 for every ￡2 of earnings above this threshold, subject to a maximum reduction of ￡30,000. This meant that those earning above ￡210,000 have been left with a ￡10,000 annual allowance - a very low level of contributions for their earnings level.

However, like all things pensions related, it is not quite that simple. Firstly, you need to determine whether you have ‘threshold income’ that exceeds ￡110,000 in the tax year.  If you don’t, then there won’t be any reduction in the annual allowance even if your ‘adjusted income’ exceeds ￡150,000.

Any contribution in excess of this amount will then be taxed at the marginal rate of tax - in this case 45% for earnings over ￡150,000.

Are you still with me?

It would appear that at least 2,400 individuals did not keep up with me in the 2016/17 Tax Year, because nearly ￡53m was paid to HMRC in Annual Allowance charges. And HMRC appear loathe to give any contributions back because of mistakes in calculations or unforeseen income that people have made from bonuses, dividend payments and the like.

This means that our advice to clients has now changed. We believe that anyone earning over ￡150,000 per annum should not pay more than ￡10,000 to their pension through regular contributions because of the possibility of over-funding. This amount should only be topped up to the maximum at the end of the tax year when a person's earnings are clear.

As you can see, pension planning for higher earners is definitely not simple any more. In my next post we will look at the problems faced by those with reasonable sized pension pots, and the ways to manage the problems that recent legislation has caused.

In the meantime, if you think that the contents of this article might affect you, then please get in touch. Foresight specialise in dealing with individuals who are affected by this issue - and our experience could mean the difference between having a very tax-efficient pension and a very expensive pension.