The UK government first introduced the concept of a tapered annual allowance, when it comes to pension savings, in April 2016. The aim was to control the cost of pensions tax relief, and applies to individuals depending on their level of taxable income within the tax year.
But how do you know if this tapering will affect your pension savings, and how is it calculated? Read on to find out more.
Annual allowance and tapering
In the UK, there is technically no limit to how much you can save in your pensions each tax year. However, there are rules that apply to the total amount that can have tax relief applied. For the tax year 21/22 this stands at £40,000 or your total pensionable income, whichever is lower. This limit applies across all your pension savings.
If you exceed this amount then you could incur some accidental taxation at the end of the tax year. And if you’re a high earner, then you could be succumbed to a tapered annual allowance.
The effects of tapering
When you reach a taxable income of more than £240,000, then you could see the annual allowance for your pension tapered. This will result in a reduced annual allowance. In the current tax year, this means that for every £2 of income earned over £240,000, your annual allowance is reduced by £1.
You could also be affected if you earn over £200,000 and have generous employer pension contributions. Once you earn over this £200,000 figure all employer pension contributions must be added as well.
The tapered annual allowance limits apply to both defined contribution and defined benefit pension input amounts.
When the full tapering applies, your annual allowance will be reduced to the minimum £4,000. This will affect you when your income and employer pension contribution total more than £312,000 per annum.
So, if you are earning in excess of £240,000, any contributions to your pensions that exceed the reduce annual allowance, will face a tax charge on this amount.
What can I do to avoid tapering?
If you think that you are affected by the tapered annual allowance, then you should do your research and use online insights and resources, such as the financial planning journal from Saltus.
You could also then consult a financial planner, to ensure that you are effectively using tax vehicles to manage your wealth. They can help navigate whether you are going to exceed your annual allowance, and if there are any options to avoid or reduce the potential charges.
A financial adviser might be able to help with any unused annual allowance, with a technique known as ‘carry-forward’ — where, as the name suggests, you can carry forward unused allowance from previous tax years. Of course, certain circumstances and limitations also apply to this technique, which is why it is worth consulting the professionals.
It could be that, with financial planning in place, you could understand and take advantage of tax reliefs available to you, to help minimise your exposure to the tapered annual allowance. It may also be the case that you could make use of salary sacrifice to reduce your gross income, or adopt the charitable approach and benefit from gift aid reductions on all payments to charities.
Another option is to strike up a discussion with your employer. This could involve negotiating additional income, to replace an element of your contracted pension contributions.
If you find that you still are exceeding the amount of annual allowance, with the tapering in place, then seeking financial advice still is recommended. It can be helpful to understand how the relevant tax charges are calculated and applied, and how they can be paid.
Disclaimer: Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested.
