In this article Paul Howson, Chartered Financial Planner at Kreston Reeves Financial Planning answers a question regarding the pension annual allowance and the significant and unexpected tax bill which can arise for some as a result of the taper system within it…
Q: “I’ve seen the recent media coverage about NHS employees being caught in a so-called “tax trap“ regarding their pension annual allowance taper – it seems that high earners in particular are being penalised for continuing to pay into their pension scheme and are only aware after the event if they have exceeded their savings limit. I find the whole thing confusing and worrying. How will I know if this affects me?”
A: We are aware of this sensitive and complex issue and would encourage anyone who thinks they may be affected to come speak to our tax and financial planning specialists for advice, and to verify your own situation. It's not just members of the widely reported NHS pension scheme who are affected - teachers, emergency service/military are other examples of individuals who could likely be subject to this tax charge if they are high earners in a final salary pension scheme.
To best explain the effects of the tax rules, it is worthwhile first looking at the background.
The pension annual allowance (AA) was introduced in 2006 and set at £215,000. It was designed to limit the amount that could be saved into a pension each year before a tax charge applied. Consequently, only those with a significant income were affected.
The AA was increased each year, but in 2011 it was reduced from £255,000 to £50,000 and in 2014 further still to £40,000, where it remains today.
When launched in 2006/07 the tax raised from those exceeding the AA was £2m; in 2016/17 this had increased significantly to £561m.
The issue has been exacerbated by legislation introduced in 2016/17 under which high earners had their standard AA of £40,000 reduced or “tapered” if adjusted income exceeded £150,000. Tapering reduced the standard AA by £1 for every £2 of adjusted income above £150,000 to a limit of £210,000. Beyond adjusted income of £210,000 no further tapering applies, but at this level of income the AA is reduced to £10,000.
For many, the first years of the tapering rules may not have generated a tax liability as it might have been possible to offset an AA excess by using unused pension relief from the previous three tax years. Now that we are in the fourth year of tapering, many have exhausted the available carried forward relief and are discovering the extent to which the annual allowance tax charge (AATC) has affected them.
It is more likely that those who are high earners and who benefit from final salary pension schemes are affected, but not exclusively so. The AATC is particularly difficult to manage for those in final salary pension schemes as the notice of “pension input”, the figure by which the pension has grown during a tax year, is not generally advised by pension administrators until at least 6 months after the end of the year in question.
For some, the impact of these rules means that they are suffering an effective tax rate of up to 90% (45% on their normal earned income and a 45% AATC on the pension excess), hence the current publicity around NHS consultants who can find the financial benefit for working extra shifts is significantly reduced.
How we can help
We are taking a collaborative approach between our financial planning and tax advisers to analyse the data and calculate the extent of the problem for those affected. We consider all available allowances to determine any excess and the resulting tax liability.
Our advisers can then meet with you to consider tax adjustment and communication with HMRC for previous years, the options to settle current AA excess, and a strategy to manage the situation going forward.
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