It's worth checking in with any clients who adjusted their pension funding based on the old rules, in case they can now pay more into their pension without a tax charge applying.
Let’s look at a case study to help, but before that, it’s worth having a quick recap on the taper rules pre and post 6 April 2020.
The taper rules from 6 April 2016 to 5 April 2020
Individuals who had adjusted income greater than £150,000 and threshold income greater than £110,000, had their annual allowance reduced. It was reduced by £1 for every £2 of income above £150,000. The maximum reduction was £30,000, so anyone with income of £210,000 or more had an annual allowance of £10,000.
If you're using carry forward to work out a client’s maximum available annual allowance, you'd apply the above rules to any years before 6 April 2020 in your calculation.
The taper rules from 6 April 2020
Individuals with adjusted income greater than £240,000 and threshold income greater than £200,000, will have their annual allowance reduced. It will be reduced by £1 for every £2 of income above £240,000. The maximum reduction is £36,000, so anyone with income above £312,000 will have an annual allowance of £4,000.
The diagram below provides a reminder of how to calculate adjusted and threshold income.
Case study
Teddy's self-employed and typically earns £240,000. He has no rental income, savings income or any other income to add to this. He's always been keen to pay the maximum into his pension without a tax charge applying, so before the taper was introduced in 2016, he paid £40,000 a year gross to his pension.
When the taper was introduced, Teddy’s adjusted income was £240,000 and his threshold income was £200,000, that is, if he continued to pay £40,000 to his pension. The full reduction would have applied to him. As his annual allowance was reduced to £10,000 for tax years 2016/17 to 2019/20, continuing to pay an annual contribution of £40,000 would mean Teddy faced an annual allowance tax charge of £13,500 (45% of £30,000). Teddy decided to reduce his contributions to £10,000 per year because he didn’t want to pay the annual allowance tax charge.
What about now?
Teddy’s adviser got in touch with him to suggest a meeting to discuss the changes and what it means for his pension savings.
If Teddy pays £40,000 into his pension now, this will reduce his threshold income to £200,000 meaning the taper will no longer apply to him. Teddy's delighted with this news and increased his contribution to £40,000 for the 2020/21 tax year.
It will be important for Teddy to review his situation each year if he wants to continue to avoid the annual allowance tax charge. This is because a change in the rules or an increase in his taxable income could mean a tax charge arises.
Summary
| | Pre 5 April 2020
£10,000 individual contribution | Post 6 April 2020
£40,000 individual contribution |
|---|
|
Adjusted income
|
£240,000
|
£240,000
|
|
Threshold income
|
£230,000 (£240,000 - £10,000)
|
£200,000 (£240,000 - £40,000)
|
|
Annual allowance
|
£10,000
|
£40,000
|
|
|
The full reduction applies to Teddy as he's ‘failed’ both the adjusted income and threshold income tests.
|
By paying an individual contribution of £40,000, Teddy's reduced his threshold income to £200,000 meaning the taper doesn't apply.
|
Find out more
Do you have any clients who reduced their pension contributions because of the taper and have they considered increasing contributions? Read our article on contributions and tax relief to find out more about tapering of annual allowance for people with high incomes.
Our policy paper Why paying a tax charge isn’t always a bad thing also contains lots of useful information and case studies covering the annual allowance, taper and lifetime allowance, as well as a very useful section on the NHS.
