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Taper trap
Individuals with adjusted income over £260,000 in the tax year could have their annual allowance reduced. In some cases, the calculation can be particularly challenging.
Key facts
- The annual allowance will be reduced for people who have ‘adjusted income’ over £260,000 a year.
- The annual allowance reduces by £1 for every £2 over £260,000.
- The maximum reduction is £50,000.
- The reduction doesn't apply to people with a ‘threshold income’ of no more than £200,000.
Employer pension contributions are included in the definition of adjusted income. So, for those affected by taper, it can become very difficult to calculate the maximum employer contribution that can be paid as the contribution paid affects the adjusted income. As a result, whatever maximum contribution is paid reduces the tapered annual allowance which reduces the maximum contribution that can be paid!
Here’s an example:
Ryan has earnings of £210,000. His employer’s normal pension contributions will amount to £40,000 so his adjusted income is £250,000. As this isn’t more than £260,000, he isn’t affected by the taper. His employer wants to pay an additional single pension contribution of £20,000 in the same tax year. His total contributions are within the standard annual allowance of £60,000 (he doesn’t have any carry forward to add to this) but the additional contribution increases Ryan’s adjusted income to £270,000.
As this is £10,000 over the limit, his annual allowance is reduced by £5,000 to £55,000. So, if the employer pays the additional contributions of £20,000, Ryan will have to pay an annual allowance charge on £5,000 as total pension contributions in the tax year will amount to £60,000.
So how much can the employer pay without creating an excess over the reduced annual allowance? The answer is £16,666. An additional employer contribution of £16,666 makes the adjusted income £266,666, £6,666 over the limit. The annual allowance is therefore reduced by £3,333 to £56,667, allowing the contribution to be paid without creating an annual allowance charge.
Further information
Disclaimer
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.