The tapered annual allowance: What you need to know

Managing pension contributions and tax liability can be tricky. If you’re affected by the tapered allowance, it can be even more challenging. The Secretary of State for Health and Social care has announced there will be a review into the impact of the tapered allowance and its impact on NHS staff. But it’s not just NHS staff that should ensure they understand how it works.

What is the tapered annual allowance?

When you’re saving into a pension there are two allowances you need to keep in mind: the annual allowance and the lifetime allowance. These two allowances limit how much you can save tax-efficiently in a pension. As the name suggests, the annual allowance dictates how much tax relief you can receive in a tax year, whilst the lifetime allowance refers to the total amount over your working life.

For the 2019/20 tax year, the annual allowance is a maximum of £40,000. However, it’s not as simple as having an allowance that applies to every worker. In some cases, your allowance may be significantly lower. One of the reasons for this is the tapered annual allowance.

If your threshold income if over £110,000 or your adjusted income is over £150,000, you could be affected by the tapered annual allowance.

First, what are the definitions of threshold and adjusted income?

  • Threshold income is your annual income before tax, less any personal pension contributions and ignoring any employer contributions
  • Adjusted income broadly covers all income that you are taxed on, this may include dividends, savings interest and rental income before tax, plus the value of your own and any employer pension contributions

Next, how much is your annual allowance reduced by? For every £2 your income exceeds the threshold, your annual allowance will reduce by £1. The maximum reduction is £30,000. This means some workers can be left with an annual allowance of just £10,000.

Exceed your annual allowance and your pension contributions will not be legible for tax relief. This could mean an unexpected tax bill if you aren’t aware of your pension position. It’s worth noting that unused annual allowance from the previous three tax years can be carried forward.

NHS: Bringing the tapered annual allowance to the forefront

The tapered annual allowance has been featuring in the news due to the issues it’s causing in the NHS. High earners within the NHS have found they can face an unexpected tax bill if they work overtime or receive a pay increase. This has led to some senior members of staff turning down additional work over fear they will need to pay out more.

As a result, Matt Hancock, Secretary of State for Health and Social Care, has stated there will be an ‘urgent review’ into the tapered annual allowance for pension relief. Solutions put forward so far include allowing NHS staff to flexibly change their accrual rate and adjust it where necessary to reflect earnings.

Whilst the review is good news for NHS staff, there haven’t been any suggestions that it could be extended to other industries. However, some are calling for the tapered annual allowance to be scrapped altogether.

Steve Webb, Director of Policy at Royal London, said: “The tapering of the annual allowance has caused major problems in the NHS. All year we have been hearing of doctors who are restricting their hours to avoid the risk of large lump sum tax bills.

“The tapered annual allowance is complex and makes it very hard for taxpayers to know where they stand. The solution is to abolish the taper outright, even if this means a lower across-the-board annual allowance for all.”

Managing your annual allowance

If you’re affected by the tapered annual allowance, it’s important you manage your pension contributions. This can help make the most of your savings and reduce your tax liability.  There are several key things to do if you’re worried about the annual allowance.

  1. Understand your annual allowance: The first step is to make sure you understand exactly what your annual allowance is. This can be difficult if you’re affected by the tapered annual allowance. But it means you can control your pension contributions, so you don’t face an unexpected bill and maximise your retirement savings.
  2. Make use of carried forward allowance: If you’ve recently been affected by the tapered annual allowance, carried forward allowance could help you save more tax efficiently. If you don’t use unused allowance from previous tax years, they will disappear after three years.
  3. Manage contributions: Actively keeping an eye on your pension contributions is important if you may exceed your annual allowance. You can adjust or even pause your contributions to ensure you don’t pay avoidable tax.
  4. Work with a financial planner: A financial planner can help you make the most out of your savings. If you’d like to maximise pension savings whilst mitigating avoidable tax on contributions, please get in touch. We’ll work with you to create a bespoke financial plan that considers your personal circumstances, including the tapered allowance where necessary.

Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.