In the 2016/17 tax year, income tax relief on pension contributions came at a cost to the Exchequer of £38.6bn.
The huge increase of employees automatically enrolled into workplace pensions has contributed. Nonetheless, more than two thirds of pension tax relief currently goes to those who pay higher or additional rate tax.
So it’s no surprise that the availability of income tax relief at the higher rates on personal pension contributions for higher and additional rate tax payers continues to be the subject of much political debate.
This has led to reductions in the annual allowance (the annual limit on the amount an individual can pay into their pension scheme and qualify for tax relief) in an attempt by the Treasury to curb the costs of pensions tax relief, without reducing the incentive for those on lower incomes to save for their retirement.
When the annual allowance was introduced in 2006, it was £215,000. It was dramatically slashed in 2011 to £50,000 and reduced again in 2014 to £40,000.
On 6th April 2016, the scope for high earning individuals to benefit from income tax relief by making pension contributions was significantly constrained with the introduction of the tapered annual allowance.
Consequently, individuals with a taxable income (income from all sources including P11D benefits) in excess of £150,000 have their annual allowance of £40,000 gradually reduced by £1 for every £2 of income. The maximum reduction takes their available annual allowance down to £10,000 – the “tapered annual allowance”.
This means that for those earning over £210,000, the annual allowance is just £10,000.
For this reason the available income tax relief on pension contributions for those earning more than £210,000 is restricted to £4,500 (i.e. 45% of £10,000). By contrast, before the introduction of the tapered annual allowance, the available income tax relief for those earning £210,000 or more was up to £18,000 (45% of £40,000). The tapered annual allowance has therefore had a 75% reduction in the tax advantage of saving into a pension.
Those who have been a member of a registered pension scheme for at least four years (regardless of whether or not they have actually made any pension contributions to it) are able to “carry forward” any unused annual allowance for up to three previous tax years, once the present year’s annual allowance is used up.
This is especially pertinent for high earners right now because this is the last tax year in which any unused annual allowance in the 2015/16 tax year is available to carry forward – crucially, the year before the tapered annual allowance took effect.
This means that up to £40,000 can still be carried forward and will cover a pension contribution made in excess of the annual allowance before 5th April 2019; allowing high earners to claim extra tax relief of up to £13,500 which will otherwise be lost once we enter the new tax year on 6th April 2019.
Although the end of tax year deadline is fast approaching, there is still time to make a sizable pension contribution and take advantage of the 2015/16 carry forward year.
As always, taking proper financial advice is essential to ensure you remain on the right side of your allowances. We will be pleased to hear from you if we can assist.