The first is where the annual allowance for higher-earning individuals may be tapered and reduced to as little as £4,000. Where the taper applies, the annual allowance is reduced at a rate of £1 for every £2 of income above £240,000.
Higher earners are those who have:
- an “adjusted income” of more than £240,000; and
- a “threshold income” of more than £200,000.
Both the adjusted income and threshold income limits must be exceeded for the taper to apply.
Adjusted income is income chargeable to income tax from all sources — so includes investment income, not just salary — plus any pension contributions paid in the relevant period. This means that sacrificing salary or bonus payments for employer contributions is not effective in reducing adjusted income.
The threshold income test is to protect people who have a spike in earnings from being unfairly impacted by the taper.
Threshold income consists of income chargeable to income tax from all sources (so again includes investment income, not just salary), plus any salary sacrifice or flexible earnings set up on or after July 9 2015, minus any personal contributions entitled to relief at source tax relief. Personal contributions may therefore be used to reduce the threshold income figure to avoid triggering the taper.
The second situation where the annual allowance can be reduced is where the Money Purchase Annual Allowance has been triggered. The MPAA is triggered when flexible pension payments are drawn from a DC scheme for the first time. This includes:
- taking a flexi-access drawdown pension payment;
- receiving capped drawdown income above the capped maximum;
- taking an uncrystallised funds pension lump sum;
- receiving your first income payment from a flexible annuity.
The MPAA is not triggered if only a pension commencement lump sum is taken, or if flexi-access drawdown income is taken from a disqualifying pension credit or a beneficiary’s drawdown.
The MPAA will reduce the annual allowance for DC schemes to £4,000. A quirk to be aware of is that in the tax year the MPAA is triggered, any contributions to DC schemes made prior to the trigger date are not tested against the MPAA. Instead, they are tested against the standard £40,000 annual allowance — lower if subject to the tapered annual allowance.
Carry forward
Carry forward allows the member to take unused annual allowance from the previous three tax years and use it to increase their allowance for the current tax year. By doing this, they can make a larger contribution without exceeding their annual allowance and incurring a tax charge.
They must use up their full annual allowance in the current tax year before they can carry forward unused allowance from previous tax years. It cannot be used in conjunction with the MPAA.
Your client also needs to have been a member of a registered pension scheme to carry forward from that tax year. This includes not just “active” members — those making contributions or accruing benefits — but also deferred members and pensioner members.
