Your guide to the tapered annual allowance
You may have plenty of things on your bucket list for when you retire. Have you always wanted to travel abroad to distant countries? Or perhaps you want to start a new and exciting hobby. It can be thrilling to think of the lifestyle you’ll lead in your post-work life, but you should also be thinking about your finances, to ensure your future income can fund the lifestyle you want.
Planning for your retirement can be complicated, especially as a high earner. You’ll have so much to consider, such as how much you need to invest in your pension pot, if you need to use different tax vehicles, and how your plan will help you to meet your financial goals.
One aspect you should also consider is the annual allowance and how tapering applies for high earners, as this could be a cause of unexpected tax bills at the end of the tax year.
The pension annual allowance
To understand tapering, you first need to be aware of the annual allowance. In simple terms, this is the total amount you can put into your pension each tax year, with the benefit of tax relief. This includes both your personal contributions and the contributions your employer makes.
At present, the annual allowance is a pretty generous £40,000 or the equivalent of your total income – whichever is lower. You must pay tax if you go over the allowance, which will be charged at the end of the tax year.
In some cases, your pension provider will issue a statement that explains if you have gone above the annual allowance. Alternatively, you can also use an online calculator to work out how much you’ve gone above the allowance.
What is the tapered annual allowance?
Your annual allowance reduces in the tax year if both your:
- Threshold income is over £200,000
- Adjusted income is over £240,000
There are plenty of resources available online which can help you to work out your threshold and adjusted income.
This reduction is what is known as the tapered annual allowance, and reduces the amount you can contribute to your pension by £1 for every £2 of income above £240,000. This can be reduced to a minimum allowance of £4,000 in a tax year.
Will you be affected?
Your annual allowance will not be affected if your threshold income for the present tax year is £200,000 or less, regardless of your adjusted income.
This is great news for some, but for those with income above £312,000 per year, you’ll be subject to the full tapering and your allowance will be reduced to £4,000.
You may be wondering what happens if your income lies between £200,000 and £240,000. It may be the case that you are still affected by tapering, as the calculation takes into account any additional sources of income, such as employer pension contributions.
Avoid accidental taxation
The first step to avoid an unexpected tax bill at the end of the tax year, is to be fully aware of the annual allowance, and tapering. If you believe that you’ll be affected by the annual allowance when it comes to your pension planning, then you should consult with a financial advisor or financial planning services.
With an expert financial plan in place, you can take advantage of various tax vehicles, other than your pension, to grow your wealth effectively and in a tax efficient way.
Disclaimer: Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested.