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Looking to boost your pension? Typically, you can put up to £40,000 into your pension(s) each year – or, up to 100% of your earnings (whichever is lower). This is known as your “annual” allowance”, and represents the tax-free limit for your contributions each tax year. However, since April 2020, the rules have changed for higher earners. The good news is that there are often still options open for those in this income bracket. Below, our guide explains how the taper works and offers three ideas to navigate it wisely. We hope this is helpful to you. If you’d like to speak to an independent financial adviser then you can reach us via:
T: Edgbaston 0121 446 5815
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E: [email protected]
How the tapered allowance works
Since pension tax breaks are so generous, the government sought to prevent higher earners from abusing the system (e.g. selling a business and putting all of the proceeds into a pension) through rules like the Tapered Annual Allowance (TPAA). In 2016, the rules changed so that those earning between £150,000 and £210,000 per year would see their annual allowance go down as their income increases (to as low as £10,000). After this point, you cannot contribute to a pension without a tax liability.
However, in 2020 the rules changed again. Now, only those earning over £240,000 per year will be affected by the TPAA. This means that fewer people need to worry about it. However, those who are impacted could see their TPAA go as low as £4,000 (i.e. those earning £300,000 + per year).
Those earning below £240,000 need to be careful, nonetheless, not to assume that they are not affected by the TPAA. This is due to the “taper test” which means that those with a “threshold income” above £200,000 could see their annual allowance reduced. For those who might be affected, here are three ideas to consider:
Three ideas to counter the TPAA
First of all, higher earners should take time to determine where their “threshold income” and “adjusted income” lie. As a starting point, if you earn over £200,000 per year – take care! The former refers to your income including salary, dividends and other (e.g. rent from tenants) but excluding pension contributions. The TPAA for this starts at £200,000. The latter, however, is your income as well as pension contributions – meaning the TPAA, here, starts at £240,000.
Once you know where your current income sits in this picture, also consider how your income may increase in the years ahead (e.g. from promotions) and how this could affect your TPAA. This can start to illuminate ways to mitigate tax on your pension contributions throughout your career. In particular:
- Carry forward. Under pension rules in 2022-23, any unused annual allowance from the previous three tax years can be used in addition to that available in the current tax year. For instance, suppose you paused your pension contributions before taking up your job in 2022-23 (e.g. to save money whilst raising your children). Here, you could potentially add up to £160,000 into your pension in 2022-23, assuming your income is £160,000 or above in this tax year.
- Use your ISA. Whilst it is not as tax-efficient as a pension when it comes to retirement planning, an ISA still offers a great “wrapper” to grow wealth. You can put up to £20,000 per year into your account(s) and any dividends, capital gains or interest generated will be free from tax. The Lifetime ISA (LISA), in particular, can be a compelling option, for those aged 18-39. Here, you can contribute up to £4,000 per year and the government will “top up” what you put in by 25% (i.e. up to £1,000). You can start accessing the money for retirement from age 60. For instance, suppose you sell some shares in a general investment account (GIA) and make a £12,000 gain. Assuming you made no other profits from asset disposals in that tax year, this would be covered by your capital gains allowance and be free from tax. From there, you could put £4000 of the proceeds into your LISA for tax-free growth and receive a 25% “bonus” from the government.
- Negotiate with your employer. If present or future pension contributions from your employer risk putting you above the TPAA threshold, then you may wish to explore other options with them. For instance, perhaps you could agree to a “salary sacrifice” where any future pay rises are capped at your TPAA, with the rest going towards “non cash benefits” like improved private medical insurance or better “death in service benefits”.
We hope this content has been informative and inspired you to develop your own financial plan. Please get in touch if you’d like to discuss these matters with us via a free, no-commitment consultation with a member of our team:
T: 0121 446 5815
E: [email protected]