Tampering with tapering
Effective financial planning and the tapering of the annual allowance are almost completely at odds with one and other. However, the recent change to tapering afforded advisers an opportunity to potentially mitigate an annual allowance charge for at least some of their clients.
There has been a fair amount of column inches written over the last year to eighteen months on the topic of the tapered annual allowance (TAA) and, in particular, how it has impacted on high earners in the public sector. Various solutions were put forward as to how to combat this inequality, with it being suggested that specific professions should be treated differently from others. The risk with the latter option was that this would have been open to challenge by other groups of individuals who felt they were being discriminated against, a view that I have always taken personally. You only have to consider the Judges and Firefighters case over the 2015 pension reforms that had a detrimental outcome for the government to see why this was a non-starter.
While it can be still argued that the TAA is an over complicated piece of legislation that creates uncertainty for effective financial planning, the new chancellor’s solution seems simple., Increasing the various thresholds from 6 April 2020 should mean only a very small minority of individuals are caught by this legislation going forward. To recap, at present, if an individual has threshold income (broadly net income before tax, excluding pension accruals) greater than £110,000, then they need to consider whether their adjusted income exceeds £150,000. If this is the case, then for every £2 over £150,000 the individual loses £1 of their (AA) to the point that at £210,000 they are left with an TAA of £10,000. Consider the example below:
Hanna is a high earning director of a small business and in 2019/20 she expected her net income to be £130,000. She has no other source of income. With the business having a good year it had been agreed to fund her Sipp with an employer contribution of £80,000.
Hanna has had her Sipp for several years, into which she has previously paid personal contributions. In both the 2016/17 and 2017/18 she paid £40,000 gross to fully maximise her AA. She made no contributions in the 2018/19 tax year when she was also unaffected by the TAA. If the company paid the £80,000 contribution in the 2019/20 tax year then the outcome for Hanna would have been as follows.
Hanna would be liable to an AA charge on £30,000 given she had £40,000 of carry forward from the 2018/19 tax year. The AA charge being a combination at 40% and 45%, if Hanna is not subject to the Scottish income tax rates
The Finance Bill contains draft legislation that substitutes the £150,000 figure, for when tapering starts to potentially kick in, with £240,000 and contains a corresponding increase in the threshold income figure. This in turn pushes the upper limit on where the tapering ceases having an impact to £312,000 as the proposal is that, rather than a minimum TAA of £10,000, this will be reduced further to £4,000, the same level as the money purchase annual allowance. This change is to be effective from 6 April 2020.
Revisiting Hanna’s scenario in the example above, if her company had postponed the payment till after 5 April 2020, bearing in mind that many companies’ tax year ends do not coincide with the fiscal year end, then Hanna may have been far better off. Presuming Hanna’s net income for 2020/21 remained the same at £130,000, then she will be well below the threshold income figure of £200,000 and so not affected by the tapering of the AA. Her company contribution of £80,000 will therefore have no impact on her AA. She would still have her carry forward from 2018/19 to factor in plus the full £40,000 from 2020/21 and in addition, if no contributions were made by either her, or her employer, before 6 April 2020, she would also have £40,000 for that tax year to carry forward for future use. Hanna would therefore have no AA charge to pay.
The positive change announced by the chancellor, and a bit of prudent financial planning by advisers, could mean some of their clients avoiding the nasty surprise of an AA charge.
This article originally appeared on Money Marketing