Changes to the Tapered Annual Allowance 2020/21
In the past few years there have been significant restrictions on the level of contributions that high earners can pay to their pension without incurring a tax charge. This was due to the introduction of the Tapered Annual Allowance in April 2016.
Because of this, many employers redesigned remuneration packages for high earners, and higher earning employees have had to make difficult decisions about saving for their retirement.
However, largely as a result of the pressure put on the Government by NHS consultants, the amount that most high earners will be able to contribute to a pension will substantially increase for the 2020/21 tax year (6th April 2020 – 5th April 2021).
Although this is good news for most, some individuals will see their ability to make pension contributions further restricted by the changes being introduced.
Therefore, we hope the information here will help you get a better understanding of:
- What the Tapered Annual Allowance is and how it works
- The changes to the Tapered Annual Allowance for the 2020/21 tax year
- What the changes mean for high earning employees’ remuneration packages
What is the Tapered Annual Allowance and how does it work?
In the UK, the standard annual pension contribution allowance is capped at the lower of 100% of annual earned income or £40,000. This is the total that can be paid by the employer and the employee together. Note that the definition of earned income is salary and bonuses, but not dividends or other personal income sources such as rental or investment income.
However, the Tapered Annual Allowance is a reduced pension contribution allowance which applies on a sliding scale for those with high total taxable income. Total taxable income includes salary, bonuses and dividends as well as other personal income sources such as rental and investment income.
Since 2016, the Tapered Annual Allowance has only potentially affected individuals with total taxable income in excess of £110,000, and only then if total taxable income when combined with employer pension contributions exceeded £150,000, during the tax year.
If combined total taxable income and pension contributions exceeded £150,000, then the annual allowance was reduced by £1 for every £2 in excess of £150,000. The minimum tapered annual allowance was set at £10,000 – this would apply if an employee’s total combined taxable income and employer pension contributions exceeded £210,000.
What changed in the 2020/21 tax year?
While the general principles of the Tapered Annual Allowance remain the same, the threshold levels will both increase by £90,000. These increases mean that only individuals with total taxable income in excess of £200,000 and total taxable income plus employer pension contributions above £240,000 during the tax year will now be affected.
While this will take most people out of the scope of the Tapered Annual Allowance, there is one more change which will reduce the amount that those with very high incomes can contribute from £10,000 to £4,000. This will affect those with taxable income plus pension contributions above £300,000.
The effect of these changes might be clearer with some examples.
Are changes required for high earner remuneration packages?
Since the introduction of the Tapered Annual Allowance in 2016 many high earning employees have decided to reduce their pension contribution. Most employers have been sympathetic to these employees’ positions and it is quite common for pension contributions to be capped at £10,000 with salary payments in lieu of pension contributions made for any balance.
Some employers have taken a blanket approach, making contributions on qualifying earnings and paying the excess entitlement as cash. With minimum contributions on qualifying earnings only around £3,500 a year, one-off contributions are then made at the end of the tax year to make use of the available allowance.
Other employers have adjusted contributions on a case by case basis, making different contributions for each employee to match the available allowance.
Neither approach is particularly easy to manage.
As the tables in the previous section illustrate, most high earning employees will no longer need to request such adjustments to their employer’s standard salary and pension terms. Most will now be able to join their company pension on the standard contribution basis. Assuming no other taxable income, an employee with a basic salary of up to £258,000 could make 8% pension contributions within the new tapered annual allowance rules – more than double the possible contribution from 2016/17 to 2019/20.
The changes to the Tapered Annual Allowance for the 2020/21 tax year will enable many high earning individuals to significantly increase their pension savings. In turn, this will simplify the management of these remuneration packages for HR and payroll teams.
We hope the information provided here will help guide your decision making in the coming weeks and months. Please let us know if you need any more information about the topics covered here or have any specific questions about your employee benefits.