From an advice perspective, maximising pension savings in the run-up to April, along with any unused annual allowance from previous years, will be high on the adviser action list for appropriate clients. At the same time, advisers and clients will need to be mindful of the impact of the lifetime allowance on pension savings.
Making use of tax allowances has always been important and as the end of the tax year approaches, advisers will need to make their clients conscious of the annual and the lifetime allowances as well as recent changes. This year, things have become slightly more complicated with the introduction of annual allowance taper rules, which will reduce the annual allowance for pension contributions substantially from £40,000 to £10,000 for some earners.
However, there are some ideas that can cut the tax impact on your clients’ pension pots and proper planning could save them a substantial amount.
Tapered annual allowance
Until now, a client would receive tax relief on annual contributions of up to £40,000. However, for people on high incomes, the government has introduced a sliding scale that reduces the £40,000 annual allowance to a minimum of £10,000. This takes effect in the tax year 2016/17.
The rules are complicated and require two different calculations of income to determine whether a client is affected. First, clients need to determine if their threshold income is more than £110,000. If it is, we need to calculate whether their adjusted income is more than £150,000 a year. If they cross both those thresholds, their annual allowance will be reduced by £1 for every £2 that the adjusted income exceeds £150,000.
Threshold income includes income from all sources, not just salary. So this includes income produced by investments and buy-to-let properties. We must also add back any income given up in a salary sacrifice arrangement that was set up after 8 July 2015. From this, deduct the pension contributions made to personal and occupational pensions. If the figure produced is less than £110,000, there is nothing to worry about – the client's annual allowance will be £40,000. If it is above, however, we need to calculate adjusted income. Adjusted income is calculated in a similar fashion to threshold income, but includes the pension contributions that a client and their employer make both from gross pay and via salary sacrifice.
Given the complexity of the income calculations, it is likely there are a number of people who are unaware that the new rules affect them. Worse still, some might not know if their income will exceed the £150,000 threshold. The government thinks there are about 300,000 people who save into pension pots that could be in this scenario.
Taper is likely to be most challenging when it comes to defined benefit schemes, because for most people in those schemes it will be difficult to work out the amount of annual allowance used up by their defined benefit pension scheme accrual.
Crucial carry forward
For those clients who exceed the annual allowance in a tax year, help could be at hand from carry forward. This enables them to use leftover annual allowance from the previous three tax years, increasing their annual allowance in the current tax year.
