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Pension Contribution Rules for Higher Earners from 2016/17

Pension Contribution Rules for Higher Earners from 2016/17

The following general rules apply for pension contributions from 6 April 2016:

  • Maximum 100% of earnings up to £40,000 annual allowance.
  • You can also carry forward unused allowances from the previous 3 years.

However, HMRC have changed the rules for Pension Annual Allowances for certain individuals.  This process involves 2 tests:

Test 1: Threshold Income

If your “Threshold Income” is £110,000 or less for the tax year, you will be entitled to the full Annual Allowance of £40,000 (on the assumption that you have not yet started to receive any income from a pension policy, which would then subject you to the Money Purchase Annual Allowance of £10,000, reducing to £4,000 from 6 April 2018).

HMRC have made the definition of Threshold Income very complicated.  However, a simplified way of understanding it is that it represents your taxable income less various deductions, the most common one being individual contributions to an occupational scheme via your salary.  Other deductions will be items such as trade losses, share loss relief and gifts to charities.  For a more detailed description of your Threshold Income, please refer to:

https://www.gov.uk/guidance/pension-schemes-work-out-your-tapered-annual-allowance.

For example, John received a salary of £140,000 and his employer and him both paid 5% pension contributions into a personal pension scheme.  His threshold income will be £140,000 – £7,000 (Employee contributions) = £133,000.  As John’s threshold income is above £110,000, he has to go to the second test of “Adjusted Income”.

Test 2: Adjusted Income

The main difference to Adjusted income is that pension contributions are added back, including contributions made by your employer.

Taking the above example of John, his Adjusted income will be £140,000 + £7,000 (employer contributions) = £147,000.

Tapered Annual Allowance

For every £2 of your adjusted income that goes over £150,000, your annual allowance for that year drops by £1.  The minimum tapered annual allowance is £10,000.

Following through on the example of John above, as his Adjusted Income of £147,000 is less than £150,000, he receives the full Annual Allowance of £40,000.  If his Adjusted Income had been £160,000, his Annual Allowance would be reduced to £35,000 as follows:  £40,000 – (£160,000 – £150,000)/2 = £35,000.

Please refer to us in the first instance to discuss your ability to make pension contributions.  It may also be necessary to seek further advice from a qualified Independent Financial Adviser.

Tax Charge for Over-Funded Pension Contributions

For 2016/17, the pension Lifetime Allowance (LTA) is currently £1m.

Savings above the LTA attract LTA tax when crystallised, as follows:

  • 55% LTA tax on excess savings taken as a Lump Sum;
  • 25% LTA tax (plus income tax) on excess savings used to provide Income.

When you draw benefits or if you die before taking any benefits, a benefit crystallisation event (BCE) takes place and the value of your benefits are tested against the lifetime allowance.  If you have not taken all of your benefits by age 75, a lifetime allowance test will be carried out at this stage, on your remaining benefits.

If you are a member of a defined contribution pension scheme, the value of your benefits is the value of your pension pot in the scheme.

If you are a member of a defined benefit pension scheme, the value of your benefits is calculated as 20 times the pension that you have accrued under the scheme plus any tax free cash that you have received.  For individuals who have been in a defined benefit scheme for many years, this can become a high figure and advice may need to be taken about your options.

Care should be taken to work out which options are best to take i.e. taking a lump sum or income.

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