A crisis in the health service has thrown light on one of the most complicated and controversial elements of the pension system.
The Tapered Annual Allowance affects high earning people. These include doctors, many of whom have found that it is more cost effective to work fewer hours or even retire than pay tax charges created by the rule. That has caused a staffing shortfall in the already stretched NHS.
If you earn more than £110,000 it might affect you too.
What is the Tapered Annual Allowance?
It makes sense to first explain the Annual Allowance. This is a cap on how much you can pay into a pension each financial year while still getting tax relief on those contributions. Right now the Annual Allowance is set at £40,000.
In 2017 the Tapered Annual Allowance was introduced. It was designed to save money by making the system a bit less generous to high earners. In the simplest terms, it gradually reduces - or tapers - the Annual Allowance from £40,000 to £10,000 once a person hits some specified earning limits.
Who is caught be the Tapered Annual Allowance?
Anyone whose annual income is more than £110,000 could be affected - but not everyone will be. It depends on two measures of income - ‘Threshold Income’ and ‘Adjusted Income’. The limits for both of these have to be triggered before a person is affected by the Tapered Annual Allowance.
In broad terms, Threshold Income includes your income from all sources minus pension contributions you’ve made. Adjusted Income is a higher amount and includes all your taxable income plus any pension contributions made to a workplace pension by you and your employer.
Anyone whose Threshold Income is more than £110,000 and whose Adjusted Income is more than £150,000 will be subject to the Tapered Annual Allowance.
There’s a more detailed explanation of how these are worked out in our Tapered Annual Allowance guide.
What is the effect of the Tapered Annual Allowance?
For those affected, the £40,000 Annual Allowance is reduced by £1 for every £2 that their Adjusted Income exceeds £150,000. Reductions continue until Adjusted Earnings reach £210,000. At that point their Annual Allowance will be just £10,000.
Bear in mind that anyone who has accessed a pension flexibly, which can be done from age 55, may be subject to an even lower Annual Allowance. The Money Purchase Annual Allowance applies in these circumstances, and allows just £4,000 to be contributed each year. You can read more on that here.
What happens if you breach the Annual Allowance?
If you pay too much into your pension in any one year your excess contribution (the amount above your annual allowance) may be added to your income. As a result this will be subject to Income Tax at your highest marginal rate.
There is some protection in these circumstances from a rule which allows you to use any unused Annual Allowance from previous years. This is called ‘Carry Forward’ and is subject to its own rules and limits. You can read more about those here.
Who is most at risk of breaching the Tapered Annual Allowance?
Anyone whose earnings are close to the £110,000 limit for Threshold Income needs to be watchful.
Those in Defined Benefit pension schemes face a particular problem, including doctors and other high-earning employees in the public sector. These are the schemes where retirement income is guaranteed and calculated as a proportion of salary.
Working out annual pension contributions into these schemes is not straightforward and clinicians may not be able to predict their contributions because it will depend on any extra hours they work - a common scenario in the health system.
Many doctors found they had contributed too much and they had breached the Tapered Annual Allowance, triggering high tax charges. Some reacted to this by working fewer hours, or even seeking early retirement.
What happens now?
The Government has promised to look at ways to make doctors’ pension scheme more flexible so that NHS employees can more easily avoid tax charges. The proposals include making NHS pension contributions more flexible, and encouraging employers to recycle contributions above the Tapered Annual Allowance back into doctors’ salaries.
Many independent observers see the proposals as insufficient and likely to add yet more complexity to an already complicated system. They have called the Tapered Annual Allowance to be rethought completely. That seems unlikely for now, not least because it will be a very expensive change for the Government.
If you think you may be affected by the Tapered Annual Allowance consider getting help from an authorised financial adviser.
The Tapered Annual Allowance is also one of the discussions in this week’s MoneyTalk Podcast.
Important Information The value of investments and the income from them can go down as well as up so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.