Annual Allowance

Annual Allowance Changes Summary

The Budget on 8 July 2015 announced some changes which will mean that high income earners in the National Health Service may face an increased tax bill from 6 April 2016 as a result of their membership of the occupational pension scheme.

Background

Members of defined benefit schemes, such as the NHS Pension Scheme (NHSPS), have their Annual Allowance (AA) position measured by testing any increase in the value of their pension (discounted by an allowance for CPI inflation) against the relevant limit. The increase in value is multiplied by a factor of 16 meaning that a member whose entitlement to pension has increased by £2,000 (after allowing for inflation) over the year must use a figure of £32,000 for AA purposes.

The main change

Those with income over £150k can still get 45% tax relief on pension contributions, but their pension saving allowance will be reduced from 2016/17 as follows;

  • The Annual Allowance (AA), currently £40,000, for those earning above £150,000 is to be reduced on a tapering basis to a maximum of £10,000 where ‘income’ exceeds £210,000. For every £2.00 of income above £150,000 the AA will reduce by £1.00.

Who is affected?

The taper applies to someone if ‘threshold income’ is above £110,000 and ‘adjusted income’ is above £150,000. This does mean that if ‘threshold income’ is below £110,000 the AA remains at £40,000.

Threshold income

Threshold income’ is made up of

  1. The individual’s income from all sources before tax (after deductions for allowable pension contributions*) plus,

  2. Any employer contributions from new salary sacrifice arrangements that started after 8 July 2015  

* Please note that contributions to the NHSPS are deducted from gross pay and therefore will automatically be outside of ‘threshold income’.

Adjusted income

Adjusted income’ is made up of

  1. Threshold income’ plus,

  2. Any personal or employer contributions to defined contribution pension arrangements

  3. The value of accrual in defined benefit arrangements (such as NHSPS)*

* Members of the NHSPS will need this information to be provided by the scheme. It is, however, unlikely to be available before the end of the scheme year and therefore members will not know if taper applies and what their AA will be until after the relevant tax year end. The employer’s share of the accrual (needed for ‘adjusted income’ figure) will be calculated by deducting personal contributions from the total.   

Summary

In summary therefore:

  • if ‘threshold income’ is £110,000 or lower the annual allowance remains at £40,000 and there is no need to calculate ‘adjusted income’.

  • If ‘threshold income’ is greater than £110,000 but ‘adjusted income’ is £150,000 or lower the annual allowance remains unchanged.

  • Finally, if ‘threshold income’ is greater than £110,000 and ‘adjusted income’ is more than £150,000 then the taper will apply.

The ‘adjusted income’ definition rules may catch many members of the NHSPS out as they may overlook the impact of employer contributions and think that they are unaffected as their actual income is below £150k.

NB Please remember that if an individual has flexibly accessed any benefits from a defined contribution arrangement the reduced money purchase AA of £10,000 will apply irrespective of income.

INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.

A PENSION IS A LONG-TERM INVESTMENT. THE FUND VALUE MAY FLUCTUATE AND CAN GO DOWN. YOUR EVENTUAL INCOME MAY DEPEND UPON THE SIZE OF THE FUND AT RETIREMENT, FUTURE INTEREST RATES AND TAX LEGISLATION.