Pension contributions for high earners
The tax relief on pensions makes them a really tax efficient way of investing for your future whatever rate of tax you pay.
If you are a high earner you need to be aware of how your income and tax back affects the amount you can pay into your pension and the potential amount of tax relief you can claim.
How much can I contribute to my pension if I’m a high earner?
For the majority of people, you can make pension contributions up to 100% of your yearly earnings or up to the annual allowance of £40,000, whichever is lower.
It’s more complicated if you’re a high earner. If your “adjusted income” is more than £240,000 a year, then the tax relief you can get on your pension contributions is limited to a reduced annual allowance, known as the tapered annual allowance.
Tapered annual allowance
If your threshold income is more than £200,000 and your adjusted income is more than £240,000, your annual allowance for that tax year will be tapered. A tapered allowance reduces proportionally according to your earnings, ie, for every £2 of adjusted income over £240,000, your annual allowance will reduce by £1. The minimum tapered annual allowance is £4,000.
Tax relief on pension contributions for high earners
Simply, everyone can claim the basic 20% tax relief on their pension contributions. This is usually in the form of a top-up from the government on any contributions you pay in up to £40,000. Even though this annual allowance is reduced for high earners, you can still benefit from generous tax-relief benefits.
Higher-rate taxpayers can claim a further 20%, while additional-rate taxpayers can claim an extra 25%.
So, if you’re an additional rate taxpayer, even at the minimum tapered annual allowance of £4,000, you could still get tax relief of £1,800 on contributions each tax year. Make sure you claim the additional relief through your tax return.
Carry forward for high earners
If you have not always paid in the maximum amount you could to your pensions, another way to benefit from tax relief is by using carry forward rules. High earners with reduced annual allowances may still be able to benefit from the carry forward rule:
- You can carry forward any unused annual allowance from the previous three tax years, even if in this year you’ve got a tapered annual allowance
- If you have unused annual allowance from a previous year in which you’ve had a tapered allowance, you can only carry forward an unused amount up to the tapered allowance
- Your gross earnings for the current tax year must cover your entire pension contribution, including the carry forward contribution
High earners and the lifetime allowance
The lifetime allowance is the maximum amount your pension can be worth when you start to take money from your pension. Over past years, the lifetime allowance as been significantly reduced. For the 2020/21 tax year, the lifetime allowance is £1,073,000.
If your pension pot exceeds this amount when you start taking from your pension you may have to pay a charge.
Whilst this seems a large amount, if you’re a high earner and you’ve been contributing to your pensions for a while, it’s possible that you could be close to the lifetime allowance.
If your pension fund is close to the lifetime allowance, you should speak to a pension adviser without delay. Remember, this isn’t what you have paid in, it is based on the value of your pension pot.
How do I work out if I have a tapered allowance?
The good news is that we can help you!
Firstly, you need to find out what your annual allowance is for the tax year. This is based on your threshold income and adjusted income.
In broad terms, your threshold income is your total taxable income excluding pension contributions, while your adjusted income is your total taxable income including all pension contributions.
Your total taxable income usually includes:
- taxable earnings (salary, bonuses, commissions) after salary sacrifice
- property rental income
- savings income
- dividend payments
- profits from self-employment
To calculate your threshold income for a specific tax year, take your total taxable income, add any salary you’ve sacrificed for pension contributions, and take off any personal pension contributions.
- You must include any salary you’ve sacrificed for pension contributions if the arrangement started or changed after 8 July 2015 (verify what your arrangement says).
- The personal pension contributions you need to subtract are only those that you have made to a personal or workplace pension – you cannot include employer contributions.
- If you have made any charitable gifts or trade losses, you might be able to subtract these also to reduce your threshold income. You should check Section 24 of the Income Tax Act 2007 for details of what can and cannot be deducted.
Once this calculation is completed, if your threshold income for the year is £200,000 or less, your annual allowance won’t be reduced.
If your threshold income is more than £200,000, you need to work out if your adjusted income is more than £240,000 to see if your annual allowance is affected.
Adjusted income is your taxable income for the year, plus employer pension contributions minus any reliefs that might apply.
- You must include any benefits you have built up in final salary schemes.
- If you have made any contributions to an occupational pension scheme through a net pay arrangement you need to include these.
- The employer contributions also include any contributions made through salary sacrifice, regardless of when the arrangement started.
If your adjusted income works out to be more than £240,000, you will have a tapered annual allowance for that tax year. This means that for every £2 of adjusted income over £240,000, your annual allowance will decrease by £1.
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The minimum tapered allowance is £4,000, so if your adjusted income is more than £312,000, you still will have an annual allowance of £4,000.
We would always recommend you speak professional advice.
I have been providing specialist pension advice to clients for many years. If you would like a no obligation discussion about your pension and retirement plans please get in touch
Lee Gardner – Financial Planner