‘So much for the golden future, I can’t even start
I’ve had every promise broken, there’s anger in my heart
You don’t know what it’s like, you don’t have a clue
If you did you’d find yourselves doing the same thing too’.
I don’t think that Judas Priest were contemplating the unintentional consequences of exceeding the annual allowance when these lyrics were written, but they could ring true for employees who are finding that their employer’s contribution into their pension is creating a personal tax liability.
The announcement that the annual allowance was to reduce from £255,000 to £50,000 from April 2011, implied the end of the golden future. The further reduction to £40,000 in April 2014 seemed to be another promise broken; however, the changes from April 2016 have created further confusion, with many clients not understanding whether they will be affected or not.
The standard annual allowance applies across all of the pension schemes a member may belong to. If a member exceeds the annual allowance in a tax year, they will be levied with an annual allowance charge, unless they are able to carry forward unused tax relief from any of the previous three tax years.
The new development from 6 April 2016, is that the annual allowance will be tapered for individuals with adjusted annual incomes over £150,000 in a tax year. Generally speaking, an individual’s ‘adjusted income’ will be their total taxable income, including any pension contributions.
Some employees affected may be able to initially minimise the impact of the tapering by the use of carry forward of unused annual allowances from previous years. But what if there is no carry forward available?
Notwithstanding that it remains the member’s responsibility to check whether they are affected by changes to the annual allowance, there are still options available to an employer, and there are certain triggers that could be used to identify possible members who may be affected.
Communication with employees remains a key driver in financial education, and a restructuring of benefits could ease the situation. A review of the options can assist both individuals and employers in making an informed decision; however, employers need to be mindful ofboth emotive and legal considerations to ensure that the solution to the problem does not create additional ‘law- breaking’ scenarios.
Employees and employers should be aware of the distortion that can occur to adjusted income by the payment of a bonus or commission, especially if paid towards the end of the tax year, as this may leave little time to adjust pension contributions to remain within the restricted annual allowance. New salary and bonus sacrifice arrangements set up after July 2015 will be caught in adjusted income and so cannot be used to avoid the tapering.
Finally, if a member does become subject to annual allowance charges, there is an option for the scheme to pay the tax charges; however, the scheme can only pay the tax if the charge is at least £2,000, based on a test against the standard annual allowance of £40,000. This is because the scheme can only test against an annual allowance of £40,000 and ultimately only a member will know the exact tapered annual allowance they are subject to.
- Steph Gordon, Employee Benefits Consultant, 2016