High earners - don’t get caught out by a pensions tax charge

High earners need to consider whether they may be subject of a ‘hidden’ tax charge in respect of the amount that they save in a pension for their retirement.

What is a high earner?

Basically, this is anyone whose ‘adjusted’ income exceeds £150,000 and ‘threshold’ income exceeds £110,000.

Adjusted income is broadly gross income from all sources (salary, benefits, self employment, rental profits, investment income etc) plus pension contributions made on behalf of the employee by the employer.

Threshold income is broadly just gross income from all sources.

There are some further complexities in respect of pension contributions made personally, pension contributions made by salary sacrifice, pensions death benefits etc which have not been considered here.

I’m a high earner, so what can I save into a pension?

In simple terms, an individual starts the tax year with an annual pensions allowance of £40,000 which means that they may be able to contribute this amount (including the associated tax relief) into a pension pot.

However, tax isn’t a simple subject and the £40,000 allowance is affected by:

  • Your earnings – if your earned income (employment, self-employment, partnership etc) is less than £40,000, then you can only contribute the amount of your earned income to the pension. If you don’t have any earnings, you can still contribute £3,600 (including the tax relief) into a pension pot
  • Unused allowances from earlier years – if you have not contributed to a pension in earlier years or have not used all of the £40,000 allowance, then as long as you have had a pension pot in the past, you may have a larger allowance to utilise
  • The new rules which potentially reduce the £40,000 annual allowance

The first two points above have been known for years but the third point is a new tax ‘trap’ to watch out for when completing your self assessment tax return. This is known as the tapered pensions allowance.

What are the new rules?

For high income individuals, every £2 of ‘adjusted’ income over £150,000 reduces the annual pensions allowance by £1.

So an individual with ‘adjusted’ income of say £175,000 would have a reduction in their pensions allowance of £12,500 ( (£175,000 - £150,000) / 2 ). Therefore they would only be entitled to a pensions allowance of £27,500 (£40,000 - £12,500).

However, the maximum reduction in the allowance will be £30,000. So those earning in excess of £210,000 will have a minimum pensions allowance of £10,000.

Ok, so where is the tax charge?

This is best demonstrated with an example.

Example

Joanne had employment income of £250,000 in the tax year to 5 April 2017. In addition, her employer also contributed £40,000 into her pension pot during that tax year and has done for many years (so she has no unused pensions allowance from earlier years to utilise).

However, as Joanne’s earnings are in excess of £150,000, she is subject to the new rules and her pensions allowance is reduced to £10,000. This means that she must pay tax on the £30,000 excessive pension contribution.

As a 45% taxpayer, the tax charge imposed upon Joanne is £13,500 (£30,000 x 45%). This tax charge must be declared via Joanne’s self assessment tax return. The tax is payable to HMRC by 31 January 2018.

If you are subject to a tax charge, you may be able to ask the pension company whom your plan is with, to settle the tax bill with HMRC. If they won’t make the payment to HMRC, then you will have to meet the tax charge out of your net income.

Speak to an expert

We are sure that you will appreciate that this is a complex area of taxation. We have simplified the many pages of tax legislation in producing the above article and the article intended as a guide only and not as a substitute for professional advice. We would recommend that you speak to a professional adviser in respect of these rules.

Our tax teams are here to help by giving tailored advice to your own circumstances – call Lee Watson at Darlington on 01325 349700, Nicola Bellerby at Durham on 0191 3842244 or Rosemary Anderson at York on 01904 784400.