The general rule for pension contributions is that each individual is entitled to an annual allowance of £40,000. Pension contributions of up to £40,000 can be made in a year without incurring any tax charge. In addition, individuals are entitled to carry forward up to three years’ worth of unused allowances, provided they were a member of a registered pension scheme at the earlier time.
However, from 6 April 2016 individuals who have high incomes have potentially faced a restriction in their annual pension allowance. The restriction applies where two conditions are met:
Condition A is that the individual has ‘threshold income’ in excess of £110,000; and
Condition B is that the individual has ‘adjusted income’ in excess of £150,000.
‘Threshold income’ is broadly equivalent to taxable income, but importantly does not include employers’ pension contributions. ‘Adjusted income’ is broadly defined as taxable income plus employers’ pension contributions.
Where the conditions are met, the annual allowance in restricted by £1 for every £2 by which the £150,000 threshold is exceeded, down to a lower floor of £10,000.
It can be possible, in certain circumstances, to plan the timing of pension contributions to avoid being affected by the high income restriction.
In 2016/17 Mr Pennybags has taxable income of £150,000, comprising a small £10,000 salary and £140,000 of dividends from his limited company. He wishes to make a pension contribution of £40,000.
Based on his taxable income alone, Mr Pennybags fails Condition A but not Condition B. However, if the company makes a pension contribution he will fail Condition B as it will take him above the £150,000 threshold. Hence, his annual allowance will be restricted, in this case to £20,000 (and the excess contribution will be taxed).
However, if the company did not make the contribution then the full £40,000 allowance would still be available and any unused amount would carry forward. Furthermore, provided Mr Pennybags doesn’t have taxable income in excess of £110,000 in 2017/18 he will be outside of the high income restriction rules. The company could then use up both the current year and prior year allowances.
If this was done as a four yearly exercise, Mr Pennybags could continue to earn £150,000 in years 1-3 and would only need to reduce his income to £110,000 in year 4. However, the company would then be able to make a full four years’ worth of pension contributions, totalling £160,000 without incurring a tax charge.
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