Decode the pension taper rules

Story

Tax relief on pension savings is among the most generous of government benefits to UK savers. But relief for higher earners has come under pressure because of fiendishly complicated pension taper rules from the taxman.

Designed to limit tax breaks to higher-income pension savers, pension taper rules came into force for the 2016-17 tax year – and pension experts say they are “nightmarish”. 

How the taper rules work

The rules reduce what those earning more than £150,000 can put into their pension in a tax year, known as the annual allowance, and still gain tax relief on contributions. For most of us, the allowance is £40,000, but this is gradually tapered if your earnings go over a certain amount.

At present, if you earn £150,000 or more, your allowance falls by £1 for every £2 of income between £150,000 and £210,000. For incomes of £210,000 or more, the allowance is £10,000. So far, so simple. But once you try to define what “income” is, things get really complex.

Income and liabilities

To work out if you will fall within the rules, you need to calculate your “threshold” and “adjusted” incomes. Threshold income includes all income sources, including salary, investments and buy-to-let properties, plus any income given up in salary sacrifice arrangements.

Then deduct any contributions made to personal and workplace pensions. Any lump sums from someone else’s unused pension on their death is not included in threshold income.

If your threshold income is less than £110,000, you will not be caught by the taper rules. If it is above, you have to calculate your adjusted income. This requires you to include pension contributions you and your employer make from gross pay and via salary sacrifice. If adjusted income is above £150,000 the taper on relief begins to kick in.

Making use of past allowances 

If you fall foul of the taper rules, you may be able to use any unused allowances from recent years to make higher contributions. But this can be problematic, as the contributions themselves can affect your threshold and adjusted income.

Alternative saving schemes

In such cases it may be worth turning to other ways of saving for retirement. These include ISAs, with an annual tax-free allowance of £20,000, and – where appropriate – venture capital trusts (VCTs) or enterprise investment schemes (EISs). These provide generous tax relief but are exposed to start-ups and are higher-risk investments.

Taking expert advice

Pension taper rules are not for the faint-hearted. A financial adviser could help you work out if there are ways to structure your contributions to avoid the taper and whether VCTs and EISs are considered suitable for your individual circumstances.

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