Will your senior employees face an unexpected tax bill?
Written by: Philip Thrush
Rules that significantly restrict the amount high earners can put into their pensions – and receive tax relief on – have now been in place for over a year, which means unexpected tax bills are just around the corner.
In the most severe cases, some employees have had their annual allowances slashed from £40,000 to just £10,000. Any pension contributions in excess of this, whether made personally or by their employer, will soon be taxed.
Some employers took early decisive steps to assist their senior employees in understanding the impact of the legislation and provided guidance and/or access to independent advice. Others did not and the responsibility has been left firmly with the individual to take appropriate action to avoid paying excessive contributions and suffering an immediate tax liability.
For years the Government has discussed the disproportionate amount of tax relief granted to those at the higher end of the earnings spectrum, but as yet, there has been no overhaul of the system to address the perceived imbalance in pension tax relief. As many commenters suggest, this may change in the future if flat rate allowances and tax relief are introduced.
Tapering was introduced as a quick fix for HMRC and will undoubtedly save a substantial amount in tax relief. In the process, it has also limited the ability of higher earners to accumulate benefits in the tax advantageous pension environment and these individuals now need to look for alternative investment strategies.
HMRC published a statement in early April to note that the number of individuals declaring an over payment to their pension rose dramatically in the 2016/17 tax year to 7,000 cases. This may well be the tip of the iceberg as many of those that may have exceeded their allowance do not realise they have. This problem may well escalate as we are now in the second year of the Tapered allowance and individuals may be continuing to overfund unknowingly?
The Key Facts
The legislation has a number of important trigger points for high earners to watch out for.
If total income from all sources (including employer pension contributions) exceeds £150,000 then care needs to be taken. For every £2 earned in excess of £150,000, the Annual Allowance reduces by £1.
Example: A member of a scheme earns £145,000 basic salary but has a £5,000 car allowance and receives a 10% pension contribution from their employer. The assessed income is therefore £164,500. This would mean that their Annual Allowance reduces by £164,500-£150,000/2= £7,250 reduction. The individual can then contribute £32,750 (£40,000 - £7,250) in the tax year and benefit from tax relief at their highest marginal rate. If the individual then receives a bonus payable at the end of March of £20,000, this will reduce the Annual Allowance by a further £10,000 to £22,750.
Once total income reaches £210,000, the annual allowance is then a flat £10,000 gross per annum.
Carry Forward Relief
It remains possible to bring forward unused contribution allowances from the preceding 3 tax years and this may allow individuals to contribute in excess of the current tax year allowance. This needs careful calculation, especially as there were potentially two annual allowances in the 2015/16 tax year. In addition, individual policies had payment periods (PIPs) that were not aligned to the tax year and this was corrected in 2015/16 by HMRC.
Constantly high earners
By April 2019, individuals consistently in the “high earners” bracket will need to undertake a comprehensive assessment of their future pension payments as there may be no ability to carry forward any reliefs. This may also impact on their ability to benefit from their current employer pension contributions and this may also need to be addressed when the company reviews any benefit offering to this group.
Tapering has had a substantial impact and has led to a great deal of confusion both for tax payers and also many financial advisors. There can be little doubt that there are still many more changes yet to come in pension legislation, however; this is a problem that needs to be addressed by employers and employees alike if the penalties are to be avoided.
The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice. The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Occupational pension schemes are regulated by The Pensions Regulator.