TECHTALK 40,000 FEBRUARY 2017 ISSUE 2 VOLUME 16 TAX YEAR END SPECIAL EDITION

Transcription

1 TECHTALK FEBRUARY 2017 ISSUE 2 VOLUME 16 TAX YEAR END SPECIAL EDITION 40,000

2 EDITOR CONTENTS Sandra Hogg Sandra is the senior tax manager within Scottish Widows with 17 years of hands on experience dealing with HMRC and advising owner managed businesses as an accountant and tax adviser. She also has over 18 years insurance industry experience as a financial planning expert within the group. She represents Scottish Widows at industry forums and at the ABI s Life Insurance Product Tax Panel and is Scottish Widows expert spokesperson on Tax and Financial Planning. CONTRIBUTORS Thomas Coughlan Tom has spent over 15 years in technical roles. He has wide experience including the provision of technical support to financial advisers covering life, pensions and investment compliance. He currently specialises in pension planning INTRODUCTION TO TAX YEAR END PLANNING Thomas Coughlan An overview of the recent changes to tax and pension rules and how these can be used to improve a client s financial position this tax year. MAKING THE MOST OF THE ANNUAL ALLOWANCE Thomas Coughlan There are now three annual allowances to understand. And the interaction between them can complicate year end pension planning. This article explains the restrictions that apply to a variety of clients. THE TAPERED ANNUAL ALLOWANCE INCOME DEFINITIONS Thomas Coughlan Understanding the income definitions for the tapered annual allowance relies on some knowledge of the income tax system. This detailed article explains how the detailed income tax calculation is incorporated within those definitions. CARRY FORWARD: A WINDOW OF OPPORTUNITY Thomas Coughlan An example-based look at the carry forward rules, including the impact of pension input period changes and the tapered annual allowance. THE TAX BENEFITS OF EMPLOYER CONTRIBUTIONS Thomas Coughlan Employer contributions for both employees and directors carry significant tax advantages. The conditions that must be met and the correct timing of contributions is covered in detail here. PENSION FUNDING BY THE SELF-EMPLOYED Thomas Coughlan Without an employer to pay pension contributions on their behalf, the self-employed can only make personal contributions. The restrictions and impact on income tax payments is looked at. MAKING THE MOST OF TAX BANDS AND ALLOWANCES Thomas Coughlan Before the end of the tax year, it s worth considering a number of simple tax planning strategies. The savings can be significant, and the steps required to achieve them are straightforward. 2 techtalk

3 WELCOME TO THE TAX YEAR END SPECIAL EDITION OF TECHTALK It may feel relatively quiet this year compared with the number of changes we ve been facing at previous tax year ends, however there are still plenty of worthwhile opportunities to add value: it s the last chance to use carry forward from 2013/2014. If it s not used before 6th April 2017, this will be permanently lost; the lead up to 5th April 2017 is also the last opportunity for high earners to calculate if, or by how much, their annual allowance is likely to be reduced under the tapered annual allowance restrictions and work out their maximum funding ceiling for 2016/2017; for clients already taking, or planning to take, their pension under the Pension Freedoms it s a great time to review their income to ensure they are drawing their pension tax efficiently and to prepare their tax affairs for the new tax year; and the majority of company year ends fall on 31st March, so it s also a key time for many company owners to review employer pension contributions. Whether it s making sure clients can maximise pension contributions or helping them to take their pension benefits in the most tax efficient way, your sound financial advice is vital at this time of year. Tom highlights some important planning ahead of the tax year end on 5th April. He starts off with a handy summary of common taxplanning strategies and reminds us about other support material available on our website. He also outlines the three different types of pension annual allowance available: the money purchase annual allowance; the tapered annual allowance for high earners; and the standard 40,000 allowance. And he uses four examples to show how the annual allowance can restrict the maximum tax-advantaged contribution in different ways for different clients. On a similar theme, Tom also explains the carry forward rules which enable unused allowances of previous tax years to be swept up and contributions of up to 170,000 to be made, provided that carry forward from 2013/2014 is used before 6th April Tom also looks at planning for high earners likely to be caught by the tapered annual allowance, focussing on the calculation of income. Once income has been calculated, it can be plugged into our carry forward calculator under Tools and Calculators on the Financial Planning area of the Scottish Widows Adviser Extranet, at: to work out the maximum allowance for this tax year. Tom also reminds us why employer pension contributions can be highly tax-efficient for company owners, and explains the timing requirements. And he covers tax year end pension planning for the self-employed, highlighting the impact of the accounting period in determining the level of income available to support self-employed contributions and considering the deadlines in detail. Tom rounds off this edition by looking at how to save tax by making the most of tax bands and allowances. I hope you will find this tax year end special edition both a useful guide and an interesting read and that we will have helped you in your planning and in your discussions with your clients on these important topics. And for more information on workplace and individual pension planning please also take a look at our extensive range of support on the Financial Planning area of the Scottish Widows Adviser Extranet, at: and Enjoy the read. Sandra Hogg techtalk 3

4 INTRODUCTION TO TAX YEAR END PLANNING Thomas Coughlan A few years of unprecedented change in the pensions industry have presented advisers with many new obstacles to negotiate before they can get the most out of the pension and tax system for their clients. The Freedom & Choice reforms have changed peoples attitudes towards pensions for the better and impacted upon the way funds are accessed at retirement. This, inevitably, has been accompanied by other provisions to counter those seeking to exploit any loopholes in the new rules. The money purchase annual allowance is one such rule: implemented to limit the artificial reduction of income tax by over 55s washing employment income through a pension arrangement. Another barrier to simple pension and tax planning is the tapered annual allowance which, although straightforward in principle, has the potential to become one of the most difficult pension restrictions to negotiate without risking a tax charge. 4 techtalk

5 As the 5th of April approaches, advisers should take the opportunity to check their clients tax positions and highlight any areas where further tax savings can be made. Income tax should be the starting point; checking that the personal allowance has been utilised, especially by couples; that higher rate income tax relief has been claimed where available; and the personal allowance has been maximised where possible. Recent changes to income tax allowances and reliefs for lower levels of income will improve the position of many, and this is the subject of the last article in this edition. Once the basics have been taken care of, other areas to give consideration to, in no particular order, are: Retirement planning: making the most of tax relief and the available annual allowance are now, mercifully, based on the same period of time the tax year. The 2nd article in this edition focuses on the limits to pension funding in the tax year, the annual allowance, including the money purchase annual allowance and the tapered annual allowance. The 4th article looks at the carry forward rules. And the 3rd article looks specifically at the income definitions that determine whether the tapered annual allowance applies, and to what extent. Tax-efficient investments: whichever is the appropriate investment vehicle from the ISA range should also come up during financial planning discussions for the tax year. These should aim towards making the most of the subscription limit within the client s financial means. Where a choice is necessary between maximising the ISA allowance and funding pensions up to the annual allowance, a tax comparison can complement the usual non-tax considerations of investment choices and access. Remuneration strategies: the end of the tax year will, for many business owners, also be the end of their financial year. The need to review business reliefs at this time provides an opportunity to explore those available to them in their capacity as an individual taxpayer as well, particularly around the taxation of their drawings from the business. Small business owners have much flexibility in this regard, and their accountant will often assist them in attaining the most tax efficient combination of salary and dividends. Pension contributions are often overlooked as a part of the overall remuneration package. A principal reason has to be they are more restricted due to the annual allowance than salary or dividends, but within the tax-advantaged limits that currently apply they can be the most tax-efficient component of the overall package. The tax benefits of different combinations of salary, dividends and pension contributions are covered in the September 2016 edition of Techtalk. TIMING The last day of the 2016/2017 tax year is a weekday, which usually means that premiums can be allocated in this tax year provided that everything needed to process the payment is received by or on the 5th April Ideally, payments should be made well in advance of this date, but obviously many individuals will still be making payments right up until the deadline and so should be aware of the deadlines stipulated by the pension or investment provider. Another aspect of timing is when to make payments in respect of the whole period. Tax year end planning is often treated as a chance to sweep up unused tax allowances and reliefs, with the consequence for some that those advantages will only be accessible to the extent that funds can be made available to pay the premiums. To avoid such issues arising next tax year, it may be preferable to start planning as early as possible and thus spread the required outlay over the twelve months of the tax year. This will be particularly relevant for those using regular income for retirement and investment planning. Timing is particularly important when carrying forward all unused annual allowances from 2013/2014. Carry forward must be used before 6th April 2017 to make sure the 2013/2014 annual allowance is fully used up. Any delay beyond this, and the full unused annual allowance for 2013/2014 can no longer be used. THE LIMITS ON TAX RELIEF Pension contributions made before 6th April 2017 obtain higher / additional rate income tax relief depending on the individual s income tax position. The additional tax relief at these rates is always restricted to the amount of tax actually paid at those rates in the year. It is not the case that a marginal higher rate taxpayer gets 40% relief on all of their contributions, and so the extent of tax relief available should be checked before a recommendation based on this is given. PENSION PLANNING Other pension planning points include: Those with income expected to fluctuate around the higher rate income tax threshold could consider delaying contributions until a later year when higher rates of tax relief might be achieved. But those with income together with pension inputs above 150,000 per annum must consider the restriction in the annual allowance. A client considering cashing in an investment bond may be able to save higher rate income tax on the encashment by combining it with a pension contribution. The encashment and the pension contribution must both be made before 6th April The income tax personal allowance can be reclaimed by making a pension contribution to reduce adjusted net income below 100,000 in 2016/2017. Equally, child benefit claimants who are set to lose some or all of their entitlement for the year should consider whether a pension contribution will enable them to retain some or all of this benefit. Contributions must be made before 6th April Those who will benefit from making an application for Individual Protection 2014 have until the 5th April 2017 to do so. Those that will be applying for Fixed Protection 2016 must have ceased all pension contributions and accrual by 5th April 2016 and cannot set up any new plans after this date. To help you understand the issues that must be considered please see our technical guidance, which can be found under: Financial Planning > Retirement Planning > Technical Guidance. techtalk 5

6 INVESTMENT PLANNING Other investment planning points include: Income tax can be saved by transferring incomeproducing investments to a lower or non-taxpaying spouse or civil partner on a no strings attached basis. A bank deposit, for example, could be transferred to a spouse with no earnings to make use of their personal allowance, 0% savings rate tax band and personal savings allowance. Tax on a significant amount of interest could be saved by doing this. Switching investments into a non-income producing form can keep adjusted net income below the limits mentioned above to preserve or reclaim the personal allowances or child benefit. Switching a deposit into an ISA or an investment bond is one way this could be achieved. THE AUTUMN STATEMENT 2016 Maximising pension allowances is especially important for those who are subject to the money purchase annual allowance and those who know they will become subject to it in the near future. A 4,000 limit to money purchase contributions from 6th April 2017 without carry forward, severely limits pension funding. Making full use of this year s allowance and the previous three tax years can give a boost to retirement savings before only a trickle of contributions is allowed annually. Clients that are already restricted should give thought to using the full 10,000 allowance before it drops to 4,000. These restrictions will largely impact upon higher earners who are already accessing their retirement fund, but should do little to dampen the appeal of pensions as a tax-efficient retirement planning vehicle. They still remain the most tax-efficient savings product and should be at the centre of clients end of year planning. TECHNICAL RESOURCES To aid your understanding of all aspects of pensions, we have produced a range of technical materials including webinars, podcasts, technical guides, case studies and Techtalk articles covering existing and forthcoming pension rules. This material can be found on the Scottish Widow Adviser Extranet as follows: Technical Masterclasses (webinars): The money purchase annual allowance The Budget and the tapered annual allowance Lifetime allowance protection Carry forward involving 2015/ adviser-online-hub/webinars Podcasts Pension Death Benefits Estate Planning With Your Pension Fading Away Tapered Annual Allowance and Pension Input Periods adviser-online-hub/masterclass-techtalk Retirement planning support material Essentials & FAQs Technical Guidance Case Studies Presentation Quarterly Updates Pension FAQs Topical news Lifetime Allowance Protection th November. For the latest developments please see: Budget analysis Tax card Category/504 We also have an extensive library of technical articles written for our Techtalk magazine. These in-depth articles cover many technical aspects of pension rules including the annual allowance, lifetime allowance, pension input periods, carry forward and tax relief. For further reading beyond this edition, search for the articles below using our Index to Techtalk articles on the Scottish Widows Adviser Extranet under: Financial Planning > Techtalk. Pension accumulation Techtalk articles Category/627 Pension decumulation Techtalk articles Category/628 6 techtalk

7 MAKING THE MOST OF THE ANNUAL ALLOWANCE Thomas Coughlan Funding a money purchase pension used to be as simple as paying within the prevailing annual allowance. For some clients this will still be the case, but for many two major changes introduced by two successive Budgets will limit contributions to well below the standard 40,000 allowance. Those two changes the money purchase annual allowance and the tapered annual allowance can apply separately or together. We ll look at all three possibilities. Before that we will recap on the starting point in calculating these two restrictions: the standard annual allowance. 40,000 techtalk 7

8 THE STANDARD ANNUAL ALLOWANCE Contributions from all sources personal, employer and third party paid to defined contribution schemes and accrued within defined benefit schemes within the tax year are assessed against the standard annual allowance, which is currently 40,000. Unused annual allowances of the three previous tax years can be added to this year s allowance for larger contributions or accrual. This, however, is of no use to those with earnings below 40,000 only able to make personal contributions: the 100% of earnings limit prevents them from maximising this year s 40,000 allowance, effectively precluding carry forward. Carry forward is covered in more detail in the 4th article in this edition. THE MONEY PURCHASE ANNUAL ALLOWANCE The motive behind introducing the money purchase annual allowance (MPAA) cannot be faulted, but its impact on those affected is uncompromising. This money purchase annual allowance was necessary to close the door on potential tax avoidance that was opened by the Freedom and Choice regime. The previously unavailable option of taking all pension benefits as a lump sum would have allowed over 55s to convert 40,000 of salary each tax year to an employer pension contribution and immediately withdraw the full amount, 25% of which would escape income tax and all of which would escape a national insurance charge. The money purchase annual allowance currently restricts contributions made to DC schemes after receiving any flexible income to 10,000. The door, then, wasn t slammed shut but left slightly ajar allowing up to 10,000 of employment income to be washed through a pension in this way. The Government, however, sees fit to reduce this to 4,000 to limit this opportunity even further. This was announced in November s Autumn Statement. The receipt of any payment classed as flexible income triggers the money purchase annual allowance, which then applies indefinitely. This includes all new income forms under the Freedom & Choice regime, listed in the table below. It is also triggered from 6th April 2015 for any clients that had set up old-style flexible drawdown before this date. The triggers for the money purchase annual allowance Flexi-access drawdown income (not the tax-free cash) Uncrystallised funds pension lump sums Receipt of capped drawdown income in excess of the cap (after 5 April 2015) Annuities that can reduce in amount Stand alone lump sum under primary protection Certain small scheme pensions Certain overseas payments Flexible drawdown set up before 6th April 2015 Any one of these trigger events causes the money purchase annual allowance to apply to all of a client s DC schemes from the following day. That this can happen on any day in the tax year means that the year in which the trigger occurs will be a special case; the year being split between the part during which the restriction does not apply, and the rest of the year in which it does. Subsequent years are straightforward as the restriction covers the full tax year. This is better explained with examples. Example Germaine takes advantage of the Freedom & Choice regime by converting her long-standing capped drawdown arrangement to flexi-access drawdown. She receives a drawdown payment on 1st February This triggers the money purchase annual allowance from 2nd February 2017 onwards. The tax year is consequently split: 6th April 2016 to 1st February 2017: no MPAA 2nd February 2017 to 5th April 2017: MPAA applies. This limits money purchase contributions to 10,000 during the latter period, which will drop to 4,000 from 6th April In the earlier period this type of contribution is only limited by the standard annual allowance. Defined benefit accrual is not restricted in either period. And overall contributions to both scheme types are tested against the standard annual allowance. To see how contributions and accrual are tested against the annual allowance in the year that the trigger event occurs, we need to take this example further. 8 techtalk

9 Example Germaine s contribution history in the 2016/2017 tax year is shown below Money purchase contributions Defined benefit accrual 10th April , / ,000 1st May ,000 31st March ,000 Germaine has paid 16,000 to money purchase schemes after triggering the MPAA. She has also paid / accrued more than 40,000 overall. As a consequence, she will have an annual allowance excess to declare when she self-assesses for the tax year. The annual allowance excess that applies will be the greater of the excess over the MPAA plus the excess over the remainder of the annual allowance, or the excess over the standard annual allowance. This ensures that the MPAA excess is not simply absorbed by the rest of the annual allowance. Example Germaine s annual allowance excess will be the greater of: The MPAA excess plus the excess above the remaining allowance ( 16,000-10,000) = 6,000 ( 7, , ,000) - 30,000* = nil 6,000 + nil = 6,000 The excess over the standard annual allowance 42,000-40,000* = 2,000 The excess, therefore, is 6,000. *assumes no carry forward available The remaining allowance referred to above is called the alternative annual allowance. This tax year it is 30,000, which is the standard 40,000 allowance less the 10,000 MPAA. The alternative annual allowance covers contributions or accrual that are not covered by the MPAA. This normally means DB accrual, but in the year the MPAA is triggered it also covers money purchase contributions that are paid before the trigger event. If money purchase contributions that are tested against the MPAA are less than 10,000, you do not need to worry about the MPAA and the alternative annual allowance. Instead, all pension inputs are tested against the standard annual allowance (or the tapered annual allowance). It is the alternative annual allowance that is enhanced by any available carry forward. But, once again, if the MPAA is not exceeded, the standard calculation is used and so carry forward can just be added to the standard annual allowance. Example If Germaine has available carry forward of 5,000, her annual allowance excess will be the greater of: 16,000-10,000 = 6,000 42,000 < 45,000: therefore, 0 The MPAA excess remains the higher of the two figures, giving an excess of 6,000. techtalk 9

10 THE TAPERED ANNUAL ALLOWANCE The tapered annual allowance works in a very different way to the money purchase annual allowance. As the name suggests the annual allowance is gradually tapered down. The extent of tapering is determined by adjusted income : a concept that is causing significant difficulties for advisers. The definition includes: taxable income, as defined under the tax legislation; tax-relieved pension contributions to registered pension schemes, except those paid under relief at source; employer pension contributions and other payments such as overseas payments. The relevant threshold is 150,000, and adjusted income must be above this for the tapered annual allowance to apply. A further test is whether threshold income is above 110,000. This is less important than the adjusted income test because, in the vast majority of cases, if adjusted income is above 150,000, threshold income will be above 110,000. Nonetheless, a calculation of income against this definition should be carried out. The definition includes: taxable income adjusted for any post 8th July 2015 salary sacrifice, less personal pension contributions paid under relief at source. These explanations do not represent exhaustive definitions. The next article in this edition takes a detailed look at what to include in taxable income based on the current tax legislation. And a link to the relevant page of HM Revenue & Customs Pensions Tax Manual is provided here: The following example explains how the calculation of income might work. Example Jennie is a high earner in 2016/2017, with a salary of 160,000 (pre-salary sacrifice). She was originally paying personal contributions of 7% to her employer s occupational pension, but in August 2015 decided to convert 5% of this to an employer contribution by entering into a salary sacrifice agreement. Her employer additionally pays a contribution of 10%. She also has a share portfolio that paid out dividends of 7,250 in the tax year. Calculate adjusted income: Taxable income: 152,000 salary - 3,200 net pay + 7,250 dividends 156,050 Plus net pay contributions: 3,200 ( 160,000 x 2%) 3,200 Plus employer contributions: 24,000 ( 160,000 x 15%) 24,000 Total 183,250 Calculate threshold income: Taxable income: 152,000 salary - 3,200 net pay + 7,250 dividends 156,050 Plus employer contributions paid via new salary sacrifice: 8,000 8,000 Total 164,050 Because adjusted income and threshold income are above their respective trigger levels, Jennie s annual allowance will be tapered. Calculate the tapered annual allowance: Adjusted income excess: 183, ,000 33,250 Annual allowance reduction: 33,250 / 2 16,625 Tapered annual allowance 23,375 Jennie s annual allowance for 2016/2017 will be 23,375. This amount can be increased by any available carry forward from the three previous tax years. These are the three set of rules that determine the annual allowance available to a particular individual. The tapered annual allowance and the money purchase annual allowance may also both apply to the same individual, for an especially complex calculation. Thankfully, most calculations of the available annual allowance are straightforward once you have all of the required information. 10 techtalk

11 USING THE ANNUAL ALLOWANCE FOR YEAR-END CONTRIBUTIONS What do these three sets of rules mean for clients trying to maximise their pension funding before the end of the tax year? We will look at four different client scenarios. Client 1 George George would like to pay the maximum contribution to his personal pension plan before 6th April His situation is straightforward: he has received no flexible income to date; his adjusted income is below 150,000; his relevant UK earnings are 50,000; and he has not paid any contributions (or accrued any benefits) in the tax year so far. What can he contribute? Having not received any flexible income, such as flexi-access drawdown income, there is no specific restriction to money purchase contributions, Adjusted income below 150,000 means there is no tapering of the standard annual allowance either, No contributions since 6th April 2016, means that the full 40,000 allowance is available. George can pay 40,000 before the end of the tax year and, as his earnings are sufficiently high, he may pay this as a gross, tax-relieved, personal contribution. In this case the net contribution will be 32,000. He will receive basic rate tax relief from the pension provider, at the rate of 20%. Higher rate relief should be claimed through self-assessment. His earnings are 7,000 above the higher rate income tax threshold, enabling a claim of 20% (40% - 20%) of 7,000: 1,400. The full contribution will not attract higher rate relief. If George is eligible for carry forward from earlier tax years this can be included as well. However, if he can only pay personal contributions, he cannot pay more than his earnings of 50,000 between 6th April 2016 and 5th April Employer contributions would be necessary for George to pay more than this. Client 2 Paul Paul would like to pay the maximum contribution to his stakeholder pension in March His situation is slightly less straightforward than George s: he has received no flexible income to date; his adjusted income is 180,000; his threshold income is above 110,000; his relevant UK earnings are 170,000; and he has benefited from a 10,000 employer pension contribution this tax year. What can he contribute? Having not received any flexible income, such as flexi-access drawdown income, there is no restriction to money purchase contributions, Threshold income above 110,000 and adjusted income of 180,000 results in a tapered reduction in the annual allowance of 15,000, reducing the annual allowance down to 25,000. The employer contribution reduces his available annual allowance a further 10,000 down to 15,000. Paul can pay 15,000 before the end of the tax year. High earnings mean that he can pay this as a personal contribution that attracts tax-relief ( 12,000 net). He will receive basic rate tax relief from the pension provider, at the rate of 20%. Additional rate relief should be claimed through self-assessment, and will be available on the full gross contribution as his earnings are more than 15,000 above the additional rate income tax threshold. If Paul is eligible for carry forward from earlier tax years this can be included as well. However, he will not get 45% income tax relief on personal contributions that exceed the amount of his earnings in the additional rate band. techtalk 11

12 Client 3 - John John would also like to pay the maximum contribution to his stakeholder pension in the 2016/2017 tax year. He received a payment of flexi-access drawdown on 31st August 2016 triggering the money purchase annual allowance from the next day. His relevant UK earnings are 110,000 and he is not subject to the tapered annual allowance. What can he contribute? Having received flexible income in the tax year total money purchase contributions before an annual allowance charge arises are restricted. This only applies from 1st September Adjusted income is below 150,000 so there is no tapering of the overall annual allowance for the tax year. No contributions paid so far in the tax year mean that the full 40,000 annual allowance is available, but the money purchase annual allowance allows only 10,000 to be paid to defined contribution schemes after it is triggered. John can pay 10,000 to defined contributions schemes before the end of the tax year. The remainder of the allowance, which will be somewhere between 30,000 and 40,000, can be accrued within defined benefits schemes. Contributions or accrual above these limits will result in an annual allowance tax charge. High earnings allow John to utilise his annual allowance for the tax year by making personal pension contributions. He will receive basic rate tax relief from the pension provider, at the rate of 20%. Higher rate relief should be claimed through self-assessment, and will be available on the full gross contribution. Personal contributions will also reduce his adjusted net income potentially restoring some or all of the income tax personal allowance, if it had been reduced. The trigger point for the money purchase annual allowance roughly splits the tax year in half. Up until the trigger point, the full annual allowance was available for funding defined contribution and defined benefit schemes, with carry forward available for both. From 1st September 2016 onwards, no more than 10,000 (without carry forward) could be paid to money purchase schemes. Any contributions that exceed the money purchase annual allowance along with those that exceed the alternative annual allowance (the remainder of the standard annual allowance) lead to an annual allowance tax charge. 12 techtalk

13 Client 4 Richard Richard intends to pay the maximum contribution to his self-invested personal pension before 6th April Building on the three previous examples, both the money purchase annual allowance and the tapered annual allowance apply: the former because he received an uncrystallised funds pension lump sum (UFPLS) from a separate plan on 1st July 2016; the latter because of adjusted income of 180,000 for the tax year. Richard has already paid 7,500 to his pension plan this tax year. What can he contribute? Having received flexible income in the tax year total money purchase contributions before an annual allowance charge arises are restricted. This applies from 2nd July Adjusted income is above 150,000 so the overall annual allowance is tapered the 30,000 excess reduces his annual allowance by 15,000 down to 25,000. Contributions paid earlier in the tax year have used up part of the annual allowance, leaving 17,500 available. Richard can pay up to 10,000 to defined contributions schemes before the end of the tax year. The remainder of the allowance, 7,500, can be accrued within defined benefits schemes. Contributions or accrual above these limits will result in an annual allowance tax charge. The tapering of the annual allowance does not affect the money purchase annual allowance. This remains at 10,000, which means the rest of the annual allowance the alternative annual allowance suffers a reduction. High earnings allow Richard to pay high levels of personal contributions, but the money purchase annual allowance restricts this ability. He can pay a maximum of 10,000 as a personal contribution to his self-invested personal pension before an annual allowance charge applies, and will receive basic rate tax relief from the pension provider. Additional rate relief should be claimed through self-assessment, and will be available on the full gross contribution. As with previous examples, Richard may be eligible for carry forward from earlier tax years, but this can only be added to the alternative annual allowance. The trigger point again splits the tax year. Up until the trigger point, the full annual allowance was available for funding defined contribution and defined benefit schemes, with carry forward available for both. From 2nd July 2016 onwards, no more than 10,000 (without carry forward) could be paid to money purchase schemes. Any contribution that exceeds the money purchase annual allowance along with the excess above the alternative annual allowance (or the excess above the standard annual allowance) will be subject to an annual allowance tax charge. These four examples show how the annual allowance can restrict the maximum tax-advantaged contribution in different ways for different clients. The money purchase annual allowance is the most restrictive for defined contribution schemes, as it always reduces the allowance to a flat 10,000 (or 4,000 from 6th April 2017) without the ability to carry forward. The tapered annual allowance is generally less restrictive: the tapering as the name suggests is gradual, so those who only just breach the adjusted income threshold are affected less than those with much higher incomes, but also because carry forward can be added to the tapered annual allowance and not the money purchase annual allowance. The interaction between these two sets of rules is complex, but high earners who have already received flexible income will need to know how the restriction works. techtalk 13

14 THE TAPERED ANNUAL ALLOWANCE INCOME DEFINITIONS Thomas Coughlan Since the tapered annual allowance was introduced, there have been a lot of questions asked about what to include in the two definitions of income. They are termed adjusted income and threshold income, and understanding both requires some knowledge of the process for calculating tax against income. We ll look at this in detail before moving on to these two new definitions. THE SEVEN STAGE INCOME TAX CALCULATION The tax legislation specifically, the Income Tax Act 2007 specifies a seven stage process for calculating an individual s income tax liability: Step 1: add up all sources of taxable income. This includes salary, bonuses, commission, taxable benefits, rental income, trade earnings, savings interest, dividends, bond gains and others. Step 2: deduct any tax reliefs that are available. One such reduction arises where the client pays to a retirement annuity contract and makes a separate claim for the tax relief. Tax relief is granted on the contribution by an equivalent reduction in their taxable income. Other deductible payments at this stage include qualifying interest payments. Step 3: deduct the personal allowance. This will be 11,000 in 2016/2017 for those who are entitled to the full standard allowance. If adjusted net income is greater than 100,000 the personal allowance will be reduced by 1 for every 2 of excess income. This step determines the client s taxable income. Step 4: calculate tax at each applicable rate. Non-dividend taxable income is taxed at 0%, 20%, 40% and 45% depending on which tax bands it falls in. The equivalent rates for dividend income, which sits on-top of non-dividend income, are 0%, 7.5%, 32.5% and 38.1%. Step 5: add up the total tax from Step 4. Add together the tax calculated at each rate on all types of income in the previous step. 14 techtalk

15 Step 6: deduct any tax reductions. Any tax reducers are dealt with in this step: investments in tax-efficient schemes such as VCTs and EISs, and the married couples allowance, for example. These reductions cannot result in a repayment of tax. Step 7: add any additional tax liabilities. The final step ensures that other tax charges, such as the annual and lifetime allowance tax charges, and the high income child benefit charge, are included. An example will help explain this process more clearly: Example In 2016/2017 Ian is paid an annual salary of 120,000 and a bonus of 25,000. He is a member of his employer s occupational pension scheme paying an annual contribution of 7.5% of salary under net pay, which is matched by his employer. In addition, his employer provides a company car with an annual taxable benefit of 6,200. He also receives the following income in the tax year: 5,000 gross building society interest and a 3,000 dividend. To his two personal pension plans - a section 226 pension plan and a stakeholder policy - he pays 1,000 and 3,000 gross per annum, respectively. The income tax calculation will work as follows: Step 1 Step 2 Step 3 Step 4 Add up all sources of taxable income. Salary and bonus 136,000* Car benefit 6,200 Gross interest 5,000 Dividend 3,000 Total = 150,200 Deduct any tax reliefs that are available. Deduction for s226 relief ( 1,000) Net income = 149,200 Deduct the personal allowance No personal allowance available as income exceeds 122,000: Net income from Step 2 149,200 Deduct personal allowance ( 0) Taxable income = 149,200 Calculate tax at each applicable rate. *salary is reduced by 7.5% due to net pay contribution Rate Non-savings Savings Dividends 20% x 35,000* = 7,000 40% x 106,200 = 42,480 40% x 5,000 = 2,000 0% x 3,000 = 0** Step 5 Add up the total tax from Step 4. Step 6 & Step 7 Tax on non-savings income 49,480 Tax on savings income 2,000 Tax on dividend income 0 Total = 51,480 Deduct any tax reductions. Add any additional tax liabilities. *the basic rate band is increased by 3,000 **within the 5,000 dividend allowance No deductions or additional tax liabilities to be applied. techtalk 15

16 The outcome of steps 1 and 2 of the income tax calculation can then be used to calculate adjusted income and threshold income for tapered annual allowance purposes. But first, we will look at what is included within those definitions, starting with Adjusted Income. Adjusted income the individual s net income for the tax year (as per steps 1 and 2 above), plus contributions paid to pension schemes under net pay, plus contributions paid gross to personal pensions, plus employer contributions for the tax year, plus where non domiciled individuals make contributions to overseas pension schemes, any relief claimed under Chapter 2 of Part 5 of the Income Tax (Earnings and Pensions) Act 2003 for the tax year, less lump sum death benefits (section 636A(4ZA) Income Tax (Earnings and Pensions) Act 2003) that accrue to the individual in the tax year. Broadly the definition of Adjusted Income starts with net income (as per step 2 above), to which is added all pension funding except personal contributions that benefit from relief at source. The resulting figure may, however, have to be adjusted for the receipt of any lump sum death benefits and/ or contributions by non-domiciles. The reason for excluding relief at source contributions from Adjusted Income is because they do not reduce taxable income whereas contributions to schemes operating net pay or receiving gross personal contributions do. The latter contributions must be added back in for this reason, ensuring that all personal contributions are included in Adjusted Income. Once Adjusted Income has been calculated, Threshold Income should be relatively straightforward as it also begins with net income as per step 2 of the income tax calculation. Threshold income the individual s net income for the tax year (as per steps 1 and 2 above), less personal contributions paid to pension schemes that operated relief at source, plus the amount of any reduction in employment income in exchange for a pension contribution (salary sacrifice) made on or after 9th July 2015, less lump sum death benefits (section 636A(4ZA) Income Tax (Earnings and Pensions) Act 2003) that accrue to the individual in the tax year. Threshold Income is arrived at by taking the individual s net income from step 2, deducting personal contributions that benefited from relief at source and adding any employer pension contributions paid under a salary sacrifice agreement that was set up on or after 9th July Again, there is an adjustment for lump sum death benefits received in the tax year. The reason for deducting relief at source contributions is again to achieve parity with other types of pension contributions. No personal contributions (unless converted to employer contributions under certain salary sacrifice agreements) should be included in Threshold Income. And personal contributions paid under net pay and other personal contributions that are paid gross with the tax claimed via self-assessment are already excluded from the net income starting point. So, a separate deduction, for relief at source contributions is necessary. Continuing with the earlier example should help to bring all of this together. Example Ian wants to pay the maximum personal contribution to his personal pension in 2016/2017. To do this it is necessary to work out his annual allowance for this year and the previous three tax years. Assuming he has no carry forward available, the maximum will be the amount of the unused annual allowance of this tax year. With good reason, Ian is concerned that he may suffer a restriction in his annual allowance. His Adjusted Income and Threshold Income, therefore, should be calculated. Adjusted Income Take Ian s net income as per step 2 above 149,200 plus net pay contributions 9,000 plus section 226 contributions 1,000 plus employer contributions 9,000 Total 168,200 Threshold Income Take Ian s net income as per step 2 above 149,200 less relief at source contributions 3,000 Total 146,200 Adjusted Income is greater than 150,000. Threshold Income is also greater than 110,000. The tapered annual allowance will apply, with a reduction of 9,100, which is half of the excess of Adjusted Income above 150,000. Ian s annual allowance for 2016/2017 is 30,900 ( 40,000-9,100). 16 techtalk

17 The presence of lump sum death benefits and overseas payments will make for more interesting calculations, but these will be occasional adjustments. For the majority of affected individuals, it will only be necessary to know their pension inputs, broken down by type, and all components of earned and unearned income. The start date of any relevant salary sacrifice agreement might not always be straightforward to determine. However, HMRC have confirmed in recent guidance that an existing salary sacrifice agreement is not included in Threshold Income because it had already been given up and without an automatic right to revert to the original salary. Existing agreements are commonly reviewed after a fixed period of time, such as every 12 months. This should have no impact on Threshold Income as no further salary is being sacrificed. It is only an increase in the amount of salary sacrifice that must be included. The components of earned and unearned income may pose more of a problem. A general rule is that any taxable form of income will be included in step 2 of the income tax calculation; in which case it will be within the net income starting point for both income definitions. If you are unsure about a particular form of income and its taxation treatment, the client s accountant should be asked to confirm the position. Company car benefit is one commonly queried form of income. This is included in step 1 and 2 of the income tax calculation, as it is a taxable benefit. It is, therefore, included within the net income starting point for Adjusted Income and Threshold Income. It is also relatively straightforward to work out the taxable benefit, and the amount will be confirmed to the employee shortly after the end of the tax year. Following the steps described here will help you to determine the impact of income on the annual allowance. Once this has been determined, carry forward can be worked out, giving you a maximum funding ceiling to base your advice on. In many cases, it will not be possible to work out exact income figures until shortly after the end of the tax year. A pragmatic approach will have to be followed, but there will inevitably be a trade-off between paying the maximum contribution and mitigating the risk of an annual allowance charge. techtalk 17

18 CARRY FORWARD: A WINDOW OF OPPORTUNITY Thomas Coughlan The option to carry forward the unused annual allowances of the three previous tax years should feature prominently in end of year tax planning. The recent alignment of pension input periods with the tax year has simplified the process to some extent, but the misaligned periods of earlier years will plague carry forward calculations for a few years yet. And the necessary step to achieve tax-year alignment the split tax year of 2015/2016 must also be understood. However, this often results in more annual allowance being available than expected. THE CARRY FORWARD RULES The conditions that must be met to be able to carry forward unused annual allowances are minimal. The member must have been a member of a registered pension scheme in the tax year they wish to carry forward from and the current year s annual allowance must have been used up. Almost any registered pension scheme confers eligibility: a paid up personal pension or stakeholder; a deferred final salary scheme; a transfer-only pension; a drawdown contract and others. A pensioner member of a final salary scheme is also eligible. A notable exception is an annuity, which is not a registered pension scheme. 18 techtalk

19 APPLYING FOR CARRY FORWARD This is straightforward: no application is required. If a member contributes more than their annual allowance in the tax year, carry forward of any available annual allowance from earlier years is automatic. There is no carry forward section on the self-assessment tax return. What does need to be declared is an excess of pension input above the total annual allowance including carry forward. This must be declared on the supplementary self-assessment form, and is separate from the usual requirement to declare on the main self-assessment form all personal contributions paid to registered pension schemes during the tax year. USING THE CURRENT YEAR S ANNUAL ALLOWANCE FIRST The annual allowance of the current year must be exceeded before it s possible to carry forward the unused annual allowances of earlier years. So, it is an excess above the current annual allowance that triggers automatic carry forward. This usually means that contributions and/or accrual for all schemes in the tax year must exceed 40,000. Where the full annual allowance is not available, it s the excess over the reduced allowance that requires carry forward. For example, an individual with adjusted income of 170,000 suffers a reduction in their annual allowance of 10,000, meaning that carry forward is required once their 30,000 allowance for 2016/2017 has been exhausted. Carry forward cannot be used to pay money purchase contributions above the money purchase annual allowance, but can enhance the alternative annual allowance for defined benefit accrual or pre-trigger money purchase contributions for clients who are affected by this restriction. CARRY FORWARD FROM EARLIER YEARS Once eligibility has been established and the current year s annual allowance fully depleted, carry forward can be calculated. The maximum carry forward is the sum of the remaining annual allowances of the three previous tax years, but any years in which the annual allowance was exceeded are set to zero rather than a negative figure. Of the previous years, earlier ones are used in preference to later years; this ensures that unused allowances remain available for up to three tax years. The three previous tax years are: 2013/2014, where the annual allowance was 50,000; and 2014/2015 and 2015/2016, where it was 40,000. The additional complication relating to the previous tax year is explained below under the split tax-year. The annual allowance of a particular tax year was used up by any contributions (or benefit accrual for defined benefit schemes) to schemes with a pension input period that ended in that year. From 6th April 2016, pension input periods for all schemes are aligned with the tax year, so this is no longer an issue, but when calculating the available carry forward from a tax year before this, misaligned pension input periods may have to be disentangled. For example, a pension input period might have run from 1st June 2013 to 31st May All contributions paid in this period were assessed against the annual allowance of 2014/2015, despite most of them probably being paid in the previous tax year. Despite the concept being relatively straightforward, the calculation can become cumbersome, even more so when membership of multiple schemes, each with a different pension input period, is included. Example In the tax year 2013/2014, a client paid 30,000 of personal contributions. 10,000 was paid to a stakeholder pension plan with a pension input period that ran from 15th April 2013 to 14th April ,000 was to a personal pension plan with a pension input period that was aligned with the tax year. The pension input amounts for the 2013/2014 in respect of these amounts is 20,000. The contributions of 10,000 to the stakeholder pension will be assessed in 2014/2015 due to the end date of that pension input period. CARRY FORWARD FROM 2015/2016: THE SPLIT TAX-YEAR Any carry forward that includes unused annual allowance from this tax year represents a special case. The introduction of taxyear aligned pension input periods from 6th April 2016 required a split in the 2015/2016 tax-year. Transitional provisions are often the most complex and this one is no different, restricting carry forward from the tax year to below the level of the full annual allowance in that year. The key change introduced by the Summer Budget of 2015 was the increase in the annual allowance to 80,000 and the division of the tax year into prealignment and post-alignment periods. (Each period bafflingly labelled a tax year in the legislation.) The two-fold increase in the annual allowance was necessary to ensure that no individual taxpayer suffered an unfair tax charge as a result of the changes. Without this, a client that had paid 40,000 to each of two arrangements one that was originally due to end in 2015/2016, the other in 2016/ would have exceeded the annual allowance through no fault of their own when those PIPs were closed early on 8th July As the original funding was within available limits under the prevailing rules, it would have been unfair to retrospectively raise a tax charge under the new rules, hence the temporary increase in the annual allowance. The split tax-year ultimately enabled existing pension input periods to be aligned with the tax-year: open periods were closed on 8th July 2015, which was followed by a period that ran from 9th July 2015 to 5th April Thereafter, all pension input periods run in line with tax years. The actual annual allowance for the pre-alignment period, which ran from 6th April 2015 to 8th July 2015, was 80,000. For the post-alignment period, which covered the rest of the tax year, it was 0, but up 40,000 of the unused pre-alignment allowance could be carried forward to the post-alignment period. This is explained in the examples below. techtalk 19