PENSION PLANNING FOR HIGH EARNERS: A GUIDE TO INCOME DEFINITIONS ADVISING HIGH INCOME INDIVIDUALS Here are two figures that high income individuals might be particularly interested in: 100,000 The personal allowance is chipped away by 1 for every 2 of income over 100,000. The effective tax rate on income between 100,000 and 123,000 can be at least 60%, because individuals with this level of income will lose part or all of their personal allowance of 11,500. 150,000 The 40,000 annual allowance could be tapered away by 1 for every 2 of income over 150,000, down to a minimum of 10,000. The tax charge on pension contributions above the tapered annual allowance can be up to 45%, because individuals with this level of income can lose part or all of their pension tax relief, and they may have to pay a tax charge in respect of part or all of their employer pension contributions or on a final salary pension accrual. In order for anyone to work out if they are affected they will need to understand what their income is. WHAT IS INCOME? The challenge is that income is not always what we might think it is. For example, where pension contributions feature in an individual s planning the definition of income is different depending on whether they are looking at: the income figure required to establish the maximum tax relief available on individual pension contributions; the income figure that would result in the individual losing all or part of their personal allowance; or the income figure that could trigger a tapering of their annual allowance. This is summarised in the following tables.
INCOME TABLE Tax relief on individual pension contributions is restricted to the individual s relevant UK earnings for a tax year Relevant UK earnings 1 of personal allowance is lost for every 2 of adjusted net income over 100,000 a year Adjusted net income for personal allowance Tapered annual allowance applies if adjusted income is over 150,000 and threshold income is over 110,000 in a tax year Threshold income Finance Act 2004 s189(2) Income Tax Act 2007 s58 Finance Act 2004 s228za(5) Earnings, including: Employment earnings and benefits, including the part of a redundancy payment above the 30,000 tax exempt threshold; Self-employed profits; Total income, including: Employment earnings and benefits, including the part of a redundancy payment above the 30,000 tax exempt threshold; Self-employed profits; Total income, including: Employment earnings and benefits, including the part of a redundancy payment above the 30,000 tax exempt threshold; Self-employed profits; Adjusted income for tapered annual allowance Finance Act 2004 s228za(4) Total income, including: Employment earnings and benefits, including the part of a redundancy payment above the 30,000 tax exempt threshold; Self-employed profits; Profits from UK or EEA furnished holiday lettings; Investment income such as dividends and interest, investment bond chargeable event gains and rental profits; Investment income such as dividends and interest, investment bond chargeable event gains and rental profits; Investment income such as dividends and interest, investment bond chargeable event gains and rental profits; Patent income, where the individual, either alone or jointly, devised the invention for which the patent was granted. Taxable state benefits, such as the state pension; Taxable pension income; All other taxable income, such as income from settlements and estates. Taxable state benefits, such as the state pension; Taxable pension income; All other taxable income, such as income from settlements and estates. Taxable state benefits, such as the state pension; Taxable pension income; All other taxable income, such as income from settlements and estates. But not the amount of any taxable defined benefit lump sum death benefits payable to the individual in the tax year in respect of a member who had reached the age of 75 at the date of the member s death. But not the amount of any taxable defined benefit lump sum death benefits payable to the individual in the tax year in respect of a member who had reached the age of 75 at the date of the member s death. Minus Deductible losses; Individual pension contributions paid gross; The grossed up amount of individual pension contributions entitled to be paid net of a deduction for basic rate tax; The grossed up amount of gift aid donations. Minus Deductible losses; Individual pension contributions paid gross; The grossed up amount of individual pension contributions entitled to be paid net of a deduction for basic rate tax; Plus Earnings sacrificed in return for making pension provision under arrangements made on or after 9th July 2015. Minus Deductible losses; Plus Employer pension contributions. 1
INCOME TABLE (CONTINUED): Tax relief on individual pension contributions is restricted to the individual s relevant UK earnings for a tax year Relevant UK earnings 1 of personal allowance is lost for every 2 of adjusted net income over 100,000 a year Adjusted net income for personal allowance Tapered annual allowance applies if adjusted income is over 150,000 and threshold income is over 110,000 in a tax year Threshold income Finance Act 2004 s189(2) Income Tax Act 2007 s58 Finance Act 2004 s228za(5) NOTES: Losses do not need to be deducted. However, their impact on the rate of tax payable by the individual has to be considered as that will affect the rate of tax relief available on their pension contribution. Relevant UK earnings cannot include investment income such as dividends and interest, or rental profits that don t qualify as furnished holiday lettings. And pension income is not classed as earnings so cannot be included in the definition of relevant UK earnings. NOTES: Dividends and savings income must be included even if they are covered by the 0% dividend tax band, 0% savings tax band or the 1,000 or 500 personal savings allowance. NOTES: Dividends and savings income must be included even if they are covered by the 0% dividend tax band, 0% savings tax band or the 1,000 or 500 personal savings allowance. Gift aid donations cannot be deducted. Adjusted income for tapered annual allowance NOTES: Finance Act 2004 s228za(4) Dividends and savings income must be included even if they are covered by the 0% dividend tax band, 0% savings tax band or the 1,000 or 500 personal savings allowance. Gift aid donations cannot be deducted. Individual pension contributions cannot be deducted. To add back employer pension contributions: for defined contribution schemes just add back the monetary amount; for defined benefit schemes take the accrual figure and deduct employee contributions (not AVCs). EMPLOYEE PENSION TAX RELIEF The following example explains how the calculation of income might work for an employee: Example Helen is a high earner in 2017/2018, with a salary of 120,000 and a bonus of 25,000. She is a member of her employer s occupational pension scheme paying an annual contribution of 7.5% of salary under net pay, which is matched by her employer. In addition, her employer provides a company car with an annual taxable benefit of 6,200. She also receives the following income in the tax year 2017/2018: 5,000 building society interest and 3,000 in dividends. She pays 1,000 into a personal pension plan and 20,000 gross as a lump sum AVC into her occupational pension scheme. And she makes gift aid payments of 1,000. Net pay is where a gross pension contribution is deducted from earnings before calculating PAYE income tax. Note that Helen s latest payslip has a section on it confirming that her annual salary is 120,000. The figure on her P60, when she receives it after the end of the tax year, will be 136,000, which is her pay after her 7.5% net pay pension contributions have been deducted, plus her bonus. 2
EMPLOYEE PENSION TAX RELIEF (CONTINUED): Table 1 To calculate relevant UK earnings Salary 120,000 Bonus 25,000 Taxable benefit 6,200 Total 151,200 Table 1 tells us that 151,200 is the most Helen can pay into a pension in 2017/2018. But of course she would need to have enough available annual allowance for 2017/2018 plus from the three previous tax years, 2014/2015, 2015/2016 and 2016/2017. Table 2 To calculate adjusted net income for personal allowance purposes Salary 120,000 Bonus 25,000 Taxable benefit 6,200 Minus: Gift aid paid net ( 1,000 x 100/80) 1,250 Individual pension contributions paid gross ( 120,000 x 7.5%) 9,000 Personal pension contribution paid net ( 1,000 x 100/80) 1,250 20,000 gross AVC paid into her occupational pension scheme 20,000 Total 127,700 Table 2 tells us that Helen has no personal allowance. Her adjusted net income is more than 123,000, so her personal allowance is reduced by 11,500 to Nil. Making further individual pension contributions or gift aid payments totalling 27,700 (including basic rate tax added by the Government) in 2017/2018 will reduce her adjusted net income to 100,000 and restore her personal allowance. But of course she would need to have enough available annual allowance for 2017/2018 plus from the three previous tax years, 2014/2015, 2015/2016 and 2016/2017 to be able to make further pension contributions. Table 3 To calculate adjusted income for tapered annual allowance purposes Salary 120,000 Bonus 25,000 Taxable benefit 6,200 Plus: Employer pension contributions ( 120,000 x 7.5%) 9,000 Total 168,200 Table 3 tells us that Helen s adjusted income is more than 150,000. That means she is potentially affected by the tapered annual allowance in 2017/2018, which would reduce her 40,000 annual allowance by 9,100 to 30,900. This has been worked out by deducting 150,000 from 168,200 and dividing the answer, 18,200, by two. 3
EMPLOYEE PENSION TAX RELIEF (CONTINUED) Table 4 To calculate threshold income Salary 120,000 Bonus 25,000 Taxable benefit 6,200 Minus: Individual pension contributions paid gross ( 120,000 x 7.5%) 9,000 Personal pension contribution paid net ( 1,000 x 100/80) 1,250 20,000 gross AVC paid into her occupational pension scheme 20,000 Total 128,950 Table 4 tells us that Helen s threshold income is more than 110,000. That confirms that she is affected by the tapered annual allowance in 2017/2018. Table 5 Helen s pension input for 2017/2018 Individual pension contributions paid gross ( 120,000 x 7.5%) 9,000 Personal pension contribution paid net ( 1,000 x 100/80) 1,250 20,000 gross AVC paid into her occupational pension scheme 20,000 Plus: Employer pension contributions ( 120,000 x 7.5%) 9,000 Total 39,250 Table 5 tells us that Helen s pension input for 2017/2018 is more than her annual allowance of 30,900 by 8,350. If she has enough unused annual allowance from the three previous tax years, 2014/2015, 2015/2016 and 2016/2017 then she can avoid a tapered annual allowance charge on the 8,350. If she has enough unused allowances available from those earlier years she could make an additional AVC of 27,700 or an additional contribution to her personal pension of 22,160 (i.e. 27,700 including basic rate tax added by the Government) and get her personal allowance back. If she makes a 27,700 contribution, not only would she get her personal allowance back by reducing her adjusted net income for personal allowance purposes to 100,000, she would also get back the full annual allowance of 40,000 by reducing her threshold income to below 110,000. So her total pension input for 2017/2018 would then be 66,950 (i.e. 39,250 plus 27,700), which uses her newly restored 40,000 2017/2018 annual allowance, but requires her to be able to carry forward unused annual allowance of 26,950 from earlier tax years. She would of course need to know all of this, and make the contribution, before the end of the 2017/2018 tax year. 4
SELF-EMPLOYED PENSION TAX RELIEF The following example explains how the calculation of income might work for a self employed individual: Example Harry is a high earner in 2017/2018, with a taxable profit of 130,000 from his detective business for the year ended 30th April 2017. He also receives the following income in the tax year 2017/2018: 5,000 building society interest and 3,000 in dividends and he pays 12,000 into a personal pension and makes gift aid payments of 1,000. Table 1 To calculate relevant UK earnings Taxable profit for the year ended 30th April 2017 130,000 Total 130,000 Table 1 tells us that 130,000 is the most Harry can pay into a pension in 2017/2018. But of course he would need to have enough available annual allowance for 2017/2018 plus from the three previous tax years, 2014/2015, 2015/2016 and 2016/2017. Table 2 To calculate adjusted net income for personal allowance purposes Taxable profit for the year ended 30th April 2017 130,000 Minus: Gift aid paid net ( 1,000 x 100/80) 1,250 Personal pension contribution paid net ( 12,000 x 100/80) 15,000 Total 121,750 Table 2 tells us that Harry has lost most of his personal allowance. As his adjusted net income is 121,750 his personal allowance is reduced by 10,875 to 625. This has been worked out by deducting 100,000 from 121,750 and dividing the answer, 21,750, by two. Making further individual pension contributions or gift aid payments totalling 21,750 (including basic rate tax added by the Government) in 2017/2018 will reduce his adjusted net income to 100,000 and restore his personal allowance. But of course he would need to have enough available annual allowance for 2017/2018 plus from the three previous tax years, 2014/2015, 2015/2016 and 2016/2017 to be able to make further pension contributions. Table 3 To calculate adjusted income for tapered annual allowance purposes Taxable profit for the year ended 30th April 2017 130,000 Total 138,000 Table 3 tells us that Harry s adjusted income is less than 150,000, so he won t be affected by the tapered annual allowance in 2017/2018. 5
SELF-EMPLOYED PENSION TAX RELIEF (CONTINUED) Table 4 To calculate threshold income Taxable profit for the year ended 30th April 2017 130,000 Minus: Personal pension contribution paid net ( 12,000 x 100/80) 15,000 Total 123,000 Table 4 tells us that Harry s threshold income is more than 110,000. However, because Harry s adjusted income is less than 150,000, he won t be affected by the tapered annual allowance in 2017/2018. Table 5 Harry s pension input for 2017/2018 Personal pension contribution paid net ( 12,000 x 100/80) 15,000 Total 15,000 Table 5 tells us that Harry s pension input for 2017/2018 is less than his annual allowance of 40,000 by 25,000. This means he could make an additional contribution to his personal pension of 17,400 (ie 21,750 including basic rate tax added by the Government) and get his personal allowance back. He would of course need to know all of this, and make the pension contribution, before the end of the 2017/2018 tax year. The good news is that as his accounting year end is 30th April he will be able to calculate his 2017/2018 taxable profit well before 5th April 2018 because it s based on his 30th April 2017 accounts. 6
POTENTIAL TRAPS AND PLANNING POINTS Here are some tips to help you avoid common traps: 1. The start date of any relevant salary sacrifice agreement might not always be straightforward to work out. An existing pre 9th July 2015 salary sacrifice agreement isn t included in Threshold Income and a review of an existing agreement shouldn t have any impact on Threshold Income because no further salary is being sacrificed. However an increase in the amount of salary sacrifice must be included. 2. Company car benefit is one form of income that often causes confusion. As it s a taxable benefit it counts as Relevant Income and it must be included in Adjusted Net Income, Adjusted Income and Threshold Income. However it won t be confirmed to the employee until shortly after the end of the tax year, so it might be necessary to estimate it or you could use the figure from the employee s latest notice of coding for that tax year. The employee should be able to give this to you. 3. 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, and there may need to be a trade-off between paying the maximum pension contribution and reducing the risk of an annual allowance charge. 4. Don t forget to include investment income in Adjusted Net Income, Adjusted Income and Threshold Income (but not Relevant Income.) Remember to include all income received up to 5th April. For example Building Society interest credited 31st March 2018 forms part of Adjusted Net Income, Adjusted Income and Threshold Income for the tax year 2017/2018, but the individual might not be informed about the amount until shortly after the end of the tax year, so an estimate may be needed. 5. Don t forget to gross up taxed income. Bank and building society interest and dividends are now received gross, but some forms of income are still received after tax is deducted. 6. If your client is self-employed bear in mind that self-employed profits are normally treated as income for the tax year in which the accounting year end falls. For example, if your client s year end is 30th April their 30th April 2017 profits fall into tax year ended 5th April 2018. This means that they are Relevant Income for tax year 2017/2018. However, if your client s year end is 31st March their 31st March 2018 profits fall into tax year ended 5th April 2018. This means that these clients won t know their Relevant Income for tax year 2017/2018 until after the end of that tax year, so an estimate will be necessary. It s also worth confirming your client s taxable profit with their accountant, because it will normally be quite different to the figure on their profit and loss account due to tax adjustments that are required to be made to the figures. 7. If deducting losses from income it s safest to confirm available losses with your client s accountant. Bear in mind that your client can t deduct buy to let rental losses or furnished holiday lettings losses from their total income. The good news is that all of this complexity means your high income clients need your advice more than ever, and there are plenty of opportunities for you to help them protect their hard earned wealth. Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change. However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given. Scottish Widows Limited. Registered in England and Wales No. 3196171. Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number 181655. 56262 09/17