Avoiding the taper charge

The new tapered annual allowance limits on a sliding scale the amount people earning more than £150,000 can receive in tax relief on pension contributions each year. In addition, the tapered annual allowance system counts a wider range of earnings as an individual's income and tapering can be applied to those with an income above a government-set threshold of £110,000. As well as salary and bonuses, the new 'adjusted income' definition includes rental income, investment income and, crucially, employer pension contributions.

Previously higher earners could receive full tax relief on pension contributions up to the maximum allowance of £40,000 a year.

But now anyone earning more than £150,000 making a pension contribution will have £1 of relief withdrawn for every £2 they earn above £150,000.

For example, people who earn £210,000 and above will be restricted to tax relief on contributions of just £10,000 per year, effectively cutting their annual allowance by £30,000.

If you breach this new lower allowance you will not receive any tax relief on the excess amount. So those earning £210,000 or more will lose relief worth £13,500 (45 per cent income tax on an excess contribution of £30,000).

Gary Smith, financial planner at Tilney Bestinvest, says this is one of the major changes higher earners need to be aware of.

"The key with any high earner regardless of whether they're in a defined benefit or defined contribution scheme is understanding how their total remuneration will be calculated in respect of the tapered annual allowance. It's not just based upon salary, it's this new adjusted income definition which includes employment income, rental income, dividends or interest from savings or an investment portfolio. But most importantly it also includes any employer pensions contributions and this is where I think a lot of people will get caught out," he says.

As employer pension contributions count towards individual income, higher earners could find it difficult to figure out how much they can pay into their pensions without triggering the charge, he explains.

Mike Morrison, head of platform technical at AJ Bell, also thinks a lot of people will struggle to navigate the new system and criticised the chancellor for failing to simplify pension planning in his recent Budget.

"I was hoping that with all the talk on pensions this year and how we were going to change the pensions tax rules that this rather complicated situation would disappear. But it hasn't, so as usual we're left with over-complex rules," he says.

It's important for everyone earning more than £110,000, excluding employer contributions, to consider if they could be in scope for the taper as employer pension contributions could push them over the edge, he says.

Another challenge facing higher earners potentially affected by the tapered annual allowance is a lack of certainty about how much they will actually earn in a year, he adds. An unexpected spike in income such as a bonus or a redundancy payment could mean a lower allowance.

"There are two stages to this problem. The first is doing the calculation up front. The second is after having done the calculation, getting a surprise payment sometime during the year. That's the problem; you never quite know how much you're going to earn during the year," he explains.

Nathan Long, senior pension analyst at Hargreaves Lansdown, agrees that estimating total income will prove a difficult issue for many people.

"High earners will now need either a crystal ball or the benefit of hindsight to navigate the new annual allowances rules. Few people know their total year's income from work, savings and investments in advance. However, those with total annual income above or around £150,000 need to be alive to these changes, or else risk a nasty tax surprise.

"Higher earners should prioritise tallying up their expected income for the year, work out if they could be caught by the new rules, and plan accordingly. Simply remaining a member of a company pension scheme could increase tax bills, so employees in particular should act now by discussing the options with their employer."

How to beat the taper:

If you're an employee it's worth speaking to your employer about how much they will pay into your pension pot to help you avoid the taper.

Tom McPhail, head of retirement policy at Hargreaves Lansdown, explains: "It may be possible for an investor to use their employer pension contribution to fill their annual allowance, leaving them free to use their own money for alternative investments such as Isa funding."

Mr Morrison agrees that this is a route worth investigating but cautions that it depends on your position within the company and level of influence with your employer.

"If you are with a big multinational and are asking to change the situation just to suit you, they probably won't," he says.

In fact, Mr Morrison says that several large companies are increasingly choosing to avoid the hassle of such arrangements by imposing a £10,000 a year cap on workplace pension contributions.

However, Mr Smith says he has also come across employers who are introducing options for higher earners either to opt out of company schemes, but still keep their death-in-service benefits (whereby your employer pays out a lump sum if you die while working at the company), or reduce their contributions.

Small- to medium-sized business owners and self-employed higher earners have a greater number of options, he says, as they are able to arrange their pension contributions either via personal contributions or through their company.

The one area that cannot be used to beat the taper is salary sacrifice schemes as any salary sacrifice arrangements entered into after 9 July 2015 count towards an individual's income.

"The chancellor was quite clever at the time by saying that any new salary sacrifice or false salaries or salary flexibilities after the day of the Budget should be included, so you can't go around the taper that way," Mr Morrison says.

However, higher earners can still make use of carry forward arrangements. Carry forward allows you to utilise any annual allowance that you haven't used during the three previous tax years, provided you were a member of a registered pension scheme.

To use it you must make the maximum available contribution in the current tax year and then you can use unused annual allowances from the three previous tax years, starting with the tax year three years ago.

"Carry forward is useful because if you pay in larger amounts, you've got several years to catch up," Mr Morrison explains.

For example, if an individual had adjusted income in excess of £210,000 in the 2016-17 tax year, they would have a tapered annual allowance of £10,000 for 2016-17. But providing they had not made any contributions in the previous three tax years they could carry forward £130,000 without incurring the tapered annual allowance charge.

Tapered annual allowance can also be carried forward in the same way as the standard annual allowance. This means if an individual is a high earner in 2016-17 and has a tapered annual allowance of £20,000 but only makes contributions totalling £10,000, they would have £10,000 carry forward available to use for 2016-17 within the next three tax years.

The tapered annual allowance is calculated in each tax year so someone who is subject to the taper in one year may not be in the next, but if they carry forward from a tax year when they were a high earner, then only the unused amount of the tapered allowance can be carried forward.

Seven steps for high earning pension savers

Source: Hargreaves Lansdown