If you, as a GP or another type of professional, earn a high income and pay into a pension plan, it’s important to understand the tapered pension annual allowance.
Most people can contribute up to £40,000 to their pension each year and benefit from tax relief. However, if your income rises above a certain level – £200,000 for the 2022/23 tax year – this allowance could be reduced or ‘tapered’.
This will likely have an adverse effect on your pension payments, so you need to know how the tapered annual allowance works and what you can do to mitigate its impact.
How does the tapered annual allowance work?
The tapered annual allowance effectively reduces the amount of money that you or your employer can contribute to a pension before having to pay tax.
The taper typically doesn’t apply if your ‘threshold income’ is less than £200,000. If you’re above this level, you need to check if your ‘adjusted income’ is greater than £240,000 (2022/23 tax year).
The annual allowance reduces by £1 for every £2 that your adjusted income exceeds £240,000, to a minimum tapered allowance of £4,000.
That means that once your adjusted income is £312,000 or more for the 2022/23 tax year, you and your employer can only make a maximum pension contribution of £4,000 each year.
Threshold income v adjusted income
Both include taxable income and are not restricted to earnings – investment income of all types and benefits in kind paid by your employer are included.
That includes, but is not limited to, your salary, bonuses, rental income, interest on savings, and any salary or bonuses sacrificed for pension contributions since 9 July 2015.
The difference is that adjusted income includes all pension contributions (including employer contributions), while threshold income excludes pension contributions.
So, if everything that counts as your taxable income plus your pension contributions exceeds £240,000, you will be subject to the tapered annual allowance for 2022/23.
Don’t underestimate the complexity behind accurately working out your threshold and adjusted income – we would recommend getting the help of an accountant to make sure you’ve got your calculations right.
What to do if you think the tapered annual allowance affects you?
If you think your annual income levels fall within the boundaries of the tapered annual allowance, it’s important to understand whether you need to expect an unexpected charge.
An accountant will be able to work out your annual allowance and advise you on how to adjust your contributions accordingly.
You may be able to ‘carry forward’ any unused annual allowance from the previous three tax years to increase the amount you can build up in pensions in the current tax year.
You can also minimise your exposure to the tapered annual allowance by reducing your gross income by sacrificing part of your salary to charity.
Otherwise, you can use other tax-efficient vehicles, such as an individual savings account to save for the future. Although your contributions will be drawn out of your net income, your investment gains won’t incur tax while invested or when you make withdrawals.
Contact us to talk about what the tapered annual allowance means for you and your pension savings.