The introduction in 6 April 2016 of a tapered annual allowance for pension contributions could result in an unexpected tax bill of £13,500 for those affected by the new rules.
Suzanne Briggs, director, said: “A number of employers offer their staff generous pension provisions, often in the form of matched contributions by the employer, and usually these are an exceptionally tax efficient form of remuneration. However, what may be considered a generous and tax efficient perk to the usual salary and bonus could now leave employees with sizeable tax bills.
“We recently held a briefing session for employers and the general feedback is that the reduction in the annual pension allowance has been under published. Additionally, many of the people we are speaking to are unaware of the changes.”
She added: “Both employees and employers should urgently review pension positions to protect against any nasty tax surprises after the end of the tax year. There are options available to help prevent the unexpected liabilities but action needs to be taken now, and not at the end of the tax year.”
The pensions annual allowance is the amount a person can contribute to a pension and claim tax relief on each year – this is both the individual’s personal contributions and any employer contributions. The annual allowance has been set at £40,000 since 6 April 2014. However, from 6 April 2016, new rules have been introduced which will reduce the annual allowance by £1 for every £2 of income the individual earns over £150,000. Those with total income of £210,000 or more will only be eligible for tax relief on contributions of £10,000 per year.
Suzanne said: “The tapered annual allowance is a significant change to the taxation of pensions and one which could unknowingly catch a number of people out if they do not plan ahead and continue to make pension contributions based on the previous rules.
“In a number of situations, an individual may not know what their total income will be until after the end of the tax year, and the amount of the bonus may be impossible to predict in advance. If a person has continued to make pension contributions throughout the year on the basis that their total income will be below the £150,000 threshold, and they then receive a large bonus which takes their income above the limit, the value of the bonus could be substantially eroded as the relief on pension contributions is clawed-back.”
She added: “In addition, an employer may not be aware of other sources of income an employee has, outside of their salary/bonus, which will count towards the total earnings and therefore may impact their annual pension allowance. If the employee and employer have been making pension contributions on the basis that the employee earns less than £150,000 a year, but it later transpires that the employee has private sources of income, such as rental properties, and their income exceeds £150,000, then they could face a hefty tax bill.”
“Some individuals may have already breached the £10,000 allowance, just two months into the tax year, but they won’t necessarily know until the end of the tax year, whether their annual allowances will be £40,000 or £10,000, or any amount in-between. As a result, they will then face an unexpected tax bill at 31 January 2018.
Chris has a fixed salary of £150,000, but in March 2017, after a very successful year, is awarded a bonus of £30,000 by his employer. Chris also has some buy-to-let properties that generate annual rental profit of £30,000, but his employer does not know about these investments. His total annual income is therefore £210,000. Throughout the year, Chris has been making pension contributions, which have been matched by his employer, and these total £40,000. As far as Chris and his employer are concerned, the pension contributions come within the annual allowance and there should be no issues. However, as Chris’s income is £210,000, he will only receive tax relief on £10,000 of the pension contributions. He and his employer have over-contributed by £30,000 so Chris will need to declare this on his 2016/17 tax return and pay tax at his marginal rate of 45%, a total of £13,500, due by 31 January 2018.
Suzanne said: “Employees and employers should urgently review their estimated income and pension contributions now so that they are aware of the implications and any potential future tax liabilities.”
For more information, please contact Suzanne at firstname.lastname@example.org