In recent years, your director and professional clients have faced increasing challenges when it comes to building up a sufficient pension fund for retirement.
For a start, the gradual reduction of the Lifetime Allowance, now fixed at just over £1 million to 2026, means even modest pension pots are likely to exceed the limit over time. You recently read about the increasing number of individuals affected by these creeping tax charges.
In addition to the Lifetime Allowance, the Annual Allowance restricts the amount of tax-efficient pension contributions a client can make in a single tax year to £40,000 gross (or 100% of their earnings).
For higher-earning clients, the much-discussed Tapered Annual Allowance could also be a factor.
Introduced in 2016, this taper potentially reduces the amount of tax-efficient pension contributions an individual can make in a year to just £4,000.
Read on to find out more about how the taper affects your higher-earning clients, and how a specific type of pension arrangement could help.
The Tapered Annual Allowance can restrict tax-efficient pension contributions to just £4,000
The Tapered Annual Allowance restricts the potential for pension contributions for those clients who earn £200,000 or more. It applies to clients who have both:
- Threshold income of more than £200,000 – this is broadly defined as “net income for the year” and includes salary, bonus, pension income, trading profits, property income, dividends and interest.
- Adjusted income of more than £240,000 – this is effectively the threshold income plus the the value of all employer pension contributions (This prevents individuals from avoiding the restriction by exchanging salary for employer contributions).
Anyone earning less than £200,000 will typically benefit from the full Annual Allowance (£40,000 in the 2022/23 tax year).
If a client’s threshold income is more than £200,000 and their adjusted income is more than £240,000 their Annual Allowance is reduced by £1 for every £2 of income.
For example, if your client’s adjusted income was £280,000, their Annual Allowance would reduce to £20,000.
The taper stops at £312,000, so everyone retains an Annual Allowance of at least £4,000.
As you can see, for clients earning £240,000 or more, the reduction in Annual Allowance can have a significant impact on pension contributions.
A defined benefit (DB) SSAS pension arrangement can help higher earners
For a defined contribution (DC) pension, when calculating the adjusted income for a high earner (and consequently the effect of the taper) the “value” of the employer contribution is typically the monetary value.
However, under a defined benefit (DB) SSAS arrangement, the “value” is 16 times the target pension created actuarially by the contribution. This is regardless of the cost to the employer of providing that target pension.
Here’s an example of how this could benefit a high-earning client.
A client has a threshold income of £220,000. Her employer would like to contribute £100,000 for her to a pension scheme.
However, that level of contribution to a DC pension would take her adjusted income (including the employer pension contribution) to £320,000. Consequently, the client’s Annual Allowance would reduce to just £4,000.
Practically, it makes a contribution of that level from the company prohibitively expensive from the clients’ Income Tax perspective.
An alternative would be for the employer to pay the £100,000 to a DB SSAS arrangement.
Here, that same contribution might actuarially produce a target annual pension for the client of around £1,500. To determine the effect of the taper, the “value” of the contribution is 16 times the target pension – or £24,000 in this case.
When this “value” is added to the client’s £220,000 income, her adjusted income is, instead, £244,000. This is only slightly over the £240,000 point at which the taper kicks in. The client’s Annual Allowance would reduce by just £2,000, to £38,000, leaving more than enough headroom for the contribution to proceed.
Note that pension and tax rules can change meaning that the allowable contribution can change as well.
Get in touch
If you have higher-earning clients that would benefit from a pension review, or could take advantage of innovative retirement planning, please get in touch.
Email hello@sovereign-ifa.co.uk or call 01454 416653.
Please note
DB SSAS should be viewed as a long-term commitment. Any activity that might seem to undermine this risks tax consequences – for example, making contributions only for a short term, and then transferring out soon after set-up, could lead to penalties.
All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
