Recovering Tapered Annual Allowance

Peter314

According to the Pensions Advisory Service:
ww.pensionsadvisoryservice.org.uk/content/spotlights-files/uploads/End_of_Tax_Year_Planning_SPOT024_V1.2.pdf

You will still be able to carry forward unused annual allowance from previous tax years and if your income subsequently drops to below the thresholds you will be restored to the normal annual allowance. If you have earnings of [FONT=Arial,Arial][FONT=Arial,Arial]£110,000 p.a[/FONT][/FONT]. (post-pension contributions) you will not be affected by the TAA.

I'm struggling to understand this and would welcome any answers to some questions.

First: where does the £110,000 figure come from (why not £150,000)?

Second: taking some simple numbers, taxable income £180,000, unused AA £30,000, which of the following is correct, and why?

Calculation 1
TAA = £25,000, so total available allowance is £25,000 + £30,000 = £55,000. Paying in the max. leaves £125,000 taxable.

Calculation 2
£30,000 unused AA brings the taxable amount down to £150,000, and the full £40,000 AA is available to bring the taxable amount further down to £110,000.

Calculation 3
Neither of the above.

From the quoted passage, it appears that Calculation 2 must be correct, but this seems to entail some kind or bootstrapping or temporal paradox. Recovering the full AA is only possible by using that full AA to get down to the threshold where there is no tapering. Maybe I'm overthinking this..?

hugheskevi

First: where does the £110,000 figure come from (why not £150,000)?

As a policy simplification, HM Treasury decided that if taxable income is below £110,000 then you are not affected by Tapered Annual Allowance, regardless of how large your pension input is.

To give an extreme example, assume you had a pension input of £100,000 (the most likely scenario for this is someone in a final salary scheme following a promotion). If taxable income was £109,999 then their Annual Allowance remains £40,000. If their taxable income is £110,001 then their Annual Allowance is £10,000 [taxable income of £110,001 plus pension input of £100,000 totals £210,001 which is sufficient to reduce Annual Allowance to £10,000, a £12,000 cliff-edge from earning £1 more!].

I would speculate the reason for the use of £110,000 is that £110,000 plus £40,000 equals £150,000 and so once carry-forward is all used you wouldn't expect people to be putting in more than £40,000 to a pension. Hence put in a floor of taxable income of £110,000 to simplify things.

Second: taking some simple numbers, taxable income £180,000, unused AA £30,000, which of the following is correct, and why?

Calculation 1.

The pension contribution (ie pension input) affects the calculation, so this needs to be taken into account. So in Calculation 1 if you paid in £55,000 from a taxable income of £180,000 then taxable income would be reduced to £125,000 to which you add pension input of £55,000 and then calculate TAA, which is £25,000. So you have a pension input of £55,000, a personal Annual Allowance of £25,000, a breach of £30,000 and unused Annual Allowance of £30,000. No tax charge is payable, and no carry-forward remains for future years.

In Calculation 2, unused Annual Allowance from previous years is only relevant in the event Annual Allowance in current year is breached, it does not affect TAA calculations.

From the quoted passage, it appears that Calculation 2 must be correct, but this seems to entail some kind or bootstrapping or temporal paradox. Recovering the full AA is only possible by using that full AA to get down to the threshold where there is no tapering. Maybe I'm overthinking this..?

I read the quoted text as simply stating that a reduced Annual Allowance is not permanent, and so will not affect future years if your income changes, and confirming that carry-forward can still be used.

Peter314

Thank you for your patience, hugheskevi. Some light may be dawning

The pension contribution (ie pension input) affects the calculation, so this needs to be taken into account. So in Calculation 1 if you paid in £55,000 from a taxable income of £180,000 then taxable income would be reduced to £125,000 to which you add pension input of £55,000 and then calculate TAA, which is £25,000. So you have a pension input of £55,000, a personal Annual Allowance of £25,000, a breach of £30,000 and unused Annual Allowance of £30,000. No tax charge is payable, and no carry-forward remains for future years.

So if the pension input was £70,000, that would reduce taxable income to the magic £110,000, meaning that AA is deemed to remain at £40,000. Full AA + £30,000 = £70,000. No tax charge is payable and no carry-forward for future years. Have I got that right..?

hugheskevi

So if the pension input was £70,000, that would reduce taxable income to the magic £110,000, meaning that AA is deemed to remain at £40,000. Full AA + £30,000 = £70,000. No tax charge is payable and no carry-forward for future years. Have I got that right..?

Yes, given the assumed £30,000 of carry-forward available.

Peter314

hugheskevi wrote: »

Yes, given the assumed £30,000 of carry-forward available.

Ok, that is the same result that Calculation 2 gives.
It is a strange, quantum world that HMRC have created: in the example given, no tax liability for pension inputs up to £55,000 or £70,000 or more. But there is tax liability for intermediate pension inputs.


They don't make it easy...

hugheskevi

It is a strange, quantum world that HMRC have created: in the example given, no tax liability for pension inputs up to £55,000 or £70,000 or more. But there is tax liability for intermediate pension inputs.

There would be a tax liability for more than £70,000 (albeit the liability would be considerably lower for a £70,001 contribution than it would be for a £69,999 contribution) but yes, it is a very strange world with sharp cliff edges that might result in avoidable 5 figure tax bills for the unwary.

It also amuses me that if you did happen to be in the position of having taxable income slightly above £110,000 and a large pension input, probably the easiest way to avoid/mitigate a tax charge resulting from TAA and putting too much into a pension...is to put a bit more into a pension to get taxable income below the magic number

Peter314

hugheskevi wrote: »

It also amuses me that if you did happen to be in the position of having taxable income slightly above £110,000 and a large pension input, probably the easiest way to avoid/mitigate a tax charge resulting from TAA and putting too much into a pension...is to put a bit more into a pension to get taxable income below the magic number

Good point! I can't believe that's what HMRC intended, but it does seem to follow from the introduction of the arbitrary £110,000 threshold.