A pay rise means Mary may have to submit to increased tax charges. But by taking steps to reduce her annual income below the threshold, she can prise back her full allowance.
Mary has worked for a large company for 20 years. This year she received a 5.25% pay rise of £5,000 and a bonus of £10,000. She now earns £100,000 a year with an additional car allowance of £5,000. She also has taxable income from her buy to let of £7,000 per year.
Mary has been a member of the company’s defined benefit (DB) pension scheme for her whole career and pays 5% into the scheme on a net pay basis. She also pays £150 per month net to her own personal pension.
A colleague mentioned they were subject to a tax charge on their pension last year because of a promotion increasing their earnings and therefore their pension benefit. Mary is now unsure how this could happen, and if she can do anything to mitigate incurring a possible tax charge.
Mary should be concerned: the level of her pay rise and service in the pension scheme could lead to an annual allowance charge. She is also now in the realms of the tapered annual allowance, which could increase the tax charge.
The first thing to do is try to estimate her net income for the tapered annual allowance calculations. This consists of her taxable income, which in this case would be £100,000 gross salary less than her net pay pension contributions to get her taxable salary of £95,000.
Next, the taxable property rental, bonus and car allowance need to be added in, which gives a figure of £117,000.
To get the threshold income, the £2,250 gross personal pension contributions is taken off, giving a figure of £114,750. As the threshold income is more than £110,000, it means adjusted income calculations must be made to establish her annual allowance for this year.
The client’s pension input amount (PIA) into the DB scheme can be estimated, because there is unlikely to be any further pay rises this tax year. The PIA based on the £5,000 pay rise and another year of service in the 60ths scheme equates to £47,169.
To calculate the adjusted income, her net income of £114,750 is added to the deemed employer contributions and her net pay contributions to the scheme. This gives an adjusted income of £161,919. As it is over the £150,000 limit by £11,919, it equates to a reduction in her annual allowance of £5,959. Her annual allowance now becomes £34,041. This exceeds the input that has already been made for this year.
Thankfully Mary has £14,500 of carry forward available, which gives her an available annual allowance of £48,541. This would mean an annual allowance charge on £878: not extremely significant, but a charge nonetheless.
However, Mary could make an extra personal contribution of £3,801 net (£4,751 gross), which would reduce her threshold income to £109,999. This would give her the full annual allowance back.
Her PIA would now be £47,169 from the DB scheme, plus £7,001 from her personal contributions. This is below her available annual allowance, including carry forward of £54,500.
The result is no annual allowance charge, more funds in her pension and a slightly increased personal allowance as a bonus, because it has reduced her overall taxable income.
Claire Trott is head of pensions strategy at Technical Connection