Annual allowance: tapering and transition

United Kingdom

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Summary and implications

As expected, the Chancellor has recently announced a reduction in the annual allowance for pension savings of higher earners. This will take effect from 6 April 2016 but transitional provisions have been introduced immediately (both to protect contributions already made and to prevent avoidance). As part of this, the pension input period (PIP) over which pension savings/accrual are measured for annual allowance purposes is to be aligned with the tax year from 6 April 2016 for all registered pension arrangements.

The transitional arrangements are complex. Any individual affected, or potentially affected, should seriously consider taking independent financial advice from a regulated adviser with appropriate experience.

High earners: the tapered annual allowance

The annual allowance for pension savings is to be reduced from £40,000 to £10,000 for high earners from 6 April 2016. The reduction will be on a sliding scale – for every £2 of income an individual has over £150,000, their annual allowance will be reduced by £1 until it has tapered down to £10,000 for those earning £210,000 or more.

The £150,000 is an "adjusted income" figure which includes employer pension contributions (to prevent avoidance through salary sacrifice). The new rules will not apply to anyone with a "threshold income" of no more than £110,000 (in tax year 2016–17).

High earners

Individuals with "adjusted income" over £150,000:

* net income; plus
* any relief given under net pay arrangements for pension contributions; plus
* any pension contributions made under net pay arrangements; plus
* any relief for overseas pension contributions; plus
* the value of any employer pension contributions; less
* any DB lump sum death benefit received as a result of the death of an individual aged over 75.

But not those with "threshold income" of no more than £110,000 (for 2016–17):

* net income; plus
* the amount of any employment income given up for pension provision as a result of salary sacrifice made on or after 9 July 2015 (anti-avoidance measure); less
* gross amount of any relief-at-source pension contributions; less
* any DB lump sum death benefit received as a result of the death of an individual aged over 75.

Aligning PIPs with the tax year

The PIP is the period over which pension inputs (DB accrual or DC contributions) are assessed for the purposes of the annual allowance. The PIP is usually a 12-month period (but can in some circumstances be longer or shorter than that). Pension inputs are tested against the annual allowance in the tax year in which a PIP ends.

In order for the new annual allowance taper to work as intended, all PIPs are being aligned with the tax year. In order to achieve this (and to make it fair for anyone who put in £40,000 prior to the Budget on the assumption the PIP would not change), there are going to be some fairly complicated transitional provisions. This is the first step in possibly removing the PIP altogether.

From 6 April 2016 all existing registered pension arrangements will have a 12-month PIP from 6 April 2016 to 5 April 2017. All future PIPs will run 6 April to 5 April and there will be no power to vary.

Transitional PIP arrangements

  • All PIPs will end on 8 July 2015.
  • A new PIP will run from 9 July 2015 to 5 April 2016.
  • The following PIP will start on 6 April 2016 and run to 5 April 2017 (and follow the tax year thereafter).

Transitional annual allowance arrangements

Individuals will have an annual allowance of £80,000 for the tax year 2015–16 (plus any carry forward from the previous three tax years) for all pension savings in relation to all PIPs ending on or after 6 April 2015 and on or before 8 July 2015. This is referred to as the pre-alignment tax year.

Post-Budget savings (i.e. 9 July 2015 to 5 April 2016) will have a nil annual allowance but up to £40,000 of the £80,000 can be carried forward (plus carry forward of any unused annual allowance from the previous three tax years). This period is referred to as the post-alignment tax year.

From 6 April 2016 the standard annual allowance of £40,000 will apply, subject to tapering for high earners and to the usual rules on carry forward.

This diagram illustrates the new annual allowance and PIP arrangements.

Money purchase annual allowance – transitional arrangements

The money purchase annual allowance is triggered when an individual accesses flexible benefits (broadly money purchase or cash balance benefits). The individual will then have an annual allowance for money purchase pension saving of £10,000 and for defined benefit accrual of £30,000 (referred to as the "alternative annual allowance"). Alternatively the individual could be subject to the "default chargeable amount" – essentially this gives an annual allowance of £40,000 of which up to £10,000 may be money purchase contributions.

As if that were not complicated enough, there will be transitional provisions in the period up to 6 April 2016. In the pre-alignment tax year, the money purchase annual allowance is £20,000 and the alternative annual allowance is £60,000 (or alternatively a default chargeable amount of £80,000). The money purchase annual allowance for the post-alignment tax year is nil, with the remainder of the £20,000 carried over (subject to a maximum of £10,000). The alternative annual allowance is also nil but with the remainder of the £60,000 carried over (subject to a maximum of £30,000). Alternatively up to £40,000 of the default chargeable amount can be carried over. In effect, a total of £40,000 can be brought forward (plus ordinary carry forward from the previous three tax years).

From 6 April 2016, the money purchase annual allowance will remain at £10,000 but the alternative annual allowance will taper down from £30,000 to nil for high earners. Alternatively, the default chargeable amount will start at £40,000, tapering down to £10,000 for high earners. The usual carry forward rules will apply.

This diagram illustrates the position in relation to the money purchase annual allowance.