Table of contents
Background to contribution limit changes – act in your window of opportunity
Carry forward – your scope for action may be greater than you think
Loss of personal allowance – even greater rewards for earlier planning
Final thoughts

For those on a high earning career path, particularly where earnings increase suddenly and significantly on a promotion, the 2020 Budget changes mean it is now even more important than before to focus on pension planning at the earliest stage possible.  In our experience, this is particularly relevant for those working in partnerships where earnings often jump upon appointment to partner.

Background to contribution limit changes – act in your window of opportunity

The annual allowance effectively acts as a cap on the level of pension contributions you can make.  The standard annual allowance is £40,000, however, high earners have been subject to a reduced tapered annual allowance since the 2016/17 tax year.  The highest earners with adjusted income1 greater than £312,000 now have a tapered annual allowance of £4,000 – the minimum tapered annual allowance has fallen from £10,000 in the 2019/20 tax year to £4,000 in the 2020/21 tax year.  Indeed, where adjusted income is greater than £300,000, the tapered annual allowance will be lower in the 2020/21 tax year than previously.

While the minimum tapered annual allowance has been reduced, some good news is that the thresholds above which annual allowance tapering takes effect were increased in the 2020 Budget.  In the 2020/21 tax year, the annual allowance is gradually tapered if your threshold income2 is greater than £200,000 (increased from £110,000 in the 2019/20 tax year) and your adjusted income is greater than £240,000 (increased from £150,000 in the 2019/20 tax year); tapering reduces your annual allowance by £1 for every £2 of adjusted income over £240,000, to the minimum level.  The result is that high earning senior employees may now have their full annual allowance available to them when they did not in previous tax years.

The chart below provides a simplified illustration of how an individual’s annual allowance and the corresponding income tax relief change at rising levels of income.

Carry forward – your scope for action may be greater than you think

Under current rules, you can carry forward unused annual allowance from the previous three tax years, whether it is the full standard annual allowance or your tapered annual allowance.  It is important to note that your gross earnings in the tax year of the contribution must still cover the entire pension contribution and tax relief is based on your marginal income tax rate in the tax year of the contribution.

For those about to achieve a significant promotion, perhaps at the latter stages of the partnership track, it is not uncommon for other priorities (both financial and non-financial) to take precedent.  If a sharp jump in earnings provides the liquidity to focus on longer-term planning, this is potentially the critical time to focus on carry forward allowances, before unused allowances start to drop away.  Furthermore, at this point a greater proportion of any contribution may benefit from a higher rate of marginal income tax relief at 45% for additional rate taxpayers.

Loss of personal allowance – even greater rewards for earlier planning

The personal allowance is reduced by £1 for every £2 of income above £100,000, such that individuals with taxable income greater than £125,000 have no personal allowance and pay an effective rate of tax of 60% on income between £100,000 and £125,000.  Making pension contributions which reduce your adjusted net income3 within this bracket will effectively receive income tax relief at 60% (or potentially higher if achieved via salary sacrifice).

Final thoughts

The changes in the 2020 Budget mean high earners will likely benefit from a renewed focus on making pension contributions earlier in their career, subject to affordability and other financial objectives.  If we roll back a decade when high earners at the end of their career could make use of an annual allowance of £255,000, today’s rules provide a stark contrast, but mean early engagement in pension contribution planning is now vital for high earners before the majority of their allowance is no longer available.  Furthermore, in the aftermath of the Covid-19 pandemic and huge rise in the budget deficit, there is a growing consensus that at some point taxes are likely to rise – the wealthy and those with high incomes are increasingly under the spotlight.

If you have been recently appointed a partner or on a partnership track, or simply neglected your pension planning for a few years, now is the time to review your annual allowance available (including carry forward), consider your future objectives and assess the affordability of any pension contributions.  If you wish to discuss any of the above or your wider financial planning, please do not hesitate to get in touch.

 

  1. In broad terms, threshold income is total taxable income minus pension contributions (other than employer contributions).
  2. In broad terms, adjusted income is total taxable income plus all pension contributions.
  3. In broad terms, adjusted net income is total taxable income less certain tax reliefs (e.g. pension contributions).

About The Author

Tom Gerrard
Tom joined Saunderson House in 2008 after graduating from Durham University with a degree in Economics. He is a ...
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