The Autumn Budget is now only days away.
Although a shift to a single rate of pension tax relief is probably unlikely, one aspect of pension tax that could be changed is the annual allowance.
There are three different pension annual allowances for Chancellor Philip Hammond to choose from when it comes to Budget changes.
There is the £40,000 standard one, as well as the £4,000 money purchase annual allowance where benefits have been flexibly accessed. But it is perhaps the tapered annual allowance which has caused the most confusion and which is also the least understood.
The tapered annual allowance is specifically aimed at higher earners. It means that anyone who earns over £150,000 could see their standard annual allowance reduced down to a minimum £10,000, severely curtailing how much they can pay into pension plans and receive tax relief on contributions.
Following the tried and tested formula for pension legislation, the rules for the tapered annual allowance are far from simple. For higher earners, their annual allowance of £40,000 is reduced by £1 for every £2 of income above £150,000, subject to a minimum of £10,000.
However, for the tapered annual allowance to kick in, the client’s adjusted income has to be over £150,000, and their threshold income has to be over £210,000.
Broadly for Sipp clients, adjusted income is the client’s total income plus their employer pension contributions. Threshold income is their total income less member contributions. (There is also an adjustment for employment income given up under salary sacrifice just in case anyone was tempted to circumvent the rules that way.)
Since these new rules were introduced in April 2016, advisers have been working with their higher-earning clients in order to accommodate them.
The problem is many people don’t know exactly what they've earned in a tax year – and therefore what their tapered allowance will be – until the very last gasp, or even after the end of the tax year.
This could be because they are self-employed and therefore don’t know the full details of their earnings. Or it could be because part of their pay package is a bonus and the final details aren’t known until late in the tax year.
If they find themselves in the (good!) position of earning more than expected, clients could delay paying pension contributions until just before the end of the tax year when all the final details are known. But that isn’t always feasible.
If they have already paid their pension contribution and it has exceeded their tapered annual allowance, then they could use carry forward of any unused annual allowance from the three previous tax years to mop up the excess.
That's what many clients have been doing over the past two tax years. However, this is a short-term solution as an unused annual allowance will run out at some point.
This means the client will have to pay an annual allowance tax charge. They can do this through their self-assessment or by asking their pension scheme to pay it, and reduce their pension benefits accordingly. Some schemes do this quite happily, but others may be more reluctant.
Clients can insist on schemes paying tax charges but only if it’s above £2,000, and – this is the clincher – if the client has exceeded their £40,000 limit. So, a client facing an annual allowance tax charge as a result of tapering may not be able to force a scheme to pay it for them and will have to find the money themselves.
The Chancellor may be looking for an 'easy’ way of raising more tax from pension contributions by limiting tax relief, and may want to target higher earners directly. If so, then lowering the tapering annual allowance threshold – say down to £100,000 – may be top of his list.
We just need to wait until Monday to find out.