Tapered Annual Allowance & Carry Forward post Budget Case Study

Back in the summer of 2020, Professional Paraplanner published my article on tapering of the Annual Allowance (AA) and Carry Forward of unused Annual Allowance in relation to tax relievable pension contributions. Given that significant pensions-related features of the Spring 2023 Budget involve the Annual Allowance and Tapered Annual Allowance (TAA), I thought that it may be useful to revisit the topic by way of an update.

Those readers with clients whose annual earnings extend beyond six figures may have had practical experience of the Tapered Annual Allowance in action. The Tapered Annual Allowance came into operation on 6 April 2017.

The Chancellor of the Exchequer announced (amongst other things) in his Spring 2023 Budget that there would be two changes affecting the Tapered Annual Allowance:

The minimum Tapered Annual Allowance would increase from £4,000 to £10,000 with effect from 6 April 2023; “Adjusted income” would increase from £240,000 to £260,000 with effect from 6 April 2023.

Whilst there was no change to the earnings figure for the “threshold income” definition (which remains at £200,000), the change to the earnings figure for the “adjusted income” definition may have brought some welcome relief for those previously impacted by the Tapered Annual Allowance at the lower amount (£240,000). In addition, the increase in the minimum Tapered Annual Allowance from £4,000 to £10,000 may encourage more clients to fund their pension at a higher level than had previously been possible.

Furthermore, the Annual Allowance itself was increased by 50% from £40,000 to £60,000.

What difference does this make in practice, particularly when it comes to Carry Forward?

Back in 2020, new (at that time) threshold and adjusted income definition amounts came into effect on 6 April. The threshold income figure was increased from £110,000 to £200,000 and the adjusted income figure was increased from £150,000 to £240,000. It is likely that each of these changes had positive effects for many high-earning pension savers who otherwise would have been impacted by an Annual Allowance Tax Charge. Some senior NHS clinicians (and others) were amongst the groups of people who had been affected by the Tapered Annual Allowance at the previous levels.

The latest, Spring 2023 Budget, revisions should have further beneficial effects for some pension savers.

In order to demonstrate the positive effects of the change, and in relation to Carry Forward, it may help to consider a case study:

Case Study

Kathy has been a member of a registered pension scheme since 2009 and therefore has potential capability to carry forward unused Annual Allowance from the previous three tax years to the current tax year. Kathy’s adviser makes her aware that the current year’s Annual Allowance must be used first before any unused Annual Allowance can be carried forward from earlier years.

Kathy’s earnings in the tax years 2020/21 and 2021/22 were £240,000. This, in turn, meant that she was not affected by tapering and her available Annual Allowance for those years was £40,000. Kathy made pension contributions as shown in the table below.

Kathy’s earnings in the tax years 2022/23 and 2023/24 increased to £312,000. Kathy is affected by the Tapered Annual Allowance in both the 2022/23 and 2023/24 tax years because her adjusted earnings exceed £240,000 and £260,000 respectively. However, because of the increase in adjusted earnings to £260,000 for the 2023/24 tax year AND because of the increase in Annual Allowance to £60,000, Kathy has a higher Annual Allowance available to her than applied the previous year (despite maintaining the same earnings).

The tables below indicate how Kathy’s carry forward position would have looked before and also after the changes to the Tapered Annual Allowance and Annual Allowance. From these, it is clear that Kathy’s maximum tax relievable contribution in the current tax year has increased from £43,000 to £73,000.

Kathy’s carry forward position, had there been no changes to Tapered Annual Allowance and Annual Allowance from 6/4/2023:

Kathy’s carry forward position, following changes to Tapered Annual Allowance and Annual Allowance from 6/4/2023:

The net effect of the changes to the Tapered Annual Allowance and Annual Allowance mean that Kathy can maximise her pension contributions in the current tax year in a highly tax-efficient manner. Given the level of her earnings, Kathy should obtain full tax relief on the pension contribution of £73,000 in the 2023/2024 tax year.

Technical notes:

1. ‘Member’ means active member, pensioner member, deferred pensioner member or pension credit member.
2. Tapered annual allowance reduces a pension scheme member’s annual allowance on a sliding scale for a tax year in which their ‘adjusted income’ exceeds a certain figure. For the 2023/24 tax year, this is £260,000. Members with an adjusted income of £360,000 or more in the tax year 2023/24 will have a maximum tapered annual allowance of £10,000. The tapered annual allowance will not apply if a member’s ‘threshold income’ is £200,000 or less, even if they have adjusted income of £260,000 or more. The annual allowance was not affected by the tapering in tax years prior to 2016/17, although it may have been affected by the money purchase annual allowance from 6/4/2015.
3. Adjusted income includes the member’s earnings, dividends, interest on savings and pension contributions (including those made as a result of a salary sacrifice or similar arrangement).
4. Threshold income is broadly similar to adjusted income except that pension contributions that entitle the member to Relief at Source and employer contributions resulting from a salary sacrifice (or similar arrangement) made before 9 July 2015 are excluded.
5. The Annual Allowance for the tax year 2023/24 is £60,000.