As someone who works with high-earning individuals, your clients are no doubt always on the lookout for ways to make the most of their hard-earned money.
Pensions may be a viable option for many of your clients. The combination of tax relief that they can receive on their personal contributions, alongside the potential investment returns their pots can generate, can make pensions a tax-efficient way to build wealth for later life.
Of course, these benefits are not entirely unlimited. In fact, you and your clients may well be aware that there’s a pension Annual Allowance, setting a maximum for how much individuals can save into their pension each tax year while still receiving tax relief.
Currently, this threshold stands at the lower of £40,000 or 100% of their earnings in 2022/23.
However, what some of your clients may not be aware of is that this Annual Allowance can be reduced for some high earners, further limiting how much tax-efficient saving they’re able to do.
This additional limit, known as the “Tapered Annual Allowance”, could be affecting your clients’ ability to effectively save and invest for their futures.
Read on to find out how this works and what your clients can do about it.
Adjusted earnings over £240,000 could reduce your clients’ ability to save tax-efficiently
The Tapered Annual Allowance comes into effect if your clients exceed two key limits on their “threshold income” and “adjusted income”.
The limits for these two metrics are:
- A threshold income of £200,000
- An adjusted income of £240,000.
For clients that exceed both of these thresholds, they’ll see their Annual Allowance reduced by £1 for every £2 they exceed the adjusted income threshold of £240,000, up to a maximum of £36,000.
All in all, this means that if you have a client whose adjusted income is £312,000 or more, they’ll only benefit from tax relief on just £4,000 of their pension contributions.
Read more below to find out how your clients can calculate their threshold and adjusted income.
Calculating threshold income
To calculate their threshold income, your clients must first take their net income – that is, their taxable income from the year minus any tax reliefs.
Then, they must deduct any pension contributions that received tax relief “at source”, such as a workplace pension, and any lump sum death benefits they received from pension schemes.
Finally, they must add any reduction in employment income that arises from any salary sacrifice and/or flexible remuneration arrangements they have with their employer.
This figure is your clients’ threshold income.
Calculating adjusted income
As with threshold income, your clients must take their net income. This time, they need to add employer pension contributions, any contributions they made under a “net pay arrangement”, and relief claimed for contributions to overseas pension schemes.
Then, they must minus any lump sum death benefits they received, just as they did with their threshold income.
This is your clients’ adjusted income.
Saving and investing tax-efficiently, even with the Tapered Annual Allowance
As you can see, the Tapered Annual Allowance could have a significant effect on how your clients can save effectively for their futures.
Fortunately, there are methods available that can help to negate this. Below are just two options your clients could explore to do so.
1. Using previous years’ allowance
Firstly, your clients may be able to “carry forward” any unused Annual Allowance they have from previous tax years.
You can carry forward unused Annual Allowance for up to three years, meaning your clients could currently go as far back as the 2019/20 tax year.
So, for example, a clients’ threshold and adjusted income might have been lower than the limits in the previous tax year.
If they didn’t use their entire Annual Allowance that year, then they may be able to make and receive tax relief on pension contributions in the current tax year using this leftover Annual Allowance.
Encourage your clients to speak to a financial expert first, as pension carry forward calculations can be complicated.
2. Finding other ways to save and invest
Alternatively, your clients could look for other ways to save and invest for their futures outside of their pensions.
For example, they might want to do so through ISAs instead, allowing them to save or invest up to the annual ISA allowance (£20,000 in 2022/23) without having to worry about Income Tax or Capital Gains Tax (CGT).
Furthermore, they might want to consider more complicated, high-risk options, such as investing in Venture Capital Trusts (VCTs) or through the Enterprise Investment Scheme (EIS).
VCTs and the EIS allow you to invest in smaller businesses in need of capital funding. Of course, smaller companies come with a greater risk of failure so, in return for the additional risk, investors are compensated with valuable Income Tax relief on a part of their investment.
These are complicated investments, so make sure your clients take financial advice before you suggest that they invest in VCTs or the EIS.
Working with a financial planner
If your clients are set to be affected by the Tapered Annual Allowance, it could severely harm the way they save for retirement.
In that case, they may benefit from working with a financial planner, such as with us at Henwood Court.
We can find the best ways for your clients to mitigate the effects of the Tapered Annual Allowance, no matter how much they earn.
If you’d like to find out more about how working with us could allow you to provide an even better service for your clients, please get in touch with us today.
Email email@example.com or call 0121 313 1370.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
Workplace pensions are regulated by The Pension Regulator.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
Enterprise Initiative Schemes (EIS) and Venture Capital Trusts (VCT) are higher-risk investments. They are typically suitable for UK-resident taxpayers who are able to tolerate increased levels of risk and are looking to invest for five years or more.
Historical or current yields should not be considered a reliable indicator of future returns as they cannot be guaranteed.
Share values and income generated by the investments could go down as well as up, and you may get back less than you originally invested. These investments are highly illiquid, which means investors could find it difficult to, or be unable to, realise their shares at a value that’s close to the value of the underlying assets.
Tax levels and reliefs could change and the availability of tax reliefs will depend on individual circumstances.