The start of a new tax-year means it’s time to give yourself a financial health-check. Although, thanks to the iniquity of the Retail Distribution Review, far more people will be reviewing their financial health themselves instead of turning to the expertise of an Independent Financial Adviser, given how off-putting the up-front costs for advice are.
Only a cynic would believe that the Treasury, having encouraged the FCA to restrict advice by implementing RDR, would then deliberately introduce complex legislation that would create a trap for higher earners, but that is precisely the effect of the introduction of the taper which comes into force on Wednesday 6th April 2016. People trying to reduce their tax obligation by maximising their pension contributions may find it difficult not to get enmeshed in the difficulties of predicting their earnings accurately enough to avoid being penalised for over-contribution to their pension. Subsequently, they end up paying far more tax than they had originally envisaged.
The taper applies to all those with an income over £150,000, an amount that is inclusive of bonuses and pension contributions as well as salary and also includes other income such as dividends, rental income etc. Forecasting this accurately is extremely difficult at the start of the year. Yet once your income, thus adjusted, goes over £150,000, the amount you can contribute in pension contributions is reduced from £40,000 to £10,000 at a rate of £1 reduction for every £2 in earnings over that threshold.
If you predict incorrectly, you will face a further tax bill on the amount in which you have over-paid into your pension at a rate of 45%. This will lead to a possible maximum hit of £13,500 at the end of the tax year if your income drifts over the top threshold of £210,000, leaving you with the minimum level of allowable pension contribution of £10,000.
This is delicate territory to say the least and is going to be a particularly stormy sea to chart a path through if you are a member of a company pension scheme and are used to just leaving it all to HR and focusing on your take-home pay. HR has no idea about any other sources of income you may have, nor can they possibly forecast the level of bonus you might receive. Because of this difficulty and the fear of being the cause of a tax obligation, some FTSE-100 companies are automatically assuming a minimum annual allowance level of £10,000 for their higher-earning employees, meaning that employees could easily end up under-contributing to their pension.
This is without even starting upon the reduction in the lifetime contribution allowance that is also coming into force on April 6th and reduces from £1.25M to £1M. These are dangerous times for pension savers and the best advice that can be given to higher earners is to swallow their fears and get expert opinion in order to avoid the traps that have been set up by recent pension legislation. Otherwise they may find that, by the end of this coming tax-year, their income is a lot slimmer than it should have been.