Spring Budget: What the pension annual allowance increase means for business owners and the self-employed

How much an individual can contribute to a pension is determined by two things; the available annual allowance and the level of earnings.

The Chancellor announced today that the maximum annual allowance has been increased from £40,000 to £60,000. This is subject to tapering where the individual’s income exceeds two limits known as the Adjusted Income and Threshold Income limits:

• Adjusted Income is essentially total income subject to UK tax less specifically allowable deductions (broadly trading losses, share loss relief and some charitable gifts) plus the value of any employer pension contributions
• Threshold Income is again total income subject to UK tax less the same specifically allowable deductions, but we also deduct the individual’s pension contributions, and add the value of any salary sacrifice arrangements which started after 8 July 2015

Today the Adjusted Income limit was increased from £240,000 to £260,000, whilst the Threshold Income limit remains at £200,000. For tapering to apply, both thresholds need to be breached, and where this happens, the £60,000 annual allowance is reduced by £1 for every £2 of Adjusted Income over £260,000, up to a maximum reduction of £50,000. Therefore, where Adjusted Income is more than £360,000, the maximum annual allowance for the year is reduced to £10,000.

Where the annual allowance is exceeded, a tax charge broadly equivalent to the tax relief given arises, however unused allowances can be carried forward for up to three tax years. When allocating these allowances, the current tax year’s allowance is used first, followed by any brought forward allowances using the earliest brought forward allowances first.

What does this mean for owner-managed businesses?

For directors/employees who are able to estimate their income for the year with a good degree of accuracy, where they have defined contribution pension schemes, calculating the amount of available allowances should be relatively straightforward.

With the rate of Corporation Tax increasing from 19% to 25% from 1 April 2023, those making pension contributions from companies with 31 March year ends may wish to make the maximum contribution for the current 2022/23 tax year, plus use any available brought forward allowances from 2019/20.

Any unused allowances from 2020/21 and 2021/22 can then be used after 1 April 2023, where they will attract Corporation Tax relief at a maximum of 25%. This will ensure full use of the available allowances and maximise the available Corporation Tax relief.

What about the self-employed, and in particular partners in professional partnerships?

Unfortunately things are becoming more complicated for the self-employed, and in particular partners in professional partnerships.

It is relatively commonplace for professional partnerships to have year ends other than 31 March or 5 April, and previously this has meant that not only can tax payments potentially be delayed, but taxable profits on which pension contributions are based are known well in advance of the tax year end.

Where Adjusted Income will clearly fall below £260,000 or above £360,000 it should be straightforward. But with the requirement to calculate all taxable profits for unincorporated businesses in line with the tax year from 2024/25, with 2023/24 being a transitional year, this makes it almost impossible to ascertain what a partner’s Adjusted Income and Threshold Income is in time for the available pension annual allowance to be calculated.

How can this best be managed?

For partners wishing to maximise their pension contributions and who suspect their allowance will be subject to taper and have no brought forward allowances available, it may make sense to miss one year of contributions, or at least leave some of the year’s allowance available so that some of that year’s allowance can be carried forward.

Because contributions are allocated against the current year’s annual allowance first, then against any brought forward balances using the oldest years first, once a brought forward balance is established, to make best use of the allowances, it will be necessary to estimate the taxable profit share for the year of the contribution to calculate whether or not any tapering is due.

A contribution can then be made that is ideally equal to the current year’s allowance plus that of the earliest brought forward year. The availability of some earlier year’s allowance will at least provide some headroom if the tapering for the current year is higher than expected. The effects of this do, however, have to be balanced against the effect of any potential loss in pension growth caused by delaying contributions.

The headline here is therefore that although annual pension allowances are increasing, careful planning is needed going forward, particularly for those involved in unincorporated businesses where the year end does not align with the tax year. It will inevitably lead to the need to use more estimated figures in planning contributions and in some cases it will be impossible to provide accurate advice where somebody wishes to make the maximum possible investment into pension schemes if their adjusted income is likely to fall into the £260,000 to £360,000 bracket.

Read more analysis in our Spring Budget hub.