ACCA Taxation (F6) Practice Exam

What is the effect of the tapered annual allowance for pension contributions?

1. The annual allowance is fixed at £40k regardless of income

2. The annual allowance is reduced by £1 for every £2 above £240k

3. The allowance is increased for higher earners

4. The allowance remains the same for all earners

The correct answer is: The annual allowance is reduced by £1 for every £2 above £240k

The tapered annual allowance for pension contributions affects individuals with income levels above a certain threshold. Specifically, it is designed so that for every £2 of income above £240,000, the annual allowance is reduced by £1. This gradual reduction continues until individuals reach an income level of £312,000, at which point the annual allowance can be reduced to a minimum of £4,000. This mechanism aims to limit the tax relief on pension contributions for higher earners, encouraging a more equitable system of tax relief based on the capacity to contribute. Hence, the tapering effect is specifically designed to enact a progressive tax treatment for pension contributions, making the correct choice one that accurately captures this nuance of how the annual allowance works. The incorrect options misunderstand or misstate the nature of the annual allowance and its relationship with income levels. A fixed annual allowance overlooks the progressive adjustment based on income, and there's no increase in the allowance for higher earners under this scheme. It's also not applicable uniformly across all income levels, which discounts the core principle of tapering entirely.