Tapered annual allowance

Since 6 April 2020, it will only affect people who meet both of the following income requirements:

• your ‘threshold income’ is above £200,000, and
• your ‘adjusted income’ is above £240,000.

Working out your threshold and adjusted income can be complicated. We explain how to do this on this page and give you examples below, but it might be helpful to get regulated financial or tax advice.  

Anyone who meets the income requirements above will see their annual allowance gradually reduce by £1 for every £2 of ‘adjusted income’ above £240,000.

For example, if your adjusted income was £280,000 your annual allowance would be reduced to £20,000.

This ‘tapering’ stops at £312,000, so everyone will retain an allowance of at least £4,000. 

If you’re affected by the taper and the contributions to your pensions exceed your reduced annual allowance, first check if you can use carry forward to reduce or remove any excess.

It is possible that your income could drop below the threshold income, which could restore you to the normal annual allowance for that tax year.

If there’s still an excess amount after carrying forward, you will face a tax charge on this amount. The amount will be added to your income and will be subject to Income Tax at your highest marginal rate.

The charge is normally declared and paid through the Income Tax self-assessment process, although it could be deducted directly from your pension savings if certain conditions are met. This is known as ‘Scheme Pays’. You’ll have to make a formal request to your pension scheme provider if you want to apply for this.

Are you looking to pay more into your pension by using up unused allowance from previous years (known as carry forward)? Then be aware that the income definitions were lower between 6 April 2016 and 5 April 2020.

That means the unused allowance you might have available to carry forward could be different for previous years, where the maximum allowance you could retain was £10,000 and the income requirements were:

• your ‘threshold income’ was above £110,000
• your ‘adjusted income’ was above £150,000.

The amount you can carry forward from these years is the difference between how much has been contributed to your pensions and your annual allowance available in each tax year. 

If you’ve taken taxable money out of your pension pot using pension freedoms (more than the tax-free part), a lower money purchase annual allowance (MPAA) might apply to you.

If you also hold a defined benefit pension (which includes ‘final salary’ and ‘career average’ pension schemes), you can benefit from the ‘alternative annual allowance’. This is £36,000 for the 2022/23 tax year. Contact your defined benefit pension provider for details.

Elizabeth’s salary is £215,000 and she receives a bonus of £10,000.

She also receives £3,000 in interest from her savings and £7,000 in taxable income (in the form of dividends, above the dividend allowance) from some company shares she owns.

Elizabeth contributes £20,000 into her group personal pension and her employer matches her contribution.

• Salary of £215,000
• Bonus of £10,000
• Interest and taxable dividends of £10,000
• Less her pension contribution of £20,000.

• Salary of £215,000
  
• Bonus of £10,000
• Interest and dividends of £10,000
• Plus her employer’s pension contribution of £20,000.

Elizabeth will be affected by the tapered annual allowance because her threshold income is above £200,000 and her adjusted income is £15,000 over £240,000.

Her annual allowance of £40,000 will be reduced by £7,500 (£15,000 divided by 2) and therefore will be £32,500 for the 2022/23 tax year.

As the total pension contributions (£40,000) are above her reduced annual allowance, there will be a tax charge to pay.

If Elizabeth had unused allowance from a previous year, and say for example that was £15,000, it would be possible for Elizabeth to make an increased personal contribution to her pension. This would in turn lower her threshold income, meaning she no longer has to pay a tax charge. 

• Salary of £215,000
• Bonus of £10,000
• Interest and dividends of £10,000
• Less her personal pension contribution of £35,000.

Elizabeth’s threshold income is now equal to £200,000 and therefore the tapered annual allowance wouldn’t apply. As a result, she still has the full £40,000 annual allowance available to use and when the £15,000 of unused allowance from a previous tax year is added, means the contributions of £55,000 can be made with full tax relief applying and without a tax charge being made.

If you think you might be getting close to your annual allowance, that it could be reduced, or you might have exceeded it, consider getting advice from a regulated financial adviser.

They can help you understand how much your annual allowance is, including any unused amounts, whether you have exceeded your annual allowance, if there may be options to reduce any potential charge, and look at your options for paying any tax charge that may be due.