Tapered Annual Allowance

Each of us has a limit as to the amount of pension savings (by way of contributions or accrual) we can make per tax year before it is subject to a tax charge. Currently, for the tax year 2023/24, that amount is £60,000 a year. This amount is known as the pension annual allowance.

Higher earners – those with a “threshold income” of over £200,000 AND an “adjusted income” of over £260,000 face a reduced pension annual allowance. “Threshold” and “adjusted” income will be explained later in this guide.

Currently the pensions annual allowance limit is reduced by £1 for every £2 of adjusted income over and above £260,000. At the extreme, the pension savings limit is reduced to £10,000 as a minimum.

The tapered annual allowance was introduced to make pension savings fair and to reduce the amount of tax relief given to higher earners.

It is always worth seeking help from a financial advisor if your income exceeds the threshold amount of £200,000 just to check that making pension contributions are still the most tax efficient way of saving for retirement. It may be that any money you intended to save into your pension might be better utilised using other financial planning strategies.

 

Threshold Income

Calculating an individual’s threshold income is the first step in a two-step process in assessing whether they are subject to a tapered annual allowance. If an individual’s threshold income does not exceed £200,000 then there is no need to calculate the adjusted income as they will not be subject to a tapered annual allowance.

To calculate threshold income, firstly total the amount of an individual’s taxable income from all sources including;

• Salary, commission, bonus,
• Pensions (including the State Pension),
• Taxable redundancy payments,
• Taxable benefits payments,
• Trading profits,
• Rental income from property (residential and commercial),
• Dividend income,
• Bond gains (onshore and offshore),
• Purchased Life Annuity payments,
• Interest on savings accounts in banks, building societies, NS&I and Credit Unions,
• Interest on unit trusts and open-ended investment companies,
• Profits on government or company bonds which are issued at a discount or repayable at a premium and income from certain alternative finance arrangements etc.

If the individual has received a taxable lump sum death benefit from a pension scheme in the tax year (due to a relative passing away), then that lump sum can be taken off the above total income to give the net threshold income;

In summary – to calculate threshold income;

• Step 1 – calculate the total of taxable income (from the list above)
• Step 2 – DEDUCT allowable reliefs. These are the allowable reliefs under the income tax act of 2007. This includes such things as early trade losses relief, share loss relief but this does NOT include the personal allowance as a deduction.
• Step 3 – DEDUCT the gross amount of pension contributions into a relief at source pension arrangement
• Step 4 – ADD Employment salary given up for pension contributions (i.e salary sacrifice)

In the rare event that a taxable lump sum pension benefit has been paid from someone aged over 75, then that can be deducted also.

If the above does not exceed £200,000 (for tax year 2023/24) then the individual will not be subject to the tapered allowance and there is no need to go on to calculate “adjusted income” – explained below.

 

Adjusted Income

If the individual’s threshold income exceeds £200,000 then adjusted income will need to be calculated to confirm the applicable tapered allowance.

To calculate adjusted income;

• Step 1 – Calculate total taxable income for the relevant tax year
• Step 2 – DEDUCT allowable reliefs. These are the allowable reliefs under the income tax act of 2007. This includes such things as early trade losses relief, share loss relief but this does NOT include the personal allowance as a deduction.
• Step 3 – ADD Pension contributions paid gross. This includes Retirement Annuity Contracts, personal contributions under a “net pay” arrangement, contributions to overseas pensions gaining UK tax relief, Defined Benefit pension contributions.
• Step 3 – ADD the value of any Employer pension contributions. For Money Purchase or Defined Contribution pensions, this is simply the total amount of contributions made by the employer. For Defined Benefit (final salary pensions) this is the pension input total for the tax year LESS the member contributions in Step 3 above.
• Step 4 – DEDUCT any taxable lump sum pension death benefits received. This would usually apply if an individual had received a lump sum from a deceased person’s pension fund if they died over the age of 75. Any taxable income must be added in Step 1 above.

 

Once you have the total “adjusted income” then the £40,000 pension annual allowance is reduced by £1 for every £2 that the adjusted income is over £260,000. The maximum reduction is £50,000 leaving a minimum annual pension allowance of £10,000. The maximum reductions is maxed out at an adjusted income of £360,000.

Both Defined Contribution (money purchase, personal pensions) and Defined Benefit (final salary pensions) are subject to the tapered annual allowance.

 

Annual Allowance Charge

This can be quite complex to calculate, but to put in simple terms the tax charge reclaims the tax relief given on pension contributions over and above the applicable annual allowance. As the tapered annual allowance is only applicable to additional rate taxpayers, the rate at which the tax charge is applied will generally be 45% on the amount that exceeds the annual allowance. It is the responsibility of an individual to declare any pension contributions on self-assessment tax returns. The pension annual allowance excess is included on the additional form SA101 on the final page.

Usually if the annual allowance tax charge exceeds £2,000, an individual can ask the pension scheme to pay the charge – i.e. the charge is taken from the individual’s pension fund rather than paid directly. The deadline for informing the pension scheme administrator of the charge and asking them to pay is 31^st July in the year following the tax year end in which the notice relates. For example, the deadline would be 31^st July 2025 in respect of a charge in the 2023/24 tax year.