The tapered annual allowance further limits the amount of tax relief high earners can claim on their pension savings by reducing their annual allowance to as low as £10,000. This reduced allowance could change from tax year to tax year depending on your income.
What’s in this guide
- Who does the tapered annual allowance affect?
- How does the tapered annual allowance work?
- What happens if I exceed my reduced annual allowance?
- What if I’m already subject to the money purchase annual allowance?
- An example of how the tapered annual allowance works in practice
- A financial adviser could help
- Useful tools
Who does the tapered annual allowance affect?
The tapered annual allowance only affects you if:
- your ‘threshold income’ is above £200,000, and
- your ‘adjusted income’ is above £260,000 (this threshold increased to £260,000 from 6 April 2023).
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.
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How does the tapered annual allowance work?
Anyone who meets the income requirements above will see their annual allowance gradually reduce by £1 for every £2 of ‘adjusted income’ above £260,000.
For example, if your adjusted income was £280,000 your annual allowance would be reduced to £50,000.
This ‘tapering’ stops at £360,000, so everyone will retain an allowance of at least £10,000.
What happens if I exceed my reduced annual allowance?
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.
What if I’m already subject to the money purchase annual allowance?
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.
Find out more about these restrictions, see our guide The annual allowance
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 £50,000 for the 2023/24 tax year. Contact your defined benefit pension provider for details.
An example of how the tapered annual allowance works in practice
Elizabeth’s salary is £245,000 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 £30,000 into her group personal pension and her employer matches her contribution.
Elizabeth’s threshold income = £235,000
- Salary of £245,000
- Bonus of £10,000
- Interest and taxable dividends of £10,000
- Less her pension contribution of £30,000.
Elizabeth’s adjusted income = £295,000
- Salary of £245,000
- Bonus of £10,000
- Interest and dividends of £10,000
- Plus her employer’s pension contribution of £30,000.
Elizabeth will be affected by the tapered annual allowance because her threshold income is above £200,000 and her adjusted income is £35,000 over £260,000.
Her annual allowance of £60,000 will be reduced by £17,500 (£35,000 divided by 2) and therefore will be £42,500 for the 2023/24 tax year.
As the total pension contributions (£60,000) are above her reduced annual allowance of £42,500, she will need to pay a tax charge.
If Elizabeth had unused allowance from a previous year, and say for example that was £35,000, 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.
If Elizabeth decided to contribute an extra £35,000 and she had unused allowance from a previous tax year
Elizabeth’s threshold income = £200,000
- Salary of £245,000
- Bonus of £10,000
- Interest and dividends of £10,000
- Less her personal pension contribution of £65,000.
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 £60,000 annual allowance available to use and when the £35,000 of unused allowance from a previous tax year is added, means the contributions of £95,000 can be made with full tax relief applying and without a tax charge being made.
A financial adviser could help
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.
