The annual pension allowance reduces incrementally for individuals with high earnings or other large sources of income. We explain how this taper system works.
HMRC makes two assessments of income for annual pension allowance. You will only face restrictions on your pension allowance if you exceed both of these assessments.
In practice, you are first assessed on what is known as your ‘threshold income’. If this exceeds £200,000, then you will also be assessed on what is described as your ‘adjusted income’. Put simply, threshold income is net income excluding pension contributions, while adjusted income is net income including all pension contributions (including those from your employer).
According to HMRC rules, should your adjusted income be £260,000 or less, then you will face no restrictions on your pension contributions. If your adjusted income exceeds £260,000, then you will have your annual pension allowance reduced, or tapered, by £1 for every £2 your adjusted income exceeds £260,000. On this basis, someone with adjusted income of £270,000 would have their pension allowance reduced by £5,000.
The rules on adjusted income mean you can invest up to £60,000 (the maximum annual pension allowance) tax-free in a pension if you have an adjusted income of up to £260,000. However, this will dwindle to just £10,000 for an annual adjusted income of £360,000 or more (see chart). All earners above this level will have a pension allowance of at least £10,000.
Before we come to threshold income and adjusted income, we first need to understand ‘net income’. This includes items such as:
Added together, these comprise your ‘total income’. You then calculate your net income by deducting any relevant tax reliefs. These could include payments made to your pension scheme that had tax relief but were paid before the relief was given (perhaps because someone else paid into your pension).
To work out your threshold income you must make the following amendments to net income:
If your annual threshold income is no more than £200,000, then your pension allowance will not be subject to tapering. However, if your threshold income exceeds £200,000, then you will have to calculate your adjusted income.
To assess adjusted income, go back to the net income figure and then make the following amendments:
Anita’s salary is £215,000. She receives a bonus of £40,000 and makes £10,000 in rental income from a property. Anita contributes £30,000 into her group personal pension and her employer contributes £30,000.
On this basis, Anita’s threshold income is £235,000. This comprises a salary of £215,000, plus a bonus of £40,000, plus rental income of £10,000, minus her pension contribution of £30,000.
Meanwhile, Anita’s adjusted income is £295,000. This comprises a salary of £215,000, plus a bonus of £40,000, plus rental income of £10,000, plus her employer’s pension contribution of £30,000.
Anita will be impacted by the tapered annual pension allowance because her threshold income is greater than £200,000 and her adjusted income is greater than £260,000, by £35,000. So, her annual allowance of £60,000 will now be reduced by £17,500 (£35,000 divided by 2) and therefore will amount to £42,500 for the 2023/24 tax year. Anita will now be liable for a tax charge as her total pension contributions of £60,000 are now greater than her reduced annual allowance.
Anita may be able to offset this tax charge if she has unused pension allowances from earlier tax years and she meets certain conditions. The arrangement here is known as carry forward.
If you’re close to breaching your annual allowance, or you may have exceeded it, or you might be able to reduce it, then you could consider taking advice. At Schroders Personal Wealth one of our key principles is to have regular reviews with an adviser. Financial advisers can help you to make the most of tax opportunities, in line with your unique circumstances.
This article is for information purposes only. It is not intended as investment advice.
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The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits which isn’t guaranteed and can go down as well as up. The benefits of your plan could fall below the amount(s) paid in.
The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor might not get back their initial investment.
Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.
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