Tapered annual allowance

Broadly, it includes all taxable income and all pension savings less certain reliefs. To expand on this, adjusted income can be calculated as follows:

Step 1: Calculate income on which the individual is charged tax for the tax year (taxable income), less certain reliefs which they are entitled during the tax year. This amount is known as ‘net income’. It’s important to note that this term doesn’t mean the same thing as income after income tax has been deducted.

Taxable income includes employed and self-employed earnings, benefits in kind, pension income, interest on savings, dividend income, rental income, and income received by an individual from a trust.

Reliefs deducted include share losses, excess tax relief on personal contributions to a net pay scheme (where contributions couldn’t be deducted from payroll by the employer perhaps because there was insufficient income from which to pay the contribution amount), tax relief given on a personal pension contribution following a claim made by an individual, certain gifts to charity. A full list of reliefs can be found in s.24 of the Income Taxes Act 2007.

Step 2: Add back in the amount of any excess tax relief on personal contributions to a net pay scheme and the amount of any tax relief given on a personal pension contribution following a claim. made by an individual.  (This includes tax relief on gross contributions paid to a retirement annuity contract.)

Step 3: Add in the amount of any employee pension contributions deducted from pay under the net pay method. (The net pay method being where employee contributions to an occupational pension scheme are deducted gross from gross pay i.e., before income tax is calculated). 

Step 4: Add in any relief claimed by non-domiciled individuals for personal contributions made to an overseas pension scheme.

Step 5: Add the value of any employer contributions being paid to any type of pension arrangement in a tax year. This also includes any employer contributions made as a result of a salary sacrifice arrangement. For a defined benefit scheme, this is the amount of accrual for the tax year (the pension input amount – see the Pensions Tax Manual for more information) less any employee ‘net pay’ contributions (as step 3). 

Step 6: Deduct the amount of certain lump sum death benefits paid to an individual in a tax year. These are any lump sum death benefits that are subject to tax based on the recipient’s marginal rate.

Looking solely at pension contributions, this means that for calculating adjusted income you would:

1. Calculate total income subject to income tax. (This should exclude any employee contributions to an occupational pension scheme that are deducted from pay).
2. Add in any employee contributions to an occupational pension scheme that are deducted from pay (yes – you are adding back in the same amount you have just deducted in the bullet point above!).
3. Add in any employer pension contributions to any type of pension scheme e.g., occupational pension scheme, personal pension.

Note: from 6 April 2024 any lump sums that are paid from 2023/24 onwards which exceed an individual's remaining lifetime allowance will be taxed as pension income at the individual's marginal rate of tax. Consequently, such taxable lump sums should be included in the calculation of adjusted income. 

In simple terms, it’s a person’s income but without adding back in any employer pension contributions. Here’s how threshold income is calculated: 
 
Step 1: As step 1 above for calculating adjusted income. 
 
Step 2: Deduct the amount of certain lump sum death benefits paid to an individual in a tax year (as step 6 above for calculating adjusted income). 
 
Step 3: Deduct the gross amount of any personal contribution paid using the relief at source method.  
 
(The relief at source method is where personal contributions are paid net of basic rate tax relief from a person’s net income (i.e., after income tax has been deducted) to a pension scheme and basic rate tax relief is added to the pension pot. Generally, personal pensions but also some retirement annuities operate using relief at source).  
 
Step 4: Add the amount of any employment income given up for pension provision because of a salary sacrifice or flexible remuneration arrangement made on or after 9 July 2015. This step is included to prevent anyone using salary sacrifice to manipulate their income so that the tapered annual allowance rules won’t apply. 
  
Looking solely at pension contributions, this means that for calculating threshold income you would:

1. Calculate total income subject to income tax. (This should exclude any employee contributions to an occupational pension scheme that are deducted from pay.)
2. Deduct any gross personal contributions paid to a personal pension or retirement annuity (where tax relief claimed by relief at source).
3. Ignore any employer pension contributions to an occupational pension scheme or to a personal pension. 

Note: from 6 April 2024 any lump sums that are paid from 2023/24 onwards which exceed an individual's remaining lifetime allowance will be taxed as pension income at the individual's marginal rate of tax. Consequently, such taxable lump sums should be included in the calculation of threshold income. 

There is a £1 reduction in the annual allowance for every £2 of adjusted income above £260,000 (assuming threshold income is above £200,000), subject to a minimum annual allowance of £10,000. 
 
Here’s a table showing what the reduction in annual allowance is for different adjusted income (assume a full annual allowance of £60,000):

If the amount of the reduction is not a multiple of £1 the tapered annual allowance is reduced to the nearest multiple of £1.  In practice, most people’s incomes will not be round £000s. For example, if someone's adjusted income is £277,595 the reduction in annual allowance would be £8797.50. The Tapered Annual Allowance would then be £51,202.50 but this would be rounded down to £51,202

Basically, adjusted income includes pension contributions while threshold income doesn’t so when working out how much pension contributions can be paid it's worth calculating threshold income first. If income is at or below the threshold limit (£200,000 for tax year 2020/21 onwards) then the tapering rules will not apply. If income is above the threshold limit, then the scope for making pension contributions should be clear.  
 
For example, if an employee's threshold income in tax year 2023/24 is £250,000 then a £10,000 employer pension contribution would result in adjusted income of £260,000 so the employee's annual allowance wouldn't be reduced under the taper rules, and no annual allowance charge would arise. However, a £60,000 employer contribution would result in adjusted income of £310,000 so the tapered annual allowance would be £35,000. This means that £25,000 of the £60,000 pension contribution would be subject to an annual allowance charge, unless there is any unused carry forward allowance from the previous three tax years.

It is possible to use carry forward where the tapered annual allowance applies in a tax year. So, any unused annual allowance from the three tax years prior to the tax year in question can still be carried forward as normal.  
 
Where the annual allowance has been reduced in a carry forward year because of the taper provisions, then the carry forward available will be based on the tapered annual allowance amount. For example. if 2020/21 is a carry forward year and £2,000 of contributions were made when a £4,000 tapered annual allowance applied, then there will be £2,000 of unused annual allowance to carry forward. More information can be found in the Carry forward section of this guide.

Where a tapered annual allowance applies, an annual allowance charge would be payable where the individual’s total pension savings – contributions or benefit accrual – are over the tapered annual allowance plus any unused annual allowance that is available to carry forward. More information can be found in the Annual Allowance section of this guide. 
 
It’s worth remembering that any annual allowance charge arising is payable by the individual (or by scheme pays, where applicable) even if the excess savings have arisen through the payment of employer contributions. 

Scheme pays is a process that allows an individual to pay an annual allowance charge from their pension arrangement. This means the registered pension scheme will pay the annual allowance charge direct to HMRC on the individual’s behalf, and the tax charge is taken out of their pension savings.

All registered pension schemes have to offer scheme pays, however, a member must meet all the following statutory conditions to have the right to use scheme pays:

• the individual’s pension savings – either contributions or benefit accrual – in the pension scheme have exceeded the standard annual allowance for the relevant tax year (the money purchase annual allowance and tapered annual allowance are ignored for these purposes).
• the individual’s total annual allowance charge for the relevant tax year – across all savings in registered pension schemes – has exceeded £2,000.
• the notice for scheme pays is made within the timescale permitted.
• the individual hasn’t already taken all their benefits from the scheme.

Where the tapered annual allowance applies, the maximum amount of charge a pension scheme can be required to pay is still based on the amount by which the individual’s pension savings in that scheme exceed the ‘standard’ annual allowance. This means that even if all the conditions listed above are met, an individual who has a reduced annual allowance cannot require their pension scheme to pay the full amount of their annual allowance charge. A pension scheme may agree to pay the balance on a voluntary basis but is not obliged to do so. 
 
Example – Philip has adjusted income of £450,000 in tax year 2023/24. Therefore, his annual allowance is reduced by the taper to the minimum of £10,000. Philip’s employer pays contributions totalling £65,000 in the tax year to his personal pension. This amount exceeds his annual allowance by £55,000. If Philip has no unused annual allowance to carry forward, there will be an annual allowance charge due on the excess, £55,000 x 45% = £24,750 (assuming the rest of UK income tax rates apply). However, Philip can only require his pension scheme to pay the tax charge that arises on the £5,000 excess above the ‘standard’ annual allowance (£5,000 x 45% = £2,250). This means that Philip may have to pay the £22,500 balance from his other resources, unless his pension scheme agrees to pay this part of the tax charge on a voluntary basis. 
 
More information about scheme pays can be found in our Scheme pays guide.

Where someone is subject to the MPAA provisions because they have ‘flexibly accessed’ pension benefits since 6 April 2015, and they are also subject to the taper provisions, the taper is applied to their alternative annual allowance amount. The alternative annual allowance amount is the standard annual allowance less the MPAA.

This means that where someone is subject to the maximum taper provisions, their alternative annual allowance for defined benefit pension savings will be £0, since the minimum annual allowance of £10,000 less the MPAA, which is currently £10,000, leaves nothing. They would still be able to use carry forward for any unused defined benefit pension savings from the previous three years. You can find out more about the MPAA in the Money purchase annual allowance section of this guide.