Tapered annual allowance
These FAQs are for financial advisers only. They mustn't be distributed to, or relied on by, customers. They are based on our understanding of legislation at the date of publication.Mon Oct 21 10:44:00 GST 2019 Back to results
Since 6 April 2016, there has been a reduced annual allowance for those with an ‘adjusted income’ of over £150,000. The reduction works by operating a £1 reduction in the annual allowance for every £2 of adjusted income above £150,000, subject to a minimum annual allowance of £10,000. So, those with an adjusted income of £210,000 or more in a tax year will have a £10,000 annual allowance for that tax year.
However, if an individual’s ‘threshold income’ is no more than £110,000 they will not be subject to the 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, 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 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 https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm053300(Opens new window)) 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:
- Calculate total income subject to income tax. (This should exclude any employee contributions to an occupational pension scheme that are deducted from pay).
- 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!).
- Add in any employer pension contributions to any type of pension scheme e.g. occupational pension scheme, personal pension.
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 as a result of a salary sacrifice or flexible remuneration agreement 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:
- Calculate total income subject to income tax. (This should exclude any employee contributions to an occupational pension scheme that are deducted from pay.)
- Deduct any gross personal contributions paid to a personal pension or retirement annuity (where tax relief claimed by relief at source).
- Ignore any employer pension contributions to an occupational pension scheme or to a personal pension.
There is a £1 reduction in the annual allowance for every £2 of adjusted income above £150,000 (assuming threshold income is above £110,000), subject to a minimum annual allowance of £10,000.
Here’s a table showing what the reduction in annual allowance is for different adjusted incomes (assume a full annual allowance of £40,000):
|Adjusted income||Reduction in annual allowance||Annual allowance|
If the amount of the reduction is not a multiple of £1, then the tapered annual allowance is reduced to the nearest multiple of £1. In practice, most people’s salaries will not be round £000’s. For example, if someone’s salary is £187,595, then the reduction in the annual allowance would be £18,797.50. The tapered annual allowance would then be £21,202.50 but this would be rounded down to £21,202.
How do I work out how much pension savings can be made without a tax charge?(Expand content) (Minimise content)
Basically, adjusted income includes pension contributions and threshold income doesn’t so when trying to working out how much pension contributions can be made it's worth calculating threshold income first. If income is at or below the threshold limit of £110,000 then the tapering rules will not apply. If income is above the threshold limit then the scope for making pension savings should then be fairly clear.
For example, if an employee’s threshold income is £140,000 then a £10,000 employer pension contribution would result in adjusted income of £150,000 and there would no annual allowance charge. A £40,000 employer pension contribution would result in adjusted income of £180,000 so the tapered annual allowance would be £25,000 meaning £15,000 of the pension contribution may be subject to an annual allowance charge, unless there is any unused carry forward allowance from previous 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 as a result of the taper provisions, then the carry forward available will be based on the tapered annual allowance amount. For example, if 2018/19 is a carry forward year and £7,000 of contributions were made when a £10,000 tapered annual allowance applied, then there will be £3,000 of unused annual allowance to carry forward.
What if pension savings in a tax year exceed the tapered annual allowance?(Expand content) (Minimise content)
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. Further information can be found under our Annual Allowance FAQs.
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.
Can scheme pays be used where a tapered annual allowance applies?(Expand content) (Minimise content)
Scheme pays is a process that allows an individual to pay an annual allowance charge from their pension arrangement. This means the scheme pays 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 of 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 of their benefits from the scheme.
Where the tapered annual allowance applies, the maximum amount of charge a scheme can be required to pay is still based on the amount by which the individual’s savings in that particular scheme exceed the ‘standard’ annual allowance. This means that even if all of the conditions listed above have been met, an individual who has a reduced annual allowance can’t require their 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. Therefore, his annual allowance is reduced by the taper to the minimum of £10,000. Philip’s employer pays contributions totalling £45,000 in the tax year to his personal pension. This amount exceeds his annual allowance by £35,000. If Philip has no unused annual allowance to carry forward, there will be an annual allowance charge due on the excess, £35,000 x 45% = £15,750 (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 £13,500 balance from his other resources, unless his pension scheme agrees to pay this part of the tax charge on a voluntary basis.
Further information about scheme pays can be found in our ‘Annual allowance – scheme pays’ FAQs.
What if the money purchase annual allowance applies as well as tapering?(Expand content) (Minimise content)
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 £6,000 (that is, £10,000 less the MPAA, which is currently £4,000). They would also have the MPAA limit and 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 our separate Money Purchase Annual Allowance FAQs.
Pensions Technical Services