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The tapered annual allowance was introduced back in the 2016/17 tax year and was designed to reduce the annual allowance for individuals with adjusted incomes over £150,000.
It works by reducing the annual allowance by £1 for every £2 of income above £150,000, with a maximum reduction of £30,000 for individuals with income of £210,000 or more. So, where an individual’s income is £210,000 or over, their annual allowance of £40,000 will be reduced down to £10,000 for that tax year.
There are two income limits used to measure whether the tapered annual allowance applies to an individual or not. The first is the threshold income limit which is set at £110,000. If the individual’s income is above this amount then they will have their adjusted income tested; where this exceeds £150,000 the tapered annual allowance will apply.
It’s important to understand which types of income are considered when looking at the threshold income and adjusted
So examples of taxable income could include:
- Earnings from employment
- Earnings from self-employment/partnerships
- Pensions income
- Interest on most savings
- Dividend income (e.g. from shares)
- Rental income
- Trust income (e.g. where the member is a beneficiary).
However, there are important differences as well as shown in the diagrams below.
Threshold Income Test
Adjusted Income test
Example – Laura’s threshold income test
- Has taxable income from employment of £80,000
- Is a member of her employer’s Group Personal Pension (GPP) scheme
- Contributions are paid using a salary sacrifice arrangement (set up after 9 July 2016).
- Laura sacrifices £10,000 into her GPP (pre-sacrificed salary is £90,000)
- Her employer makes an additional contribution of £5,000
- She receives her late father’s pension plan (who passed away at age 81) as a lump sum death benefit which she paid tax on at her highest marginal rate.
Therefore, Laura’s threshold income will be £90,000. This is calculated as:
- £80,000 (Gross income from all sources) + £10,000 (any pre-sacrificed salary) = £90,000
- Laura’s threshold income is below £110,000
- Therefore no adjusted income calculation is required
- The taxable death benefit can be ignored or deducted if included in her taxable income.
If Laura’s threshold income has been £110,000 or over, then she would have been subject to the adjusted net income test and her employer’s pension contribution would have been factored into the calculation.
Example – Trevor’s adjusted income test
- Has taxable income from employment of £140,000
- Is a member of his employer’s occupational money purchase scheme
- Contributions are paid using the net pay arrangement.
- He contributes £20,000 to his pension scheme
- His employer matches his contribution of £20,000.
Therefore, Trevor’s adjusted income will be £180,000.
£140,000 (Gross income from all sources) + £20,000 + £20,000 (employers’ + employees’ pension contributions) = £180,000. Trevor’s annual allowance will be reduced by £15,000.
- (£180,000 - £150,000)/£2 = £15,000.
Therefore Trevor will have an annual allowance of £25,000. This is calculated by:
- £40,000 - £15,000 = £25,000.
What happens if the Money Purchase Annual Allowance (MPAA) also applies?
If the individual is subject to both the tapered annual allowance and the MPAA the situation can be determined as follows:
- Determine how much applies to the MPAA and how much to the alternative annual allowance (this latter is applicable for any pre-trigger event contributions made within the tax year and any accrual within a Defined Benefit pension scheme). You will need to deduct the MPAA from the available tapered annual allowance, and whatever remains is the available alternative annual allowance. If nothing remains then the alternative annual allowance is nil.
So for example, if an individual’s tapered annual allowance is £20,000, deduct the MPAA of £4,000 from £20,000, leaving £16,000 available as the alternative annual allowance.
It is possible, in some cases, for individuals to make a personal pension contribution to reduce their income below the threshold limit, thereby removing the need for the second adjusted income test. This may be very useful where employer contributions are made which can be ignored under the threshold income criteria, but which would be factored into the adjusted income test.
Knowing how the tapered annual allowance works, in terms of the types of income to include and what deductions if any can be made, will be important in determining whether or not any tapering will apply and at what level.