If your income in the current tax year is going to be more than £200,000, then you might have to take pension tapering into account to calculate your pension contribution allowance.
What is the tapered annual allowance?
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The tapered annual allowance refers to the progressive reduction of your annual allowance that applies to higher income earners whose income exceeds a certain threshold. Essentially, it’s a method used to adjust the pensions tax benefits available to higher earners, to maintain fairness and balance within the pension system.
The standard pension annual allowance lets you, your employer (or any other third party) contribute up to £60,000 to your pension(s) each year before you start paying tax on it. However, if you have more than £200,000 taxable income, this allowance may begin to reduce. This reduction process is known as tapering.
How does the tapered annual allowance work?
It works in two steps – each is linked to a different way of measuring your income.
Step 1 – calculate your threshold income
Tapered annual allowance only applies if your threshold income is £200,000 or more.
It includes:
- Taxable income from employment, including bonuses etc.
- Taxable income from self-employment.
- Salary and bonus sacrifice pension contributions, unless the sacrifice agreements were made before 6 July 2015.
- Income from savings and investments, including salary, rental income and dividends.
- You need to take off the value of any personal (employee) contributions paid into personal pensions (including workplace pensions called GPPs or Group SIPPs), including the tax relief claimed within the scheme. This is sometimes called the gross value of the contribution.
If that total is £200,000 or more, you then need to work out your adjusted income.
Step 2 – add your pensions contributions
To calculate your adjusted income, you will need to include the following:
- Your threshold income.
- Pension contributions from your employer, including those raised by salary/bonus sacrifice agreements.
- Any contributions where you've claimed separate tax relief from HMRC - if paid into a Section 226 policy, or payments from your own funds into an occupational scheme where you couldn't claim tax relief within the scheme. This does not include extra tax relief on personal pension contributions for higher or additional rate tax payers.
- A value in respect of benefits in Defined Benefits scheme. This is the total of your pension input (normally calculated for annual allowance purposes), less the cash value of contributions paid by your employer.
If that comes to £260,000 or more, your annual allowance starts to be tapered. You lose £1 of annual allowance for every £2 by which your adjusted income is more than £260,000. This goes on as your adjusted income increases, up to a ceiling of £360,000. At that point, your annual allowance is tapered to its minimum level of £10,000 a year.
Example:
If you have a salary of £240,000 and contribute £24,000 via salary sacrifice to your company pension via an agreement made before 6 July 2015, this reduces your taxable pay to £216,000. However, with your employer paying 15% of your pay into your pension (£36,000) and £10,000 in dividends from shares, your threshold income is above £200,000 and your adjusted income is £286,000. This is £26,000 above the £260,000 income, meaning that it reduces your annual allowance by £13,000. Thus, your tapered annual allowance for that tax year is £47,000.
Tax benefits depend on individual circumstances and are subject to change.
What happens if I exceed my tapered annual allowance?
If the benefits you build up in pension schemes exceed your tapered annual allowance, the first thing to do is see if you have any annual allowance to carry forward from previous years. You can “mop up” any annual allowance you haven’t used from the last three tax years. If your annual allowance was tapered in any of those years, the calculation for that year starts with the tapered annual allowance for that year.
If the excess isn’t “mopped up” by carry forward, the remaining excess is then subject to the annual allowance charge. This is the same as the tax you would have paid if that amount had been paid to you as income, on top of your actual income. This is often referred to as being charged at your highest marginal rate. This can be paid through your self-assessment tax return, or your pension provider may allow it to be paid from your pension. You will need to ask them, as different providers, have a different approach.
It's important to remember that the value of your pension can go down as well as up, and there's a possibility that you could get back less than you've paid in.
