What is the pension tapered annual allowance?

If you’re lucky enough to earn more than 99.5 per cent of the population, you might have encountered the tapered annual allowance.

The taper, as it’s known for short, restricts how much high earners - defined in this instance as those pocketing more than £260,000 a year - can pay into a pension every year and get tax relief.  

While the taper only impacts a fraction of the population, it poses a major headache for those restricted by it. 

Not only does the taper squeeze what you can save for your retirement, but the rules are complex; staying within the required limits isn’t always straightforward.

If you’re not careful, you could end up with a charge that completely wipes out the generous tax perks of paying into a pension. 

However, on a more positive note, the taper has recently been reformed, and the changes are favourable. Let's find out more. 

What is the tapered annual allowance?

Before we get to the taper, let’s start with the standard annual allowance. 

The annual allowance is the maximum amount that you can pay into a pension every year and receive tax relief.

For most people, this is the lower of £60,000 or 100 per cent of earnings. 

For instance, if you earn £70,000 a year, your allowance will be £60,000. But if your annual wage is £45,000, your allowance will be £45,000.  

However, the standard annual allowance rules do not apply to everyone.

If you’re a particularly high earner, your allowance could reduce to as little as £10,000 due to the tapered annual allowance, which was introduced in April 2016 by then-chancellor George Osborne.

At the time it affected individuals with threshold income exceeding £110,000 and adjusted income topping £150,000, but these levels have since risen to £200,000 and £260,000, respectively (more on that further down). 

Hang on.. what do adjusted and threshold income mean?

This is where things start to get a bit complicated.

Threshold income is your net adjusted income for the year - in other words, everything you earn including salary, bonus, pension income, bank interest, trading profits, rental income - minus any pension contributions.

Adjusted income, meanwhile, is your threshold income plus any pension or company pension contributions (this is to take account of workers who exchange some of their wage for company pension payments).

If you're ever in the process of trying to calculate your tapered annual allowance, it’s worth enlisting the expertise of a financial adviser to make sure you arrive at the right figure. 

How has the taper changed over the years?

In April 2020, in recognition of some NHS doctors reducing working hours to avoid hitting the taper, the limits for threshold and adjusted income subsequently rose to £200,000 and £240,000, respectively. Other changes, however, were less favourable. The government also reduced the minimum allowance to £4,000. 

The rules changed again from April 2023, after Jeremy Hunt announced reforms to various pension allowances within his Spring Budget.  

The chancellor restored the minimum taper to £10,000, while the threshold for adjusted income leapt £20,000 to £260,000. 

How exactly does the taper work?

The amount you can pay into pension tapers if you breach both the threshold income and adjusted income limits. 

Once your threshold income exceeds £200,000, your allowance reduces by £1 for every £2 your adjusted income rises above £260,000. The minimum this can taper to is £10,000. 

So, if your adjusted income for the current tax year is £290,000 - thus exceeding the minimum limit by £30,000 - your annual allowance would drop £15,000 (£30,000/2) to £45,000.

What might the recent changes mean for me?

The combination of the minimum taper rising to £10,000, the standard annual allowance increasing to £60,000, and the adjusted income limit rising to £260,000 has afforded high earners significantly more scope to plough money into pensions and receive tax relief.

In the 2022/23 tax year, tapering halted once earnings hit £312,000, but this now occurs at £360,000. 

See the chart below. 

Here's an example of how the new rules might benefit you: 

Nicola has adjusted income of £320,000 a year.  

In the 2022/23 tax year, this would have reduced her annual allowance to the minimum of £4,000.  

However, due to the budget changes, her allowance for the 2023/23 tax year will only fall to £30,000 - meaning she can pay 7.5 times more into a pension and get tax relief at 45 per cent. 

Over the next 10 years, presuming current taper rules remain unchanged, Nicola can save an extra £260,000 into her pensions. 

What’s more, with the lifetime allowance now scrapped, she can grow her pot without the worry of being hit with a hefty tax charge at retirement. 

What happens if I accidentally breach the limit?

Any pension contributions that breach your annual allowance are classed as ‘excess contributions’. 

If this were to happen, any overpayment is added to your taxable income for the year in question and taxed at your marginal rate, clawing back the upfront tax relief you received when making the contribution. 

Alternatively, you can ask your pension scheme to pay the charge, though this isn’t always possible. 

In short, any payments above annual allowance would negate the tax benefits of paying into a pension over, say, an individual savings account (ISA).

Plus your money is tied up until at least age 55, and you might be taxed on what you draw out in the future. 

Can I exceed the taper and still get tax relief?

In some cases, yes you can. 

This is due to something called carry forward, which allows you to bring forward any unused pension allowances from the previous three tax years. 

The total of these allowances can be added to your current year’s allowance, meaning you can pay more into a pension and get tax relief at the top rate of income tax you pay.

But you should tread carefully here. The calculation isn’t always simple - previous years' allowances might also be affected by the taper. And as outlined above, the consequences for getting it wrong and overpaying can wipe out the upfront tax benefits of paying into a pension. 

Where can I find help?

The taper is a particularly complex area of retirement planning. But get it right the rewards can be significant, notably 45 per cent tax relief on your pension contributions. 

And the budget changes have presented a great opportunity for anyone whose pension funding was previously restricted by the taper. 

If you’re a high earner who’s seeking to make the most of your retirement savings, it's wise to take professional advice from a regulated financial adviser, one who specialises in retirement planning. 

An expert adviser will calculate your tapered annual allowance for the current tax year and work out if you can carry forward any unused allowances.

They can also advise on any further opportunities to grow and protect your wealth in a tax-efficient way. 

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