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Tapering of annual allowance for high incomes - adjusted and threshold incomes

Published  06 April 2023
   12 min read

This reduces the annual allowance for people with an adjusted income over £260,000 and a threshold income over £200,000.

Key facts

  • The annual allowance is reduced for individuals who have ‘adjusted income’ over £260,000 a year.
  • The annual allowance reduces by £1 for every £2 over £260,000
  • The maximum reduction is £50,000, this happens when 'adjusted income' is over £360,000
  • The reduction does not apply to individuals who have ‘threshold income’ of no more than £200,000.

Since 6 April 2023, people with a taxable income over £260,000 will have their annual allowance for that tax year restricted. This means that for every £2 of income they have over £260,000, their annual allowance is reduced by £1. Their reduced annual allowance is rounded down to the nearest whole pound.

The maximum reduction is £50,000. So anyone with an income of £360,000 or more has an annual allowance of £10,000. People with high income caught by the restriction may have to reduce the contributions paid by them and/or their employer or an annual allowance charge will apply.

However, the tapered reduction doesn't apply to anyone with 'threshold income' of £200,000 or less.

The earnings thresholds and minimum tapered annual allowance have changed over time. It is essential that when checking the taper that applies in a specific year the correct basis is used.

6 April 2016 and 5 April 2020
Between these dates individuals who had taxable income over £150,000 had their annual allowance restricted. It was reduced, so that for every £2 of income they had over £150,000, their annual allowance was reduced by £1. The maximum reduction was £30,000, so anyone with income of £210,000 or more had an annual allowance of £10,000.

6 April 2020 and 5 April 2023
Between these dates individuals who had taxable income over £240,000 had their annual allowance restricted. It was reduced, so that for every £2 of income they had over £240,000, their annual allowance is reduced by £1. The maximum reduction was £36,000, so anyone with an income of £312,000 or more has an annual allowance of £4,000.

What is the difference between adjusted income and threshold income?

Definitions of adjusted income and threshold income are crucial to understanding whether or not someone's affected by the tapered reduction.

Both include all taxable income - so this isn't restricted to earnings. Investment income of all types and benefits in kind, such as medical insurance premiums paid by the employer, will also be included. 

The difference is pretty simple; adjusted income includes all pension contributions (including any employer contributions), while threshold income excludes pension contributions.

Unfortunately, HMRC's definitions of adjusted and threshold income tend to cause a bit of confusion because they start with something called 'net income'. A common sense meaning of this would be 'income after tax', but it's not.

Net income in this context is all taxable income, minus various deductions. The most important (or at least the most common) of these deductions are personal contributions paid to money purchase and defined benefit occupational pension schemes, under the net pay arrangement. This is where the sponsoring employer of the pension scheme deducts employee contributions before tax under PAYE.

The other deductions include things like trade losses, share loss relief and certain gifts to charities.  A full list of the deductions can be found at s.24 of the Income Tax Act 2007 (opens in a new window).

Understanding the two definitions becomes easier if we consider taxable income from a more practical viewpoint. For example, when someone says, 'I earn £x', they don't usually mean the amount after the deduction of net pay arrangement contributions. We can therefore assume that when someone has earnings of £160,000 and pays contributions of £20,000 under the net pay arrangement, they'll say their earnings are £160,000, not £140,000. The £160,000 includes the pension contributions.

So this is a good place to start when calculating adjusted income (which includes pension contributions). For threshold income, all personal pension contributions need to be deducted and you don't include employer contributions.

How do you calculate adjusted income and threshold income?

This image explains how you calculate threshold income and adjusted income.. This image is an infographic and has alternative text available if you are using a screen reader.

Calculating adjusted income and threshold income

This image explains how you calculate threshold income and adjusted income.

For threshold income include all earnings and investment income, deduct gross personal contributions whether under relief at source or net pay arrangement, add any employment income given up through a salary exchange agreement set up after 8 July 2015 and finally deduct any taxed lump sum death benefit received. For adjusted income include all earnings and investment income, add any employer contributions and finally deduct any taxed lump sum death benefits received. 

Case studies

Take a look at our case studies to understand how the tapered annual allowance works in practice.

 

 

Tapering of annual allowance - Simon This image shows the position for Simon. Simon has employed income of £240,000 and rental income of £24,000 this tax year. So, his total taxable earnings are £264,000.  To calculate his threshold income, take his taxable income of £264,000 and deduct a pension contribution he made to a GPP of £15,000.  Simon's threshold income is £264,000 minus £15,000 which equals £249,000. As Simon's threshold income is over £200,000 his adjusted income needs to be calculated.   To calculate his adjusted income, take his taxable income of £264,000, add in his employer's GPP contribution of £30,000. His adjusted income is £264,000 plus £30,000 which equals £294,000.   Simon's annual allowance is reduced by £294,000 minus £240,000 divided by 2 which equals £27,000. His annual allowance is therefore £40,000 minus £27,000 which equals £13,000.  He faces an annual allowance tax charge on £32,000 (£30,000 + £15,000 - £13,000) unless he has unused annual allowance to carry forward from previous years.. This image is an infographic and has alternative text available if you are using a screen reader.

Tapering of annual allowance - Simon

This image shows the position for Simon.

Simon has employed income of £260,000 and rental income of £24,000 this tax year.  

To calculate his threshold income deduct gross member contributions paid (whether under relief at source or net pay arrangement). 

Simon contributes £15,000 to his group pension plan. 

Add any employment income given up through a salary exchange agreement set up after 8 July 2015. 

This doesn’t apply to Simon. 

Deduct any taxed lump sum death benefits received. 

This doesn’t apply to Simon. 

Simon’s threshold income is £269,000 being £260,000 plus £24,000 minus £15,000.   

As his threshold income is over £200,000 the taper annual allowance applies, and you have to calculate his adjusted income. 

To calculate his adjusted income add any employer contributions to his taxable income. 

His employer contributes £30,000 to his group pension plan. 

Deduct any taxed lump sum death benefits received. 

This doesn’t apply to Simon. 

Simon’s adjusted income is £314,000 being £260,000 plus £24,000 plus £30,000. 

The reduction to Simon’s annual allowance is £27,000 being (£314,000 minus £260,000) divided by 2. 

His annual allowance is £33,000 being £60,000 minus £27,000. 

Simon faces an annual allowance tax charge on £12,000 being £30,000 plus £15,000 minus £33,000, unless he has unused annual allowance to carry forward from previous years. 

 

 

This image shows the position for Rex.. This image is an infographic and has alternative text available if you are using a screen reader.

Tapering of annual allowance - Rex

This image shows the position for Rex.

Rex is self-employed with income of £260,000.  He also has dividends from his investments of £10,000.  

To calculate his threshold income deduct gross member contributions paid (whether under relief at source or net pay arrangement) from his taxable income. 

Rex makes a single contribution of £75,000 into his personal pension plan this year, using carry forward. 

Add any employment income given up through a salary exchange agreement set up after 8 July 2015. 

Rex is self-employed, so this doesn’t apply. 

Deduct any taxed lump sum death benefits received. 

This doesn’t apply to Rex. 

Rex’s threshold income is £195,000 being £260,000 plus £10,000 minus £75,000.   

As this is below £200,000 the tapered annual allowance does not apply and there is no need to calculate his adjusted income. 

 

 

This image shows the position for Ruby. This image is an infographic and has alternative text available if you are using a screen reader.

Tapering of annual allowance - Ruby

This image shows the position for Ruby

Ruby is employed in the public sector, with earnings of £320,000 this tax year and she’s a member of her defined benefit scheme. 

To calculate her threshold income deduct gross member contributions paid (whether under relief at source or net pay arrangement) from her taxable income. 

Ruby contributes £32,000, 10% of her earnings into her defined benefit scheme. 

Add any employment income given up through a salary exchange agreement set up after 8 July 2015. 

This doesn’t apply to Ruby. 

Deduct any taxed lump sum death benefits received. 

This doesn’t apply to Ruby. 

Ruby’s threshold income is £288,000 which is £320,000 minus £32,000.  As her threshold income is over £200,000 the taper annual allowance applies, and you have to calculate her adjusted income. 

To calculate her adjusted income add any employer contributions to her taxable income. 

To calculate the employer contribution for a defined benefit scheme you need to take the member’s contribution from the pension input amount.

The pension input amount is the closing value of her accrued pension minus her opening value increased by CPI. Ruby’s pension input amount was £75,000, minus £32,000 giving you an employer contribution of £43,000. 
Deduct any taxed lump sum death benefits received. 

This doesn’t apply to Ruby. 

Ruby’s adjusted income is £363,000 being £320,000 plus £43,000. 

As her adjusted income is over £360,000 her annual allowance is reduced to £10,000. 

She has no unused annual allowance from previous years, so she’ll face an annual allowance tax charge at her marginal rate of income tax on £65,000 being £75,000 minus £10,000. 

As the charge will be more than £2,000, she can ask the scheme to pay this charge on their behalf.  They will then reduce her benefits to cover the cost of the charge. 

*Please note for a DB scheme, this would be the pension input amount minus any employee contributions

   

 

This image shows the position for Sebastian. This image is an infographic and has alternative text available if you are using a screen reader.

Tapering of annual allowance - Sebastian

This image shows the position for Sebastian

Sebastian has employed income of £250,000, a car allowance of £7,500, taxable savings of £2,000 and a redundancy payment of £50,000, only £20,000 of this redundancy payment is taxable. So, his total taxable earnings are £279,500.

To calculate his threshold income, take his taxable pay of £279,500 and deduct his pension contribution of £14,000 to a group personal pension. Sebastian’s threshold income is £265,500 minus £14,000 which equals £265,500. As Sebastian’s threshold income is over £200,000 his adjusted income needs to be calculated. 

To calculate his adjusted income, take his taxable pay of £279,500 and add an employer pension contribution of £14,000. Sebastian's adjusted income is £279,500 plus £14,000 which equals £293,500.

The reduction to his annual allowance is £293,500 minus £260,000 divided by 2 which equals £16,750.  This is deducted from the annual allowance of £60,000 leaving Sebastian with an annual allowance of £60,000 minus £16,750 which equals £43,250. Sebastian faces an annual allowance charge on £14,000 plus £14,000 minus £43,250 which equals £15,520 unless he has unused annual allowance to carry forward from previous years.

   

This image shows the position for Karen. This image is an infographic and has alternative text available if you are using a screen reader.

Tapering of annual allowance - Karen

This image shows the position for Karen 

Sebastian has employed income of £290,000, a car allowance of £7,500, taxable savings interest of £2,000 and a redundancy payment of £50,000 this tax year. 

To calculate his threshold income deduct gross member contributions paid (whether under relief at source or net pay arrangement) from his taxable income. 

Sebastian contributes £14,000 to his group pension plan. 

Add any employment income given up through a salary exchange agreement set up after 8 July 2015. 

This doesn’t apply to Sebastian. 

Deduct any taxed lump sum death benefits received. 

This doesn’t apply to Sebastian. 

Sebastian’s threshold income is £305,500 which is £290,000 plus £7,500 plus £2,000 plus £20,000 minus £14,000.   

Only the taxable element of the redundancy payment above £30,000 is included in Sebastian’s definition of threshold income. 

As his threshold income is over £200,000 the taper annual allowance applies, and you have to calculate his adjusted income. 

To calculate his adjusted income add any employer contributions to his taxable income. 

His employer contributes £14,000 to his group pension plan. 

Deduct any taxed lump sum death benefits received. 

This doesn’t apply to Sebastian. 

Sebastian’s adjusted income is £333,500 being £290,000 plus £7,500 plus £2,000 plus £20,000 plus £14,000. 

Only the taxable element of the redundancy payment above £30,000 is included in Sebastian’s definition of threshold income. 

The reduction to Sebastian’s annual allowance is £36,750 being (£333,500 minus £260,000) divided by 2. 

His annual allowance is £23,250 being £60,000 minus £36,750. 

Sebastian faces an annual allowance tax charge on £4,750 being £14,000 plus £14,000 minus £23,500 unless he has unused annual allowance to carry forward from previous years. 

Anti-avoidance

Anti-avoidance rules were put in place to stop people entering into a salary exchange or flexible remuneration arrangement after 8 July 2015 so they could receive additional pension contributions, but reduce their adjusted or threshold income.

The anti-avoidance rules apply if:

  • it's reasonable to assume that the main purpose, or one of the main purposes, is to reduce the amount of their reduction under the tapered annual allowance for the current tax year, or two or more tax years which include the current tax year
  • they involve reducing adjusted income or threshold income for the tax year (or both)
  • they involve any of the reductions above, being cancelled out by an increase in the adjusted income, or threshold income, for a different tax year

If the anti-avoidance rules apply, the income used to calculate the reduction to the annual allowance for that tax year is the income before any adjustments were made.

Carry forward

It's still possible to carry forward unused annual allowance from previous years to a year where the taper applies.

However, the amount of unused annual allowance available when carrying forward from a year where the taper has applied will be the balance of the tapered amount.

Flexible drawdown

If someone flexibly accesses their retirement savings, they're subject to the money purchase annual allowance.

People who have flexibly accessed their retirement savings will continue to have a money purchase annual allowance of £10,000. But where this applies, the alternative annual allowance (normally £50,000), which their defined benefit savings are tested against, will be restricted by the same taper.

Money purchase annual allowance (MPAA)

If someone's subject to the MPAA as well as tapering, the taper reduces the 'alternative annual allowance' which applies to any DB benefits they may have.  This is the standard annual allowance minus the MPAA of £10,000, so currently the alternative annual allowance is £50,000.

Related articles

Before the introduction of the tapered annual allowance, transitional rules were introduced from 8 July to align pension input periods (PIPs) with the tax year by 5 April 2016:

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The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

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