Tapering of annual allowance for high incomes - adjusted and threshold incomes
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.
What is the difference between adjusted income and threshold income?
What is the difference between adjusted income and threshold income?
Definitions of adjusted income and threshold income are crucial to understanding if 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.
Threshold and adjusted income over the years.
Threshold and adjusted income over the years
Individuals with a taxable income over the adjusted income will have their annual allowance for that tax year restricted. This means that for every £2 of income over the adjusted income, their annual allowance is reduced by £1. Their reduced annual allowance is rounded down to the nearest whole pound.
Dates |
Threshold income |
Adjusted income |
Maximum reduction in annual allowance |
Minimum annual allowance |
6 April 2016 to 5 April 2020 |
£110,000 | £150,000 | £30,000 | £10,000 |
6 April 2020 to 5April 2023 |
£200,000 | £240,000 | £36,000 | £4,000 |
From 6 April 2023 |
£200,000 | £260,000 | £50,000 | £10,000 |
How do you calculate adjusted income and threshold income?
How do you calculate adjusted income and threshold income?
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
Case studies
Take a look at our case studies to understand how the tapered annual allowance works in practice.
Case Study 1 - Simon
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 tapered 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.
Case Study - 2 Rex
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.
Case Study - 3 Ruby
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 tapered 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 member contributions.
Case study - 4 Sebastian
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.
Case study - 5 Karen
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 tapered 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.
What are the anti-avoidance rules?
What are the anti-avoidance rules?
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.
Can you carry forward unused annual allowance if the taper applies?
Can you carry forward unused annual allowance if the taper applies?
Yes, 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.
The tapered annual allowance and the money purchase annual allowance.
The tapered annual allowance and the money purchase annual allowance.
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.
Further information
Disclaimer
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.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.