Increased thresholds but lower maximum contributions for those affected
The annual allowance taper affects high earners and results in a reduction in their annual allowance, reducing the tax relievable amount that they are able to pay into pensions each year.
The taper was originally introduced in 2016 but changes were made in the Spring Budget so that from April 2020, the income from which the taper applies was increased by £90,000. There are two tests to see if the taper applies. Firstly, you must have “threshold income” in excess of £200,000. If this is the case, it is then assessed whether your “adjusted income” is in excess of £240,000. The calculation of these is shown in the graphic below:
BOTH CALCULATIONS START WITH TOTAL TAXABLE INCOME
(ALL earnings and investment income)
The current Annual Allowance (the amount that you can pay into a pension and receive tax relief on each year) is £40,000. This is tapered by £1 for every £2 of adjusted income in excess of £240,000. The maximum reduction is £36,000 so those with adjusted income of £312,000 or more will be limited to making maximum payments of just £4,000 p.a. Under the prior tapering regime, the maximum reduction in annual allowance was £30,000 (to a minimum of £10,000) so those who set up regular contributions to match their maximum allowance prior to 2020 may have to amend their contributions to take the lower tapered allowance into account. They may also be able to increase their contributions due to the higher thresholds.
What can I do if caught by the taper?
Due to the difference between the calculations of threshold income and the adjusted income, it may be possible to make personal pension contributions to bring the threshold income below £200,000. For example, someone with earnings of £250,000 could make gross pension contributions of £55,000 by “carrying forward” unused allowances from previous years to bring their “threshold income” below £200,000. The adjusted income test is then not applied as the threshold income test is passed. For high earners that are affected, “carrying forward” unused prior annual allowances can be an effective way of maximising contributions.
How does the taper interact with carry forward?
All individuals can use any unused Annual Allowance from the previous three tax years in order to potentially make pension contributions of up to £160,000 in any one tax year. However, you will need to check whether the taper applied in any previous tax years when calculating the amount that can be carried forward.