Tapered annual allowance: at a glance
- What do I need to know? You could lose some of your annual tax-free pension allowance as a higher earner.
- What does it mean for me? When you pay into your pension you usually benefit from tax relief, meaning a tapered allowance reduces your ability to save tax-efficiently.
- Why does it matter? Maximising alternative tax-efficient savings options is important to reduce your tax exposure, especially if the tapered annual allowance applies to you.
Early retirement planning is key to building and protecting your wealth for the future, especially when you’re earning the most from your career.
But growing your pension savings can be more challenging as a high earner due to rules like the tapered annual allowance. And research by Flagstone shows only 14% of people in the UK are on track to retire at the age and income they want.
In this guide, you’ll learn how the tapered pension allowance works, how to calculate your annual allowance, and what happens if you maximise your contributions.
What is the tapered annual allowance?
HMRC introduced tapered annual allowances in April 2016 to reduce the amount of tax relief available to high earners when saving for their pension.
Since 06 April 2023, the standard annual allowance is £60,000. This is the maximum you can contribute to your pension each year without a tax charge in most cases. But there are some circumstances where the full allowance may not apply to you.
For example, certain types of pension schemes can limit your annual allowance due to how defined benefits are measured within tax rules.
Additionally, HMRC may reduce your pension allowance if your threshold income exceeds £200,000 a year and your adjusted income is greater than £260,000 (more on these later).
Your allowance tapers down the more you earn.
The tapered annual allowance can reduce to a minimum of £10,000.
Exact calculations can be complicated and depend on a number of factors, including how you make your contributions. If you’re unsure about the impact on your finances, consider speaking with a qualified financial adviser.
How does the tapered annual allowance work?
If your income exceeds both the threshold and adjusted income limits, HMRC starts to taper down your tax-free pension allowance.
For every £2 of your income that exceeds the £260,000 adjusted income limit, HMRC deducts £1 from your annual allowance.
Both your adjusted income and threshold income have to exceed their limits for pension tapering to come into effect. If either figure is below the limit, you may contribute the maximum £60,000 a year depending on your circumstances.
Carrying forward unused allowances
You can sometimes carry forward unused allowances for up to three years. This means that, if you don’t take advantage of your full allowance in one year, you may be able to contribute more in future, subject to eligibility and HMRC rules.
But there are a handful of conditions that restrict whether you can carry forward your allowance.
For example, you must have been a member of the registered pension scheme for the years you wish to carry forward. Whether you have a defined benefit pension can also complicate your calculations.
This is because HMRC calculates your pension input differently, basing its assessment on the increase in your benefits, not just your contributions.
What is threshold income?
HMRC uses threshold income as an initial measurement to determine whether your income (before pension contributions) is high enough for pension tapering to apply.
If your threshold income exceeds the allowance, HMRC will then consider your adjusted income.
Your threshold income takes your net earnings and applies specific adjustments. Your net income includes:
- salary
- bonuses
- interest from savings and investments
- dividends
Some personal pension contributions can reduce your threshold income in certain circumstances. But if you’ve used salary sacrifice since 08 July 2015 this is also added back when calculating threshold income. This means salary sacrifice doesn’t reduce your threshold income.
What is adjusted income?
Adjusted income refers to your total taxable income plus employer pension contributions. HMRC uses your adjusted income to determine whether your pension allowance should be reduced under the tapered allowance rules, and by how much.
How do I calculate my tapered annual allowance?
If either your threshold income or adjusted income is below the relevant limit, your annual pension allowance remains at £60,000.
But if both income types exceed their limits, your allowance will be reduced, so you’ll need to work out your tapered allowance to plan contributions effectively.
You can calculate your tapered annual allowance by using both your threshold and adjusted income with the HMRC pension annual allowance calculator.
What happens if I exceed my pension’s annual allowance?
Whether your pension contributions are tapered or not, you can still contribute more than your annual allowance. But HMRC applies a tax charge to the excess, effectively taxing the overpayment at your marginal rate.
There are some schemes where your provider may pay these charges. This is sometimes referred to as ‘Scheme Pays’. But it depends on your agreement, so it’s best to check which rules would apply to you in these circumstances.
Maximising tax-free allowances and income
Exceeding your annual pension allowance can reduce the tax efficiency that pension contributions typically provide. So, it’s important to consider other tax-free savings options, as well as how to maximise the value of your savings to protect and grow your wealth for retirement.
As a higher earner, considering other savings options like using your annual ISA (Individual Savings Account) allowance, can help to maximise your tax efficiency. ISAs allow you to save a maximum of £20,000 tax-free every year across different account types (such as Cash ISAs or Stocks and Shares ISAs).
But there are new limits to Cash ISAs that will take effect from 06 April 2027. From that date, you can only use a maximum of £12,000 every year for cash savings. For savers over the age of 65, the rules won’t change.
Premium bonds also offer a tax-free way to save money. When you hold Premium Bonds, National Savings and Investments (NS&I) enters you into a monthly draw for the chance to win tax-free cash prizes.
But the money you save in Premium Bonds doesn’t earn interest. And while savings interest isn’t tax-free for additional rate taxpayers, high-interest savings accounts can still help to grow your wealth with relatively low risk.
Plan ahead for reduced tax relief
For high earners, the tapered pension allowance can reduce from £60,000 to as little as £10,000 depending on your income. Understanding your tapered annual allowance is important, as it helps you plan contributions effectively.
If you exceed the tax-free pension allowance, some cash may even be better placed in a Cash ISA or high-interest savings accounts for growth and protection.
Making full use of annual allowances, investing in a diversified portfolio, and planning for higher taxes can help to support a comfortable retirement income and build generational wealth.
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