Pension tax rules can be surprisingly complex for high earners, and one of the most important areas to understand is the tapered annual allowance. Designed to limit the amount of tax relief available on pension contributions for those with higher incomes, this rule can reduce your pension allowance for high earners, leading to surprise tax bills if not managed carefully.
Understanding how the tapered annual allowance works, including how it’s calculated and when it applies, is important for staying tax-efficient and maximising your retirement savings. In this guide, we’ll explain the key concepts, walk through examples, and explore what high earners can do to minimise the impact.
What is the annual allowance?
The annual allowance is the maximum amount you can contribute to your pension each tax year with tax relief. For most people, the annual allowance is £60,000. If you earn less than £60,000, the maximum amount of personal pension contributions you can make will be equal to your total relevant UK earnings.[1] Additionally, if you earn less than £3,600 a year, you can get tax relief on pension contributions you make up to £2,880 each tax year.[1]
The tapered annual allowance
If you’re a high earner, your pension annual allowance may shrink. Once your total income, including pension contributions, goes over £260,000, your annual allowance starts to reduce. Even if you earn between £200,000 and £260,000, extra income could push you into this taper zone.
How does the tapered annual allowance work?
The tapered annual allowance was introduced in 2016 to limit the amount high earners can contribute to their pensions with tax relief.
- If your threshold income (your total income not including pension contributions) is over £200,000, and your adjusted income (your total income including pension contributions) is over £260,000, your annual pension allowance starts to reduce.
- For every £2 over this threshold, your allowance falls by £1.
- The lowest it can drop to is £10,000.
For example, if your income and employer pension contributions add up to £300,000, you are £40,000 over the threshold. This reduces your allowance by £20,000, meaning you can only contribute £40,000 to your pension that year instead of the full £60,000.
For example, if your income and employer pension contributions add up to £300,000, you are £40,000 over the threshold. This reduces your allowance by £20,000, meaning you can only contribute £40,000 to your pension that year instead of the full £60,000.
If your income reaches £360,000 or more, your allowance will be fully tapered to the minimum £10,000. At that level, it may be worth considering other retirement savings options or discussing with your employer whether to receive extra income instead of pension contributions.
Calculating threshold and adjusted income
To determine if the tapered annual allowance applies to you, you’ll need to calculate two figures: threshold income and adjusted income. If both exceed specific limits, your pension annual allowance will start to reduce. The UK government has a useful tool to help taxpayers: https://www.tax.service.gov.uk/pension-annual-allowance-calculator
The tapered annual allowance can be confusing, speaking to a financial adviser is recommended.
Step 1: Work out your threshold income
Threshold income is your total taxable income from all sources, but it excludes pension contributions that receive tax relief.
| Include | Exclude |
|---|---|
| Salary, bonuses, and benefits (e.g. company car) | Employer pension contributions |
| Income from self-employment or freelancing | Personal pension contributions under net pay or relief at source schemes |
| Rental income | |
| Dividends | |
| Interest from savings and investments | |
| Other taxable income (e.g. trust or foreign income) |
An example of calculating threshold income
| Income Source | Amount |
|---|---|
| Salary | £180,000 |
| Rental income | £15,000 |
| Dividend income | £5,000 |
| Total | £200,000 |
Anna’s threshold income is £200,000. Since this is not over the £200,000 threshold, she won’t be affected by tapering.
Step 2: Calculate Your Adjusted Income
Adjusted income includes all income from the threshold calculation plus any pension contributions made by you or your employer.
| Include | Exclude |
|---|---|
| All threshold income components | Pension contributions made via salary sacrifice before 9 July 2015 |
| Employer pension contributions | |
| Personal contributions where tax relief is claimed |
An example of calculating adjusted income
| Components | Amount |
|---|---|
| Threshold income | £210,000 |
| Employer pension contributions | £60,000 |
| Personal pension contributions | £10,000 |
| Adjusted income | £280,000 |
As Jane’s adjusted income is £20,000 above the £260,000 limit, her annual allowance is reduced by £10,000 (reduced by £1 for every £2 over the threshold). Therefore, her allowance drops from £60,000 to £50,000.
Impact on pension contributions
If you go over your annual allowance limit, it can result in a tax charge at the end of the tax year. It isn’t technically a ‘penalty’, but it can catch people by surprise, which makes it challenging to manage.
- If you or your employer overpay into your net pay pension, the pension provider will still automatically provide basic rate tax relief at source.
- If your employer makes contributions via salary sacrifice, you will receive immediate income tax relief as well as relief on National Insurance directly into the pension.[2]
- If overpayments are made, HMRC will look to claw back some of this tax relief at the end of the tax year.[3]However, your funds will remain in your pension and will consequently be complicated to access should you need the money to settle the tax bill.
Carry forward rules
The tapered annual allowance can also impact something known as carry forward. If you have maxed out your pension contributions for the current tax year, you can look back up to three previous tax years and use any unused allowance to make additional contributions.[4] Although there are some technicalities you need to be mindful of if you want to carry forward your pension annual allowance:
You can’t make personal pension contributions of more than your relevant UK earnings into your pension. This applies even if your unused allowance in previous years is greater than your current year’s earnings. If you had £100,000 of carry forward available to you, but only had £80,000 of UK relevant earnings, you would be unable to put the whole £100,000 into your pension and could lose out on £20,000 of the available carry forward.
Previous tapering also applies, and tapering started at just £150,000 in previous tax years. It was only increased to £240,000 in the 2021/22 tax year and more recently to £260,000.[5]
How to pay the annual allowance tax charge
Through your pension provider also known as Scheme Pays:
- If your tax charge is over £2,000, you may be able to ask your pension scheme to pay it directly from your pension pot.
- This reduces your future retirement benefits, as the tax is settled using part of your savings.
- You’ll need to notify your scheme by 31 July following the end of the tax year in which the charge arose.
- You also still need to report the charge on your Self Assessment tax return.
Pay the tax charge yourself:
- You calculate and pay the charge directly to HMRC via your Self Assessment tax return.
- You’re responsible for ensuring the charge is paid in full and on time, usually by 31 January following the end of the tax year.
- This method does not affect your pension pot but requires you to have the funds available to cover the charge.
The decision on how to pay the tax charge can affect your future pension benefits. It’s recommended that you seek financial advice to understand the best option for your circumstances.
Strategies for high earners
If you’re at risk of breaching the annual pension allowance for high earners or triggering the tapered limit, there are a few strategies that may help manage your pension contributions. Salary sacrifice arrangements can be a tax-efficient way to reduce your threshold income by exchanging part of your salary for employer pension contributions, which can help keep you below tapering thresholds. You may also be able to time your contributions strategically, especially if your income varies year to year. For example, making larger contributions in lower-income years to avoid triggering a tax charge.
Given the complexity of pension rules for high earners, it’s wise to seek independent financial advice.
Recent changes and future outlook
In recent years, the UK government has introduced several key changes to pension rules. From April 2023, the standard annual allowance increased from £40,000 to £60,000, providing more scope for tax-relieved pension contributions. The adjusted income threshold for tapering rose from £240,000 to £260,000, while the minimum tapered allowance increased from £4,000 to £10,000.[6] The Money Purchase Annual Allowance (MPAA) also rose to £10,000, allowing more flexibility for individuals who have already accessed their pensions but wish to continue saving.
Looking ahead, the landscape remains uncertain. While no changes have been confirmed, there is, as always, ongoing speculation about potential reforms. As pensions are closely tied to wider tax and spending policy, future budgets may bring further adjustments. For this reason, it’s important to stay up to date with legislative changes and consider working with a financial adviser. Having expert guidance can help ensure your pension allowance for high earners strategy remains compliant, tax-efficient, and resilient to policy shifts.
Is the annual allowance affecting you?
As you’re probably gathering, it can become a complex topic so, ultimately, if you’re affected by the annual pension allowance for high earners, you should be working with a financial planner to make sure you don’t receive any unwanted tax bills or cause yourself a significant financial headache.
Article sources
Editorial policy
All authors have considerable industry expertise and specific knowledge on any given topic. All pieces are reviewed by an additional qualified financial specialist to ensure objectivity and accuracy to the best of our ability. All reviewer’s qualifications are from leading industry bodies. Where possible we use primary sources to support our work. These can include white papers, government sources and data, original reports and interviews or articles from other industry experts. We also reference research from other reputable financial planning and investment management firms where appropriate.