Tapered Annual Allowance

Pension Contribution and 40k Annual Lifetime Contribution. Having a basic understanding of tapered annual allowance is very important as it may limit the amount of tax relief you may be able to claim on your pension contributions.

If you are earning a high income and paying into a pension plan, then this is where tapered pension annual allowance kicks in.

‘Tapered annual allowance’ and ‘40k annual lifetime’ contribution explained

Most folks are able to contribute up to £40,000 each year to pensions and enjoy tax relief benefits. However, if your income reaches or goes above a certain level – this is currently capped at £200,000 for the tax year 2022/23 – then your annual allowance may be reduced or, in other words, ‘tapered’.

Unless you’ve done careful planning with a financial accountant, you may find yourself dealing with some very unwelcoming tax charges.

How does tapered annual allowance work?

The tapered annual allowance exists to reduce the amount of money you or your employer may contribute to a pension before tax deductions. However, as we just discussed, the taper does not apply if your threshold income is under £200,000. If it is above this cap, you must check whether your ‘adjusted income’ is higher than £240,000 for the tax year 2022/23.

The annual allowance reduces by a pound for every two pounds – whenever your adjusted income goes beyond £240,000 – and it reduces to minimum tapered allowance of £4,000.

The example below practically demonstrates how you might use the threshold and adjusted income measures to understand whether the taper affects you:

The first thing you need to ask yourself is this: is my total taxable income higher than £200,000 a year? If yes, then your annual lifetime contribution is £40,000. If no, then you must ask: is my adjusted income below £240,000 after all my personal pension contributions (plus any employer contributions) have been considered? if yes, your annual lifetime contribution is £40,000. If no, then your annual allowance will reduce by £1 for every £2 of income which is higher than £240,000. After your ‘adjusted’ income comes up to £312,000 or higher, the minimum allowance of £4,000 is applicable.

Please note that the above is a very generic example. There may be other factors that need to be considered, and so, the process of determining both ‘threshold’ and ‘adjusted’ income may get complicated. As such, it is always best to seek professional guidance from a financial accountant.

How tapered allowance works and how it affects annual 40k contribution

Here’s a real-world example to help explain things further:

Let’s take Michael who is a senior executive at a renowned company. His taxable income and pension contributions are as follows:

Taxable income

Basic salary – £180,000

Bonus – £50,000

Rental income – £20,000

Dividend income – £20,000

Total income = £270,000

Pension contributions  

Personal contributions without salary sacrifice – £10,000

Employer contributions – £10,000

In order for Michael to come up with his ‘threshold’ income, he must add up his taxable income. So, that’s: 180,000 + 50,000 + 20,000 + 20,000 – 10,000 (personal pension contribution). His threshold income is, therefore, £260,000.

Since Michael contributes to his personal pension and has employer pension contributions, he must workout his ‘adjusted’ income in the following way (which must include all pension contributions):

Michael first adds his £260,000 threshold income to the £10,000 personal pension contribution and £10,000 employer pension contribution – allowing him to determine his adjusted income which is £280,000.

Since his adjusted income is effectively £40,000 above the £240,000 threshold, his annual allowance is taped down by £1 for every £2 above this threshold. So, in Michael’s case, this would be £40,000 / 2 = £20,000.

We have, thus, worked out that Michael’s new tapered allowance is £20,000 for the tax year 2022/23. We arrived upon this figure by first taking the £40,000 annual allowance into account and then taking away the adjusted excess income of £20,000.

In any case, it is always best to work with a financial advisor to accurately determine how tapered annual allowance affects you and how much tax relief you can gain as a result.

HMRC Further details can be Found here

Our friendly and approachable Accountants in Slough, Adam Accountancy can advise you personally on the ones that apply to you.

Published On: November 16th, 2022 / Views: 12851 /

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