For most people, the maximum amount both you and your employer can pay into pensions (Annual Allowance) is the lower of
- Your earnings.
- £40,000 pa (increases to £60,000 pa from 6th April 2023).
Reduced/Tapered Annual Allowance
Many may not be aware but higher earners may suffer a reduction in the amount that they and their employers can pay into pensions. This is because a tapered annual allowance on pension contributions may be applied when your earnings package is above certain thresholds. If your adjusted income is above a certain limit, then the maximum amount you and your employer can contribute to pension schemes in total is scaled down. Your total income goes through two tests:
- Threshold Income Test: applies if your income is above £200,000. This means you must then add both employer and employee pensions for that tax year (or the equivalent if a defined benefit income) to you income to work out your Adjusted Income (income + pension contributions).
- Adjusted Income Test: If your adjusted income is above £240,000 (increases to £260,000 pa from 6th April 2023), then for every £2 above this limit, your pension annual allowance of £40,000 is reduced by £1 (tapered annual allowance).
- E.g., Tax Year 22/23 Adjusted Income £300,000 = £60,000 over £240,000. Annual allowance £40,000 is reduced by £1 for every £2 over £240,000 = £60,000/2 = £30,000 reduction. Your tapered annual allowance is £40,000 less £30,000 = £10,000. The maximum you and your employer can pay into pensions in tax year 2022/23 is £10,000 pa.
- E.g., Tax Year 23/24 Adjusted Income £300,000 = £40,000 over £260,000. Annual allowance £40,000 is reduced by £1 for every £2 over £260,000 = £40,000/2 = £20,000 reduction. Your tapered annual allowance is £60,000 less £20,000 = £40,000. The maximum you and your employer can pay into pensions in tax year 2022/23 is £40,000 pa.
- The minimum your tapered annual allowance can be reduced to (MTAA) is £4,000 pa (£10,000 pa from 6 April 2023).
Recovering Some or All of you Annual Allowance
Despite being restricted by a tapered annual allowance, if you have unused annual allowance from the previous 3 tax years, you can recover some or all of the taper reduction.
- E.g., Tax Year 22/23 Adjusted Income £270,000 = £30,000 over £240,000 limit but you have £70,000 of unused allowances carried forward from the previous 3 years.
- Annual allowance £40,000 is reduced by £1 for every £2 over £240,000 = £30,000/2 = £15,000 reduction. Your tapered annual allowance is £40,000 less £15,000 = £25,000. The maximum you and your employer can pay into pensions in tax year 2022/23 is £25,000 pa. Your employer’s pension contributions of £25,000 have used up your Tapered Annual Allowance and you then make an additional carry forward contribution of £70,000. Your income of £270,000 is reduced due to your pension contribution of £70,000 i.e., £200,000.
- This is at the Threshold Income of £200,000 so you now do not need to do the Adjusted Income test to taper your allowance, so you have back your full Annual Allowance of £40,000, meaning you still have £15,000 of carry forward of unused allowance left too.
This is unusual but we have discussed this with a Senior Tax Inspector at HMRC and he confirmed that whilst unusual, recovering tapered annual allowance reductions work, in theory and practice, in the same way that by paying pension contributions of £25,140 to get your income down from £125,140 to £100,000 means you get back your full personal allowance of £12,570 meaning technically tax relief of 60% on the £25,140 contribution or if you earn £60,000 and therefore lose child benefit (family allowance), if you pay £10,000 into a pension scheme, your income is adjusted down to £50,000 meaning you now are entitled to child benefit again.
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