Pension Tapering – Beware!
The UK pension taper adjusts the amount of tax-free pension savings higher earners can contribute annually. This taper specifically affects the annual allowance, which limits the total contributions a person can make into their pension while benefiting from tax relief. For higher earners, the annual allowance is reduced based on their income level, which can have significant implications for tax liabilities but can also be a nasty surprise if these rules were not highlighted at the time of contributing (and perhaps only became apparent when completing a self assessment (personal) tax return the following year.
Key Points:
- Amounts
The UK sets an annual pension contribution allowance, currently £60,000 for most individuals, allowing tax-free contributions up to this limit. For higher earners, however, this allowance tapers down once their adjusted income surpasses £260,000. The adjusted income includes all taxable earnings and pension contributions. The minimum annual allowance for those impacted by the taper is £10,000.
- Tapered Annual Allowance Thresholds
The taper threshold begins at an adjusted income of £260,000. For every £2 of income over this threshold, the allowance is reduced by £1. This taper continues until the allowance reaches the minimum level of £10,000, effectively capping tax-free contributions at this amount for individuals earning £360,000 or more annually. - Impact on High Earners
Higher earners with a tapered allowance face restrictions on the tax advantages of contributing to pensions, often facing a significant tax bill if they inadvertently exceed their personal allowance. Exceeding the adjusted annual allowance triggers a tax charge on the excess amount, equal to the individual’s marginal rate of income tax. This tax charge, known as the annual allowance charge, can reduce the net benefit of pension savings. This can be a huge admin hassle so more often than not we see clients settle out of their own bank account. - Carry Forward Unused Allowances
Individuals can carry forward any unused allowance from the previous three tax years, provided they were members of a pension scheme during that time. This provision can soften the impact of the taper and allow higher earners to make more significant pension contributions if they have spare allowances from past years. This or other tax planning with a financial advisor and/or accountant is recommended.
The calculations and definitions here can be complex and fiddly. The most important takeaway from reading this is to understand that the issue exists and if potentially affected, get in touch with an advisor as early in the tax year as possible.
