Pensions are long term investments. You may get back less than you originally paid in because your capital is not guaranteed and charges may apply.
UK pension savers have an annual allowance that dictates what they can save without having to pay tax on their contributions. Most people can save the total value of their salary or £40,000 a year, whichever is lower. But higher earners are subject to something called the tapered annual allowance.
Essentially, the taper means that if you earn over a certain amount, you can save less into your pension before you have to start paying tax on it. But the rules are complicated and sometimes the government changes them, which means it can be hard to know what’s what.
Make the most of your tax-free ISA allowance.
In the 2020 budget, the UK government increased the threshold income and adjusted income limits that are used to calculate the tapered annual allowance.
Threshold income is all of your earnings and includes chargeable gains on investment bonds, which are subject to UK Income Tax.
However, it is net of all pension contributions that you pay personally to UK registered pension schemes.
Your threshold income does not include foreign earnings as they are not taxed in the UK.
Adjusted income is all of your earnings that are subject to UK Income Tax, including all pension contributions paid by you personally and by your employer.
The difference between threshold income and adjusted income is that the former excludes pension contributions but the latter includes all pension contributions.
Starting from 6 April 2020, the adjusted income limit rose to £240,000 (up from £150,000) and the threshold income limit was raised to £200,000 (up from £110,000).
The chancellor also lowered the minimum reduced annual allowance that you can have under the tapering rules from £10,000 to £4,000. This means that people at the top end of the earnings spectrum can only put £4,000 a year into their pension before paying income tax on those contributions.
The Pension Annual Allowance (AA) is the annual limit on the amount of contributions paid to, or benefits accrued in, a pension scheme before you have to pay tax.
For the 2021/22 tax year, the annual allowance is £40,000, but higher earners get less. The taper is the calculation that works out exactly how much you can save based on your income levels within the tax year.
It applies to all pension savings that you make or that are made on your behalf.
For every £2 your adjusted income goes over £240,000, your annual allowance for the current tax year reduces by £1. The minimum reduced annual allowance you can have in the current tax year is £4,000.
To see if the taper annual allowance applies to you, you will need to work out your:
Net income in a tax year
Pension savings in a tax year
Threshold income in a tax year
Adjusted income in a tax year.
Remember, income isn’t just your salary, but any taxable income. This could include:
Earnings from employment
Earnings from self-employment or partnerships
Most pensions income (State, occupational and personal pensions)
Interest on most savings
Income from shares (dividend income)
Rental income
Income received by an individual from a trust
You will have a reduced (‘tapered’) annual allowance if:
Your threshold income is over £200,000 (previously £110,000) and
Your adjusted income is over £240,000 (previously £150,000)
You will not be subject to the tapered annual allowance if your threshold income for that year is £200,000 or less, no matter what your adjusted income is.
Net income is not the same as ‘income after tax’. It is all taxable income minus various deductions. The most common deduction to look out for is pension scheme contributions made under Net Pay arrangements. This is where the employer deducts contributions before tax under PAYE.
The government provides a step-by-step guide to calculating threshold income:
Start with your net income for the tax year.
Deduct the gross amount of your pension contributions to all schemes where you had ‘relief at source’. They are contributions made by you or someone else on your behalf but exclude contributions made by your employer.
Deduct the amount of any lump-sum death benefits you received from registered pension schemes.
Add any reduction of employment income for pension provision through any relevant salary sacrifice arrangements made after 8 July 2015.
Add any reduction of employment income for pension provision through any relevant flexible remuneration arrangements made after 8 July 2015.
If your threshold income is under £200,000, you do not need to go on to calculate your adjusted income, otherwise – you do.
Fortunately, gov.uk also provides handy steps for calculating your adjusted income. These are:
Start with your net income for the tax year
Deduct the gross amount of your pension contributions to all schemes where you had ‘relief at source’. Relief at source usually applies to personal and stakeholder pension schemes and some workplace pension schemes. They are contributions made by you or someone else on your behalf but exclude contributions made by your employer
Deduct the amount of any lump-sum death benefits you received from registered pension schemes
Add any reduction of employment income for pension provision through any relevant salary sacrifice arrangements made after 8 July 2015
Add any reduction of employment income for pension provision through any relevant flexible remuneration arrangements made after 8 July 2015
If you are subject to the tapered annual allowance, for every £2 your adjusted income goes over £240,000, your annual allowance for that year reduces by £1.
From 6 April 2020, the minimum that this can reduce to is a tapered annual allowance of £4,000.
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Salman is our personal finance editor with over 10 years’ experience as a journalist. He has previously written for Finder and regularly provides his expert view on financial and consumer spending issues for local and national press.