Changes introduced by the government will have an important bearing on the amount of tax to be paid on pension contributions. Here we spotlight what’s different and what it means.
Updated 16 March 2021
Increases to both the threshold income and adjusted income limit*, which are used to work out an individual’s annual pension allowance, will affect how much you can pay into your pension tax-free.
The annual allowance and tapering
The annual allowance is the maximum that can be saved in a pension scheme each year with the benefit of tax relief. Ignoring tapering, this is £40,000 plus any amount by which your pension inputs fell short of the annual allowance in the previous three tax years. However, the £40,000 figure tapers down for high-income individuals.
Before April 2020, this tapering started when a person had adjusted income over £150,000 and the normal £40,000 allowance limit tapered down to £10,000, depending on how high the income was above that amount.
For the 2020-21 and 2021-22 tax years, the starting point for tapering will be adjusted income of over £240,000 and reduces the allowance from £40,000 down to a lower £4,000 minimum. So, since 6 April 2020, you will have had 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 the year is £200,000 or less, no matter what your adjusted income is.
If you are subject to the taper, for every £2 your adjusted income exceeds £240,000, your annual allowance for that year reduces by £1.
Here’s a very simple example:
Say you have an adjusted income of £300,000 for the 2020/21 tax year. This exceeds the adjusted income limit by £60,000.
Your annual allowance would be reduced by half of this – so by £30,000 – leaving you with a tapered annual allowance of £10,000, which is the standard annual allowance of £40,000 less the £30,000 reduction under the tapering rules.
Making contributions in excess of the allowance
Making contributions in excess of the allowance creates an income tax charge at your marginal rate. Many people in defined benefit pension schemes, more commonly known as final salary schemes, have found that a modest increase in their pay can result in a tax liability that is sometimes greater than the pay increase.
The change will reduce this problem only slightly. Even an annual allowance of £40,000 is not enough to shelter those on quite modest pay levels from extra tax on a bonus or pay increase.
If your pension savings in the tax year are more than your available annual allowance, you should include the excess amount on your self-assessment return.
This amount is added to your taxable income. If you have an income tax charge on excess pension inputs, you can elect for your pension scheme to pay the charge on your behalf, although this will result in a reduction to your pension at retirement.
* Note: Your threshold income is all UK income (not just salary) but after all pension contributions paid by you personally and by your employer (known as pension inputs). Adjusted income is all of your income before pension contributions. Find out more information about pension taxation here.
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