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In certain circumstances the member’s Annual Allowance may be reduced, as explained below. This is known as the Tapered Annual Allowance and will happen if the member’s threshold income exceeds £200,000 and their adjusted income exceeds £240,000, in a tax year. If this applies to the member, their AA will reduce by £1 for every £2 of adjusted income over £240,000, subject to a maximum reduction of £36,000. The maximum reduction means anyone with an adjusted income of £312,000 or more will have an AA of £4,000, rather than £40,000.

If someone is subject to the £4,000 money purchase AA and earns more than £240,000 in a tax year, the balance of that year’s AA for any defined benefit savings will be restricted. This means for those with an income of £312,000 or more, the remaining AA for defined benefit pensions will be zero (£4,000 tapered AA, minus £4,000 Money Purchase AA), although any defined benefit carry forward can still be used.

Definition of Threshold Income
Threshold income is the sum of A + B – C – D.

A, B, C and D are defined below.

A is Net income. Net income is total taxable income for the tax year, after any tax relief is deducted. Total income is income from all sources such as employment income and benefits in kind, earnings from self-employment or partnership, most savings interest, most pension income, dividends from shares and rental income from property.

From this total any tax reliefs are deducted (see section 24 of the Income Taxes Act 2007 for what’s allowed). This includes: qualifying loan interest payments; business losses in early years of trade; gifts of shares and securities made to charities, and qualifying contributions to registered pension schemes for which tax relief cannot be given directly from employment earnings. This means, for example, contributions to retirement annuities where the provider doesn’t give tax relief at source as well as contributions to occupational pension schemes in excess of earnings.

B is the amount of any employment income exchanged for pension contributions using relevant salary sacrifice or flexible remuneration arrangements set up on or after 9 July 2015.

C is the gross amount (before tax relief) of any contributions paid to pensions that have tax relief deducted at source from net income. This includes personal pensions set up after 30 June 1988 as well as free-standing additional voluntary contribution schemes.

D is the amount of any taxable lump sum received in the tax year from a registered pension scheme as the result of the scheme member dying after age 75.

Adjusted Income is A + E + F + G – D

A and D are as defined above for threshold income

E is the amount of any qualifying contributions the member made to registered pension schemes for which tax relief cannot be given directly from employment earnings. This means, for example, contributions to retirement annuities where the pension provider doesn’t give tax relief at source, as well as contributions to occupational pension schemes in excess of earnings. This amount will have been deducted in the calculation of A above but is added back here.

F is the gross amount of any pension contributions the member made which were deducted from employment income before tax, under a net pay arrangement (this method of tax relief is primarily used for occupational pension schemes). This also includes contributions to overseas pension schemes for those who are non-domiciled for UK tax purposes. Both of these will have been deducted in the calculation of A but are added back here.

G is the total amount of employer contributions paid into any registered pension schemes.

Alignment of Pension Input Periods

Annual Allowances are measured across a pension input period (PIP). Depending on how the member’s pension was set up, the PIP may not have originally matched the tax year. To ensure the Tapered Annual Allowance works as intended, the government decided to align all PIPs with the tax year from 6 April 2016.

The annual allowances and PIP rules for this year are complicated. If you require detailed information you can refer to HMRC’s online Pensions Tax Manual.

For further information about the tapered AA and the annual allowance for 2020/21, visit www.gov.uk.