I have a client that has taxable income for the tax year ended 5th April 2021 of £230,000 of which rental income is around £23,000 and attracts relief for the mortgage interest payments. Their employer has made £15,000 contribution and they have also made personal contribution of £15,000. Would they get caught by the tapering of annual allowance charge?

What is the annual allowance?

The annual allowance is a limit on the amount that can be contributed to your pension each year, while still receiving tax relief. It’s based on your earnings for the year and is capped at £40,000 (with the exception for 2015-16 that had transitional rules please see PTM057100).

What is the tapering annual allowance?

The tapered annual allowance (TAA) was introduced from 6 April 2016 for high earners and legislation can be found FA 2004 S228ZA.

The tapering annual allowances looks at if both your adjusted income and your threshold income is above the limits. For every £2 of ‘adjusted income’ above the limit, £1 of annual allowance will be lost. Please see the table below of the limits:

Adjusted incomeThreshold incomeMinimum Annual allowance
5 April 2016 to 5 April 2020£150,000£110,000£10,000
From 6 April 2020£240,000£200,000£4,000

You will note that as of 6 April 2020, the limits were increased. For every £2 of ‘adjusted income’ above £240,000, £1 of annual allowance will be lost. The maximum reduction was £36,000 meaning that anyone earnings over £310,000 had their annual allowance is capped at £4,000.

What is net Income?

When looking at the TAA the legislation FA 2004 S228ZA, it refers to net income in step 1 & 2 of ITA 2007 s23.

Net income is taxable income less deductions. A full list of the deductions can be found at s.24 ITA 2007. However, care needs to be taken regarding the 20% tax deduction given for loan interest relief as this is step 6 of ITA 2003 S23 and therefore is not accounted for.

HMRC guidance PTM057100 provides a breakdown on how to calculate the threshold income and adjusted income but legislation reference is FA 2004 S228ZA.

The calculations

Adjusted incomeThreshold income
Taxable income£230,000£230,000
Add employers’ contributions£15,000
Less: gross members contributions-£15,000
Add Employment income via salary exchange£0
Less: Lump Sum death Benefits£0£0
Adjusted income/threshold income£245,000£215,000

Annual allowance reduction

(£245,000-£240,000): 5,000/2 = £2,500

Annual allowance 2020/21: £40,000-£2,500-=£37,500 reduced annual allowance for the year

Other areas you may wish to consideration

  • PTM055100 – Individuals can carry forward annual allowance they have not been utilised on a FIFO basis for last 3 years. If TAA restrictions apply, the taxpayer may have carried forward provisions to fall back on.
  • Net relevant earnings – Tax relief on pension contributions made by an individual into a qualifying pension scheme is limited to the higher of 100% of their relevant UK earnings, or £3,600 per annum. HMRC guidance PTM044100.
  • Interaction with tapering annual allowance and the money purchase annual allowance – PTM057100
  • Remember for defined benefit schemes you calculate the contributions differently see PTM053301

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