What is the annual allowance and how does it affect high earners?

All higher earners should be aware of the annual allowance, as it’s one of the main causes of unexpected tax bills at the end of the tax year. The annual allowance is the maximum gross amount of total pension savings you can make each year without incurring a tax charge.

What is the annual allowance?

For most people, the annual allowance is currently £60,000. If you earn less than £60,000, the maximum amount of personal pension contributions you can make will be equal to your total relevant UK earnings.[1]

‘Tapering’ is applied to reduce the annual allowance by £1 for every £2 of income above £260,000, down to a minimum allowance of £10,000. For example, if your earnings and employer pension contributions total £300,000, you will be £40,000 over the threshold, and your allowance will reduce by £20,000. The most you can put in your pension in that tax year will therefore be £40,000 instead of £60,000.

If you earn as much as £360,000, you’ll be subject to full tapering right down to £10,000 and may need to consider alternative methods for building your retirement funds. It might even be worth discussing receiving additional income, in lieu of pension contributions, with your employer.

The annual allowance and carry forward

The tapered annual allowance can also impact something known as carry forward. If you have maxed out your pension contributions for the current tax year, you can look back up to three previous tax years and use any unused allowance to make additional contributions.[4] Although there are some technicalities you need to be mindful of:

You can’t make personal pension contributions of more than your relevant UK earnings into your pension. This applies even if your unused allowance in previous years is greater than your current year’s earnings. If you had £100,000 of carry forward available to you, but only had £80,000 of UK relevant earnings, you would be unable to put the whole £100,000 into your pension and could lose out on £20,000 of the available carry forward.

Previous tapering also applies and tapering started at just £150,000 in previous tax years. It was only increased to £240,000 in the 2021/22 tax year and more recently to £260,000.[5]

Is the annual allowance affecting you?

As you’re probably gathering, it can become a complex topic for high earners so, ultimately, if you’re affected by the annual allowance, you should be working with a financial planner to make sure you don’t receive any unwanted tax bills or cause yourself a significant financial headache.