The annual allowance has applied from the tax year 2006-07 onwards. There have been various changes since then with the current allowance set at £40,000 for 2017-18. In basic terms an individual can make pension savings up to £40,000 and claim tax relief. If pension savings go above the annual allowance a tax charge applies.
From 6 April 2016, a tapered reduction in the annual allowance applies for those with an ‘adjusted income’ over £150,000. This definition is based on the individual’s taxable income after allowing for certain reliefs plus the value of their pension savings during the tax year.
The annual allowance is reduced by £1 for every £2 of income above £150,000, subject to a minimum reduced annual allowance of £10,000.
Where the reduction would otherwise take an individual’s tapered annual allowance below £10,000 for the tax year, their reduced annual allowance for that year is set at £10,000.
If the individual’s net income is no more than £110,000 they will not normally be subject to the tapered annual allowance.
As an example, an individual with income of £160,000 has a reduced annual allowance of £35,000 for the tax year. The £10,000 of income above £150,000 creates a reduction of £5,000 from the annual allowance of £40,000 – resulting in a reduced annual allowance for the tax year of £35,000.
However, an individual with income of £215,000 has a reduced annual allowance of £10,000 for the tax year. The £65,000 of income above £150,000 creates a reduction of £32,500 which would otherwise have reduced the annual allowance to below £10,000 – in this case it would have been reduced to £7,500.