Adjusted Income and Threshold Income: How the Tapered Annual Allowance Really Works

The tapered annual allowance is, on paper, a straightforward concept: high earners get a reduced annual allowance for pension contributions. In practice, the calculation involves two distinct income tests — "threshold income" and "adjusted income" — that interact in ways that confuse even experienced professionals. Getting them wrong leads either to unexpected tax charges or, more commonly, to legitimate pension contributions being unnecessarily restricted.

This guide explains both tests in detail, with worked examples showing how employer contributions affect the calculation and how common planning steps can move a person out of tapering altogether.

The Two Tests: Why Both Exist

HMRC introduced the tapered annual allowance from 6 April 2016 to reduce the tax relief available to the highest earners. The original threshold was modest, but from 6 April 2020, the thresholds were raised significantly:

• Threshold income: £200,000 (from 2020/21)
• Adjusted income: £260,000 (from 2023/24)

The two-test structure has a specific purpose: the threshold income test provides a quick filter that exempts most people from detailed calculation. If your threshold income is £200,000 or below, you are automatically outside the taper — regardless of what your adjusted income figure looks like. Only if threshold income exceeds £200,000 does HMRC require you to compute adjusted income.

Threshold Income: The First Test

Threshold income = net income minus personal pension contributions

Net income, for this purpose, means your total income for the tax year (employment income, self-employment income, rental income, dividends, interest, and so on) minus:

• Personal pension contributions (those you make from your own funds, not employer contributions)
• Gift Aid charitable donations
• Trading losses brought forward

Importantly, employer pension contributions are excluded from the threshold income calculation. This means that even if your employer makes very large contributions to your pension, those contributions do not inflate your threshold income figure.

Practical implication: An individual earning a salary of £180,000 with no other income is below the £200,000 threshold income limit. Even if their employer contributes £50,000 to their pension, the threshold income test shows £180,000 — and the taper does not apply. Their annual allowance remains at £60,000.

Another implication: Making personal pension contributions reduces threshold income. If your threshold income is, say, £205,000, making a £6,000 personal contribution (which reduces net income by £6,000 after the contribution relief) could bring threshold income to £199,000 — below the trigger point — and remove you from the taper entirely.

Adjusted Income: The Second Test

Only if threshold income exceeds £200,000 must you calculate adjusted income.

Adjusted income = threshold income + all employer pension contributions (including salary sacrifice contributions)

This is where the calculation becomes more complex. Employer contributions — including contributions made under a salary sacrifice arrangement — are added back to the threshold income figure to produce adjusted income.

Why? HMRC is concerned that high earners might avoid the taper by routing all contributions through their employer rather than making personal contributions. The adjusted income test closes this route by counting all pension input — regardless of who makes it.

Worked Example A — Standard Employee:

• Salary: £220,000
• Personal pension contributions: £5,000 (relief at source)
• Employer pension contributions: £20,000

Threshold income = £220,000 − £5,000 = £215,000 (above £200,000 → proceed to adjusted income test)

Adjusted income = £215,000 + £20,000 = £235,000

The taper applies. The tapered annual allowance is calculated as: standard AA (£60,000) minus £1 for every £2 of adjusted income above £260,000.

Since adjusted income is £235,000 — below £260,000 — the taper does not reduce the annual allowance below £60,000. The individual has a full £60,000 annual allowance despite being above the threshold income threshold.

Key insight: Threshold income above £200,000 triggers the second test, but the taper only bites once adjusted income exceeds £260,000.

Worked Example B — Very High Earner:

• Salary: £300,000
• Personal contributions: £0
• Employer contributions: £30,000 (including salary sacrifice)

Threshold income = £300,000 (no personal contributions to deduct) → above £200,000

Adjusted income = £300,000 + £30,000 = £330,000

The taper calculation: £330,000 − £260,000 = £70,000 excess. Taper = £70,000 ÷ 2 = £35,000 reduction.

Tapered annual allowance = £60,000 − £35,000 = £25,000.

The minimum tapered annual allowance is £10,000 (from 2023/24 — raised from £4,000). If the calculation would produce a figure below £10,000, the allowance is capped at £10,000.

Salary Sacrifice and the Taper

Salary sacrifice contributions are treated as employer contributions for adjusted income purposes. This is a frequent source of confusion for employees who believe salary sacrifice is "their" contribution — for threshold income purposes, the salary reduction is what matters; for adjusted income, the contribution made by the employer (following the sacrifice) is added back.

Worked Example C — Salary Sacrifice:

• Contractual salary: £280,000
• Salary sacrifice of £30,000 (so taxable salary = £250,000)
• Employer base contribution: £20,000

Threshold income = £250,000 (no personal contributions — sacrifice is complete)

Adjusted income = £250,000 + £30,000 (sacrifice) + £20,000 (employer base) = £300,000

Taper: £300,000 − £260,000 = £40,000 excess. Reduction = £20,000. Annual allowance = £40,000.

The £30,000 sacrifice increased pension contributions but also increased adjusted income — the taper is not avoided through salary sacrifice for high earners with adjusted income already above £260,000.

Planning to Reduce Adjusted Income

For individuals close to the taper thresholds, there are legitimate planning steps that can reduce adjusted income and therefore increase the effective annual allowance:

Making personal pension contributions to reduce threshold income. As described above, personal contributions reduce the threshold income figure. If this brings threshold income below £200,000, the taper is avoided entirely regardless of employer contributions.

Gift Aid donations. Charitable donations under Gift Aid reduce net income and therefore threshold income. For someone just above the £200,000 threshold income trigger, a modest Gift Aid donation may be sufficient to escape the taper.

Pension contributions from a spouse. If a business owner is facing tapering, having the company make contributions to the spouse's pension (where genuine employment exists) removes those contributions from the business owner's adjusted income while still building pension wealth within the family.

Carrying forward. If the tapered annual allowance is unavoidable, carry forward of unused allowances from the previous three years can supplement the reduced current-year allowance. Carry forward uses the annual allowance that actually applied in each earlier year — not the current tapered figure. If the individual was not subject to tapering in prior years, they may have up to £180,000 of unused allowance to carry forward (three years at £60,000 each, minus any contributions made).

The Money Purchase Annual Allowance and the Taper

The Money Purchase Annual Allowance (MPAA) — triggered when a member begins to access their pension flexibly — takes priority over the tapered annual allowance. Once the MPAA is triggered (£10,000 in 2026/27), the individual's money purchase annual allowance is capped at £10,000 regardless of their income level. The remaining standard annual allowance (up to £50,000) can be used for defined benefit accrual if available — but most affected individuals have only DC pensions.

High earners who have both triggered the MPAA and who would otherwise face tapering should seek regulated advice. The interaction of these two caps is an area where a miscalculation can produce significant and unexpected tax charges.

Self-Assessment Reporting

The tapered annual allowance is not applied automatically by employers or pension schemes. Individuals who exceed the annual allowance — including a tapered allowance — must report the excess through Self Assessment (SA100, pension tax charge pages) and pay the annual allowance charge.

HMRC does allow a "scheme pays" arrangement for annual allowance charges of £2,000 or more: the pension scheme pays the charge on the member's behalf, and the member's pension entitlement is reduced accordingly. This avoids an immediate cash outflow but reduces the pension fund.

The rules for threshold income, adjusted income, and the taper are set out in Finance Act 2004 (as amended). Tax rules change; the figures used in this guide reflect 2026/27 legislation. Rates and thresholds in prior years differ. Always verify current figures with HMRC or a regulated tax adviser.

How Global Investments Can Help

Global Investments advises high earners and business owners on navigating the tapered annual allowance — modelling threshold and adjusted income across multiple scenarios, identifying planning opportunities before the tax year ends, and coordinating pension contributions with salary, bonus, and dividend income.

If your income is approaching or above £200,000 and you want to ensure you are using your pension allowances efficiently, contact our advisory team to arrange a review.