Whilst salary sacrifice might seem a good idea, it doesn’t help individuals subject to the Tapered Annual Allowance since any contribution paid to a pension scheme by an employer as a result of a salary/bonus sacrifice, or any pension deducted under a net pay arrangement is included within the definition of "adjusted annual income".

Individuals whose adjusted annual income exceeds £150,000 and whose threshold income exceeds £110,000 will have a reduction in their annual allowance by £1 for every £2 of income above the limit. The annual allowance tapers down to a minimum of £10,000 for those individuals whose income exceeds £210,000.

Calculating an individual's adjusted income is no easy matter. Firstly, there is unlikely to be certainty of income until close to the tax year end. Secondly, the definition is wide and takes into account the following:

  • The total amount of income for the tax year on which an individual is subject to income tax, which will include salary, bonus, profits from self-employment, benefits in kind, pension income (including uncrystallised funds pension lump sums), income from property, savings, dividends and taxable lump sum death benefits (post 5 April 2016)
  • Less certain allowances and reliefs, e.g. excess tax relief under net pay pension schemes (where full tax relief is not available through payroll), pension scheme tax relief upon making a claim (e.g. in relation to a Retirement Annuity Contract), gifts to charities and trade losses
  • Plus any pension scheme tax relief deducted in the previous bullet-point
  • Plus any employee pension contributions deducted from gross salary (net pay arrangements) in the tax year the payment is made
  • Plus the value of any employer contributions (which includes any employer contributions as a result of a salary sacrifice for the tax year
  • Less any lump sum death benefits paid to individuals in the tax year which were taxable at the individuals marginal rate (i.e. taxable lump sum death benefits received on or after 6 April 2016).

However, to protect individuals who may experience spikes in their earnings or contributions, a further test is necessary to see if the individual first exceeds a threshold income test. This is set at £110,000 and includes the following:

  • The total amount of income for the tax year on which an individual is subject to income tax, which will include salary, bonus, profits from self-employment, benefits in kind, pension income (including uncrystallised funds pension lump sums), income from property, savings, dividends and taxable lump sum death benefits (post 5 April 2016)
  • Any salary sacrifice or flexible earnings set up on or after 9 July 2015.

The individual is able to deduct personal pension contributions where HMRC has granted relief. Employer contributions do not need to be included and any lump sum death benefit on which income tax is payable can also be deducted.