Stealth pension tax trap set to catch 600,000 amid frozen thresholds

More than 600,000 taxpayers could be affected by the pension taper by 2032 if Labour keeps income thresholds frozen

More than 600,000 taxpayers could be affected by the pension taper by 2032 if Labour keeps income thresholds frozen

More than 600,000 high earners across Britain could be caught by pension tax rules by 2032 if the Government continues to freeze key income thresholds.

The number of taxpayers affected by the pension tapered annual allowance will continue to rise as fiscal drag pulls more people into the system, analysis shows.

HM Revenue and Customs (HMRC) data reveals around half a million earners are already affected by the taper in the current tax year ending in April, according to research by pension consultancy Barnett Waddingham for the Financial Times.

The analysis found that if the Government leaves the thresholds unchanged, a further 114,000 taxpayers will be affected within the next five years.

That would take the total number of higher earners caught by the taper to more than 600,000, representing an increase of more than one fifth.

The pension tapered annual allowance reduces the amount some higher earners can contribute to their pension while still receiving tax relief.

For most taxpayers, the standard annual pension contribution allowance is £60,000.

However, once an individual's adjusted income, which combines taxable earnings and pension contributions, exceeds £260,000, that allowance begins to reduce.

The allowance continues tapering until it reaches a minimum of £10,000.

Anyone who exceeds their available allowance could face an additional tax charge.

The £200,000 income threshold at which the taper starts has remained frozen since 2020 as successive Governments have sought to increase tax revenues.

Had that threshold risen in line with inflation, it would now stand at more than £254,000.

Wage growth has increased even faster over the same period, meaning more taxpayers are being drawn into the taper through fiscal drag.

The standard annual pension contribution allowance was increased from £40,000 to £60,000 in 2023, partly offsetting the impact of the frozen threshold.

Tyron Potts, head of pensions research at Barnett Waddingham, said: "For high earners, annual allowance tapering can swiftly and stealthily erode pension tax relief, so understanding your adjusted income and how the taper applies will be essential to avoiding an unexpected tax bill."

He added that a single bonus or one-off payment could be enough to push someone above the threshold.

Not all experts believe the impact will be significant for most taxpayers.

Sir Steve Webb, former pensions minister and partner at consultancy LCP, said: "A combination of a much higher starting allowance and a more gentle taper mean that the impact is marginal for most people."

He added that the frozen threshold "is likely to be much less of an issue than it used to be".

The Treasury defended the policy, saying the tapered annual allowance "only applies to the highest-earning savers, ensuring the benefits of pension tax relief are targeted fairly towards those who need them most".

The changes come as further tax measures affecting pensions are due to take effect in the coming years.

From April 2027, unused pension pots will be brought within the scope of inheritance tax for the first time.

Mr Potts warned that higher earners could face pressure on their pension savings from multiple directions.

He said: "Those affected risk seeing the tax advantages of pensions eroded both on the way in and on the way out, potentially leaving less overall for their families and loved ones."

The Government has also frozen other income tax thresholds, including the point at which personal allowances begin to be withdrawn for those earning more than £100,000.

That can result in some taxpayers facing effective marginal tax rates of as much as 62 per cent once national insurance contributions are taken into account.