Quick Answer
The tapered annual allowance reduces the maximum pension contribution for directors with adjusted income above £260,000 in 2026/27. For every £2 of adjusted income above that threshold, the standard £60,000 annual allowance falls by £1, down to a minimum of £10,000. Directors taking a mix of salary and dividends often breach the threshold without realising it because dividends count as income in both the gateway and taper calculations.
What Is the Tapered Annual Allowance for Directors?
The tapered annual allowance is an HMRC rule that reduces the standard pension annual allowance for high earners. In 2026/27 the standard annual allowance is £60,000. If your adjusted income exceeds £260,000, that limit falls by £1 for every £2 of income above the threshold, until it reaches a floor of £10,000. The taper has applied in its current form since 6 April 2023, when the Spring Budget raised the adjusted income trigger from £240,000 to £260,000 and the minimum allowance from £4,000 to £10,000.
For most limited company directors running agencies or consultancies below £2 million revenue, the taper is not a live issue. But once a director is drawing salary plus dividends totalling more than £180,000 to £200,000 a year, it becomes something to model carefully. The combination of a salary-dividend extraction strategy and employer pension contributions can push adjusted income above £260,000 without it being obvious from looking at payslips or dividend vouchers alone.
If you are still determining the right salary and dividend split for your 2026/27 tax year, our director salary calculator lets you model different extraction mixes and see the pension headroom available. The optimal director salary guide for 2026/27 explains how the income thresholds interact with your personal tax position.
How the Taper Calculation Works: Step by Step
The calculation has two stages. The first is the threshold income test, which acts as a gateway. Threshold income is broadly your net income — salary, dividends, savings interest, rental income — minus any personal pension contributions you make under relief at source. Post-2015 salary sacrifice amounts are added back in, so you cannot use salary sacrifice to reduce threshold income. If your threshold income is £200,000 or below, the taper does not apply regardless of how large your pension contributions are.
If threshold income exceeds £200,000, the second stage applies: adjusted income. Adjusted income starts with threshold income and adds all employer pension contributions, including amounts contributed by your limited company on your behalf. If adjusted income remains at or below £260,000, there is still no taper. Only when both tests are failed does the reduction begin.
The formula is: Tapered Annual Allowance = £60,000 minus ((Adjusted Income minus £260,000) divided by 2). Three worked examples for 2026/27:
| Adjusted Income | Excess over £260,000 | Reduction | Tapered Allowance |
|---|---|---|---|
| £280,000 | £20,000 | £10,000 | £50,000 |
| £320,000 | £60,000 | £30,000 | £30,000 |
| £360,000+ | £100,000+ | £50,000 (cap) | £10,000 (floor) |
Source: GOV.UK — Work out your reduced (tapered) annual allowance
The Director-Specific Dividend Trap
Most guides to the tapered annual allowance are written with salaried employees in mind. For limited company directors, the income picture is more complex and the taper can bite in ways that are not immediately obvious.
The critical point is that dividends count as income in both the threshold income and adjusted income calculations. A director running an agency in Manchester who takes £50,000 salary and £190,000 in dividends already has £240,000 of threshold income — above the £200,000 gateway. If their limited company then contributes £60,000 to their pension as an employer contribution, adjusted income becomes £300,000, triggering a £20,000 reduction and leaving a tapered allowance of £40,000, not £60,000. The company has contributed £60,000 but the director only had £40,000 of headroom. The excess £20,000 is subject to an annual allowance charge at their marginal rate.
The reason this catches directors out is the asymmetry in the calculations: employer contributions are excluded from threshold income (so they do not fail the first test on their own) but included in adjusted income (so they can fail the second test). A director who passes the threshold income test with room to spare can still find that adding a large employer pension contribution pushes adjusted income above £260,000. Modelling both figures before instructing the pension contribution is essential.
Worked example: the dividend trap
- Director salary: £50,000
- Director dividends: £190,000
- Threshold income (salary + dividends): £240,000 — gateway test FAILED
- Proposed employer pension contribution: £60,000
- Adjusted income (£240,000 + £60,000): £300,000 — taper applies
- Excess over £260,000: £40,000 → reduction of £20,000
- Tapered annual allowance: £40,000
- Excess contribution: £20,000 (subject to annual allowance charge)
Figures are illustrative. Your actual position depends on all sources of income. Always model before contributing.
Pension Annual Allowance
Maximum tax-efficient pension contribution per year
Pension Lifetime Allowance
Lifetime allowance removed from April 2024
Corporation Tax Main Rate
For profits over £250,000
Employer National Insurance Rate
On salaries above £5,000 (secondary threshold). Rate rose from 13.8% to 15% from 6 April 2025.
Tax Planning Strategies for High-Earning Directors
The most effective strategy is to model threshold income and adjusted income before the tax year ends, not after. Once you know which side of the £200,000 and £260,000 lines you are on, the planning options become clearer. If threshold income is below £200,000, employer contributions can be maximised without taper risk. If both thresholds are breached, contributions should be capped at the tapered allowance unless carry forward is available to absorb the excess.
Directors have more control over their income timing than employees. If a large dividend is not needed in the current tax year, deferring it to the following year can keep threshold income below £200,000 and switch off the taper entirely. A Shoreditch-based creative agency director who took £190,000 in salary and dividends in 2025/26 but had a quieter year in 2026/27 could restore the full £60,000 allowance simply by adjusting the dividend declaration in April. This is a legitimate use of the director's discretion over dividend timing.
Where the taper cannot be avoided in the current year, carry forward from prior years can extend the effective allowance. If your tapered allowance was £45,000 in 2024/25 and you contributed nothing, £45,000 carries forward. Combined with the current year's tapered amount, a larger contribution becomes possible. Carry forward is applied against the oldest year first, so you must use 2023/24 unused allowance before drawing on 2024/25.
Watch out: the Money Purchase Annual Allowance
If you have accessed pension savings flexibly — for example by entering drawdown or taking an uncrystallised funds pension lump sum (UFPLS) — the Money Purchase Annual Allowance (MPAA) of £10,000 applies to money purchase contributions. This replaces the tapered annual allowance calculation for money purchase pensions and blocks carry forward. If you are drawing down any pension savings while also building pension contributions through your company, take advice before making further contributions.
Carry Forward and the Tapered Allowance
Carry forward allows you to use unused pension annual allowance from the three preceding tax years. For 2026/27 that means drawing on 2023/24, 2024/25, and 2025/26. There is one important rule: if you were subject to the taper in a prior year, only the unused portion of that year's tapered allowance carries forward — not the full £60,000 standard amount.
As a worked example, suppose in 2024/25 your tapered allowance was £35,000 and you contributed £15,000. You carry forward £20,000 from that year. If in 2025/26 your tapered allowance was £40,000 and you contributed £30,000, you carry forward a further £10,000. In 2026/27, if your tapered allowance is £30,000 and carry forward totals £30,000, your effective allowance for the year is £60,000 — allowing a £60,000 employer contribution with no annual allowance charge.
Carry forward calculations sit alongside your broader annual tax planning. Our annual tax review checklist for directors covers pension carry forward alongside other year-end planning actions.
What Happens If You Breach the Annual Allowance?
If contributions to money purchase pensions exceed the tapered annual allowance (after accounting for any carry forward), the excess is subject to an annual allowance tax charge. The charge is calculated at your marginal income tax rate — 20%, 40%, or 45% — and is reported on your Self Assessment tax return for the relevant tax year.
If the annual allowance charge exceeds £2,000 and the total contributions exceed the standard annual allowance of £60,000, you can ask the pension provider to pay the charge directly from the pension using the "scheme pays" mechanism. The charge reduces your pension fund accordingly. Voluntary scheme pays is available in some circumstances even if the conditions for mandatory scheme pays are not met, depending on your pension provider's rules.
The rules governing the tapered annual allowance are set out in full at HMRC Pensions Tax Manual PTM057100. The GOV.UK calculation tool at pension-schemes-work-out-your-tapered-annual-allowance lets you input your figures and confirm your position for 2026/27. This article on pension contributions for limited company directors covers the mechanics of employer contributions and the corporation tax deduction in detail.
How Alto Accounting Can Help
Alto Accounting is an ACCA registered practice that works with UK limited company directors and agency founders. We help directors model threshold income and adjusted income before year-end, identify carry forward available from prior years, and structure employer pension contributions to stay within the tapered allowance — or use the taper strategically when income can be timed to advantage.
Book a free consultation to review your pension position for 2026/27.
Frequently Asked Questions
Does dividend income count toward the tapered annual allowance?
Yes. Dividends are included in net income for both threshold income and adjusted income calculations. A director taking significant dividends alongside a modest salary can breach the £200,000 threshold income limit without realising it. For example, a director on £50,000 salary and £180,000 in dividends has £230,000 of net income — well above the £200,000 gateway. Once threshold income exceeds £200,000, the adjusted income test applies and tapering may begin.
Can my limited company still contribute to my pension if my adjusted income is above £260,000?
Yes, your company can still make employer pension contributions, but the maximum tax-efficient amount falls as your adjusted income rises. For every £2 of adjusted income above £260,000, your annual allowance reduces by £1 — down to a minimum of £10,000. If your tapered allowance is £30,000 and your company contributes more than that, the excess attracts a tax charge at your marginal rate. You can also use carry forward from prior years to increase your effective limit for the current year.
What is the minimum pension annual allowance under the taper?
The tapered annual allowance cannot fall below £10,000, regardless of how high your income is. This floor is reached when adjusted income hits £360,000 (£260,000 threshold plus £100,000 excess, which produces a £50,000 reduction from the standard £60,000 allowance). A director earning £500,000 adjusted income still has a £10,000 annual allowance.
Can I carry forward unused allowance if I was subject to the taper in previous years?
Yes, but only the unused portion of your tapered allowance carries forward — not the full standard allowance. If your tapered allowance was £35,000 in 2024/25 and you contributed £20,000, you carry forward £15,000 from that year. Carry forward is applied in order from the oldest year first. For 2026/27, you can draw on unused tapered allowance from 2023/24, 2024/25, and 2025/26.
Does salary sacrifice reduce my threshold income for taper purposes?
No. Anti-avoidance rules introduced in 2015 mean that salary sacrifice entered into after 8 July 2015 is added back to threshold income. The income you give up through salary sacrifice is treated as if you still received it, so it cannot be used to bring threshold income below the £200,000 gateway or to reduce your adjusted income calculation.