Two colleagues, one pension scheme, very different outcomes

Figures relate to tax year 2025-26 (UK) · 2025 (US)

Two people sit in the same office on the same salary. One pays into the pension and saves tax at the top rate.

The other does the same and finds a charge waiting. The difference is the annual allowance taper, and it bites hardest in a bonus year.

Then there is a second difference nobody mentions. One of them is American, and the relief that makes a UK pension attractive works differently for them.

Key takeaways

• The annual allowance caps pension saving that gets tax relief.
• High earners see the annual allowance tapered down sharply.
• Two income measures decide whether the taper applies.
• Employer contributions count towards the limit.
• Unused allowance can be carried forward three years.
• Exceeding it produces a charge at your marginal rate.
• Americans get the British relief but a smaller net benefit.
• A bonus year is when the taper usually catches people.

What is the annual allowance?

A cap on how much can go into your pensions each year with tax relief. Per GOV.UK guidance on the limit, the standard figure is £60,000 for 2025-26 and it counts everything, including what your employer puts in. Go above it and a charge claws back relief you never qualified for.

The cap covers the total going in, not just the part you personally contribute from your salary.

That surprises people whose employer contributes generously on their behalf each year.

What is the taper?

A reduction in that cap for high earners, falling away as income rises. Once you cross the thresholds, the allowance drops by £1 for every £2 of excess income, down to a floor of £10,000. So the people with most capacity to save are given the least room in which to do it.

The reduction happens automatically rather than on application, and nobody writes to warn you.

Most people discover it from a scheme statement long after the year has ended.

What are threshold and adjusted income?

Two separate measures you have to pass before the taper applies. Threshold income is broadly your income before pension contributions, and adjusted income adds employer contributions back in. You only taper if both exceed their limits, which is why the test catches some people and spares others earning the same.

Working out both figures accurately is the whole exercise, and estimates rarely suffice.

Small differences in how a scheme counts a benefit can move you either side of the line.

Why does a bonus year catch people?

Because a one-off payment can push both measures over at once. Somebody comfortably inside the limits in a normal year can find themselves tapered to the minimum because of a single bonus or a share vesting. Contributions that looked fine in March turn into a charge in April.

Our guide to UK bonus payments on a US return covers the wider effect of bonuses.

Contributions usually carry on automatically while the annual allowance quietly collapses.

A worked example

Take an illustrative example. An American in London earns £150,000 with a £60,000 bonus and a generous employer pension contribution.

Her adjusted income passes the threshold comfortably, so the taper cuts her allowance towards the floor.

Total contributions for the year still reach £48,000, because nothing in the payroll changed.

The excess over her tapered annual allowance produces a charge at her marginal rate, on money she never saw and cannot touch for decades.

How the taper reduces the cap

Can you carry forward unused allowance?

Yes, from the previous three tax years, which is the main relief available. You use the current year first and then the oldest unused year, and you must have belonged to a scheme in each year you draw on. Carry forward frequently rescues somebody facing one unusually large year.

Our guide to employer pension contributions covers how contributions are counted.

A running record of unused annual allowance makes this far easier when you need it.

What happens if you exceed it?

A charge arises at your marginal rate on the excess, and you report it through Self Assessment. In larger cases you can ask the scheme to pay it from your pension instead, which preserves your cash but reduces the pot. Neither option is pleasant, and you have to choose one actively.

Our guide to registering for Self Assessment covers the return it goes on.

Deadlines apply to asking the scheme to pay, so do not leave it until the last minute.

How does this differ for an American?

The British relief works the same way, but the net benefit is smaller. A British colleague saves tax at their top rate with nothing else to consider. An American also has an American return, where the relief may not be matched and where the credit position changes once British tax falls.

Our guide to UK pensions and US tax covers the treaty treatment.

The pension still beats the alternatives, but by a narrower margin than the headline relief suggests.

Does America recognise the contributions?

Through the treaty, generally yes, which is the good news. A qualifying UK scheme can attract relief on the American side too, within limits, so the position usually works. The detail matters though, and it turns on the kind of scheme and the kind of contribution.

Our guide to salary sacrifice for US citizens covers one common structure.

A scheme falling outside the treaty definitions produces a far worse answer.

Does the exclusion complicate it?

It can, because the earnings exclusion and pension relief interact awkwardly. Excluding salary from American tax removes the income that relief would have offset, so the two partly cancel. Somebody leaning heavily on the exclusion gets less from a pension contribution than they expect.

Our guide to the foreign earned income exclusion covers the claim.

Modelling both reliefs together is the only way to see your real position.

What about the credit position?

Cutting your British tax bill cuts the credit available against the American one. Pension relief cuts British tax, so somebody relying on credits loses part of the benefit on the other side. The effect matches any other British relief.

Our guide to Form 1116 and the foreign tax credit covers the mechanism.

Where surplus credits exist, this rarely costs anything at all.

What is the money purchase allowance?

A much lower cap, which bites once you flexibly access a defined contribution pension. Taking taxable income from a pot flexibly cuts your annual allowance for future contributions sharply and permanently. Nothing reverses it, which makes a casual early withdrawal expensive.

Our guide to pension lump sums on a US return covers taking money out.

Taking even a small flexible payment can close down future saving entirely.

Does it apply to a defined benefit scheme?

It does, and the measurement is quite different. Instead of counting contributions, you measure growth in your promised benefits over the year using a set formula. A promotion in a final salary scheme can produce an enormous notional input with no cash changing hands.

Our guide to teachers' pensions and US tax covers one such scheme.

Public sector members meet this rule more often than anybody else.

What about the NHS and other public schemes?

They are a common source of charges, particularly for senior clinicians. Defined benefit growth plus high income produces exactly the pattern the taper targets. Successive governments have introduced mitigations over the years, with mixed success.

Scheme statements arrive late, so the first warning often comes after the tax year closes.

Americans in those schemes carry the British charge and the American reporting together.

Should you stop contributing?

Sometimes, though it is rarely the first answer. Cutting contributions to stay inside a tapered annual allowance can make sense once carry forward runs out. Giving up an employer match to dodge a charge is usually a false economy, because the match outweighs the charge.

Work out the match value before changing anything in the payroll.

Opting out of a scheme carries consequences that outlast the year worrying you.

Can you use salary sacrifice around it?

Sacrifice cuts threshold income, which can keep you below one of the two tests. It does not cut adjusted income the same way, because the test adds employer contributions back. So it helps some people and not others, depending on which test they fail.

Our guide to UK share incentive plans covers a related payroll structure.

The American treatment of sacrifice raises a separate question worth settling first.

What records do you need?

Pension savings statements from every scheme, your P60, details of any bonus, and a note of unused allowance from earlier years. Those four let anyone work out the position properly. Schemes issue statements automatically only above certain levels, so you may need to ask.

Request a statement from each scheme rather than waiting for one to arrive on its own.

Deferred pots from former employers are the ones people forget.

When will you know the figure?

Often not until well after the year has ended, which is the practical problem. Defined benefit input values take time to calculate, and statements arrive late. So you plan on estimates during the year rather than on certainties afterwards.

Estimating in January and checking in July is a reasonable rhythm for somebody near the limits.

Waiting for the statement means the year is already closed when you learn the answer.

Does it affect your American filing?

The charge itself counts as British tax, so it raises the British tax available as a credit. The contributions and the scheme may also need reporting, depending on the arrangement. So the taper makes your American return slightly better and your paperwork slightly worse.

Our guide to retiring to the UK covers the longer view.

A charge you pay in Britain is not wasted from an American perspective.

Does the annual allowance apply if you leave Britain?

It applies for any year you are contributing to a UK scheme with British tax relief, so somebody who leaves partway through a year still has a calculation to do for that year. Once you stop contributing the question falls away, though the pot itself carries on and the American reporting continues regardless.

Our guide to moving back to the US covers the departure year.

The year of departure is usually the messiest one to work out.

Is the annual allowance the same as the lifetime limit?

No, they are separate controls doing different jobs. The annual allowance caps what goes in each year, while the lifetime rules governed what the pot could grow to before being drawn. The lifetime allowance itself has been dismantled and replaced by limits on tax free lump sums instead.

So advice written before the change can be badly out of date on this point.

Check the date on anything you read about lifetime limits.

What if two schemes both contribute?

You add them together, because the cap applies to you rather than to each arrangement. Somebody with a workplace scheme and a personal pension counts both, and a mid-year job change frequently produces two sets of contributions in one tax year. That overlap is a common cause of an unexpected charge.

List every scheme that received money during the tax year before calculating anything.

A new employer rarely knows what the previous one contributed.

Can your employer help with the charge?

Some do, usually by offering cash instead of a contribution once you are tapered. Taking salary rather than pension avoids the charge but gives up the tax advantages entirely, so it is a trade rather than a solution. Whether it suits you depends on your marginal rates in both countries.

Ask what alternatives the scheme offers before assuming contributions must continue.

Americans should price the cash alternative on both returns before accepting it.

When should you start watching the annual allowance?

From the first year your total income approaches the thresholds, rather than from the year a charge appears. The taper depends on figures that are only final after the year ends, so anybody within reach of the limits benefits from a rough calculation each autumn while there is still time to change contributions.

An estimate made in October is worth far more than an exact figure the following September.

By the time a scheme statement lands, every decision for that year has already been made.

How to work out your tapered allowance

1. Add up every contribution for the year, employer ones included.
2. Calculate threshold income before pension contributions.
3. Calculate adjusted income, adding employer contributions back.
4. Check whether both measures exceed their limits.
5. Reduce the allowance by £1 for every £2 of excess income.
6. Apply the floor and compare the annual allowance against total contributions.
7. Use carry forward from the three previous years if available.
8. Decide whether to pay any charge yourself or from the scheme.

Mistakes and penalties we see with the annual allowance

The first is forgetting that employer contributions count towards the same cap you are measuring against.

The second is leaving a deferred scheme out of the calculation entirely.

The third is taking a small flexible payment from a pot and closing down future contributions permanently.

The fourth is opting out of an employer match to dodge a charge that costs less than the match was worth.

How US UK Tax Accountants helps

We work out both income measures properly, because the taper turns on definitions rather than on your salary, and a small misclassification moves you across the line.

Then we model the American side alongside it. Our pensions service covers the whole position.

If you are near the limits and a bonus is coming, get in touch before the contributions are made.

Last reviewed 24 October 2026. This article is general information and not personal tax advice, and pension limits change frequently.

For the neighbouring question, Britain stopped capping the pot and started capping the cash walks through it in detail.