Carried interest reforms and the pension savings annual allowance

This article summarises the issue, focusing on pension schemes that operate on a defined contribution basis, and suggests practical steps that affected individuals and investment management businesses might consider.

Individual and employer contributions to a registered pension scheme are relieved or exempt from income tax (subject, in the case of individual contributions, to a cap equal to the individual’s taxable remuneration). However, if those contributions exceed the individual’s available annual allowance for a tax year, the excess is subject to the annual allowance charge at the individual’s marginal income tax rate. This ‘claws back’ the exemption or relief given to those excess contributions when they were made.

The standard annual allowance is £60,000. But, for individuals whose ‘threshold income’ exceeds £200,000 in a tax year, their annual allowance will reduce by £1 for every £2 of ‘adjusted income’ that they receive above £260,000, subject to a minimum annual allowance of £10,000 (i.e. when their ‘adjusted income’ reaches £360,000).

Broadly, an individual’s ‘threshold income’ is their employment and private income that is subject to UK income tax less their own pension contributions (though special rules can apply to contributions made through ‘salary sacrifice’ or ‘salary exchange’ arrangements), and their ‘adjusted income’ is their employment and private income that is subject to UK income tax plus any employer pension contributions.

For investment managers with a predictable ‘adjusted income’ above £360,000 (e.g. for employees their base salary and bonus, and for members of limited liability partnerships their profit share), the prospective taxation of carried interest as trading profits will not affect their annual allowance, which in any event will already be tapered down to the minimum £10,000.

However, for other individuals, the extent to which their annual allowance might taper down could be difficult to determine until after the end of the tax year due to the potential variability of carried interest receipts which, from 6 April 2026, will be treated as trading profits (and so be included in the calculation of ‘threshold income’ and ‘adjusted income’ for annual allowance tapering purposes).

This means that an amount of carried interest might arise which reduces an individual’s annual allowance after pension contributions made in that year have already exceeded that reduced allowance.

Individuals in those circumstances could be exposed to unexpected annual allowance charges of up to £22,500 (or up to £24,000 for Scottish taxpayers) based on current income tax rates. As time passes, these charges could be even higher as the new carried interest rules reduce any unused annual allowance available to ‘carry forward’ into subsequent tax years to offset against higher contributions. It is important to note that future tax charges on the eventual distributions from the pension scheme will not be reduced to reflect any annual allowance charges imposed on the original contributions. This ‘double tax’ situation could result in effective total tax charges of up to 90 percent (or up to 96 percent for Scottish taxpayers) based on current rates.

It’s also important to bear in mind that ‘investment management services’ are broadly defined by the draft legislation and include incidental or ancillary services. HMRC interpret ‘investment management services’ very widely for the purposes of the current carried interest regime, and state in their published guidance that where an individual works in a business and receives carried interest, this is compelling evidence that the individual performs investment management services.

The potential implications for individuals’ pension savings annual allowances of carried interest being brought wholly within the income tax regime is therefore also relevant to all individuals working for investment houses (including support function professionals) in receipt of carry.

Individuals whose annual allowances could be affected by changes to the tax treatment of carried interest from 2026/27 should review their planned pension savings carefully. This might include considering:

• The level of their regular personal pension contributions;
• The timing of any additional voluntary contributions compared to when carried interest is expected to arise; and
• The extent to which any unutilised annual allowance brought forward from earlier years might be available to shelter contributions.

Any pension savings annual allowance charges would normally be self-assessment matters for the individual concerned (although a ‘scheme pays’ facility is available in certain circumstances). However, points for investment management businesses to consider include whether it would be possible and appropriate to:

• Provide guidance to affected employees or partners, or facilitate their obtaining personal advice, on the potential impact of the carried interest changes on their pension positions;
• Advise affected individuals of estimated amounts of carried interest that are expected to arise to assist with their pension planning; and
• Offer affected defined contribution pension scheme members additional flexibility to vary pension contributions ‘in year’ in response to carried interest reducing their annual allowance.

KPMG has extensive experience assisting individuals and businesses to understand and manage tax aspects of pensions and carried interest. Please contact Alex Thornton, Eli Hillman, Rhys Thomas, Rob Turbervill, or your usual KPMG in the UK contact, to talk through how these prospective changes might affect you personally, or their potential impact on your business.

For further information please contact:

• Alex Thornton
• Eli Hillman