Pension Annual Allowance guide

The pension annual allowance is a crucial aspect of retirement saving, determining how much money you can contribute to your pension each tax year while still benefiting from tax relief.

Getting a clear understanding of the pension annual allowance and it’s implications for different income levels is important.

Our pension annual allowance guide highlights the various scenarios in which your annual allowance might be reduced or exceeded so you can better plan your pension contributions and avoid any unnecessary income tax charges.

What is the Annual Pension Allowance?

The pension annual allowance is the limit on how much money you can contribute to your pension in any one tax year while still benefiting from tax relief.

It’s essential to note that the annual allowance is not the maximum pension contributions you can make; you are still allowed to make higher contributions but you won’t normally receive tax relief on those contributions exceeding the pension annual allowance.

How much is the Annual Pension Allowance?

The current annual allowance for most people is £60,000 which is an increase of £20,000 from the previous allowance.

The annual allowance is applicable to all your pension savings collectively and isn’t given per pension scheme. If you exceed it a tax charge is typically made which recovers any excess tax relief that was automatically granted at source.

Pension Annual Allowance Calculator

The annual allowance calculation varies depending on the type of pension scheme you have.

In general the calculation is based on the contributions made by you, your employer, and any third party on your behalf.

Defined Contribution Pensions: For defined contribution pensions, the annual allowance is calculated based on the total of:

• Your own contributions (plus any tax relief you receive).
• Any employer contributions.
• Any contributions made on your behalf by someone else.

Defined Benefit Pensions: For defined benefit pensions, the annual allowance is calculated based on the capital value of the increase in your pension benefits over the tax year. You can request this information from your pension provider.

The pension annual allowance only covers 100% of your earnings up to the £60,000 limit. If your earnings are below the £60,000 threshold you will only receive tax relief on the actual amount you earn.

HMRC provides a free pension annual allowance calculator so you can check if you have to pay income tax on your pension savings.

Tapered Annual Allowance for higher earners

The tapered annual allowance is a gradual reduction of the annual allowance for high earners with an income above £200,000 a year.

It currently can reduce the annual allowance for high earners to as low as £10,000 per tax year.

Money Purchase Annual Allowance

The money purchase annual allowance (MPAA) is a reduced annual allowance of £10,000 that might apply if you’ve taken more than the amount you’re entitled to take tax free through flexible retirement income or as a lump sum.

Carry Forward of Unused Annual Allowances

You may be able to contribute more than your yearly limit to your pension and still take advantage of income tax breaks by utilising any unused annual allowances.

This process is called carry forward and is restricted to carrying forward surplus allowances from a maximum of the three previous tax years.

Exceeding the Pension Annual Allowance

If you go over the yearly limit during a specific tax year tax relief will not be granted for contributions exceeding the annual allowance threshold and you will incur an annual allowance charge.

Pension Annual Allowance Charge

The annual allowance charge is a tax charge applied when you exceed the annual allowance in a particular tax year.

The sum by which you’ve gone over the annual allowance will be combined with your remaining taxable income for that tax year and will be liable to income tax at the applicable rate(s) for you.

It can be possible to request that your pension plan covers the fee directly from your pension by using an option called scheme pays.

This method would result in a reduced pension and it’s not always possible so you’ll need to check with your provider first.

How do I pay the Annual Pension Allowance Tax Charge?

HMRC expects you to complete a self assessment tax return to calculate and pay the annual allowance tax charge.

If you don’t already complete a tax return you should register for self assessment from the first tax year you have incurred the annual allowance charge.

A tax return is still required even if your pension provider has paid some or all of the annual allowance charge for you.

You will need to complete the pension savings tax charges section of your tax return and include the portion of your overall pension savings that surpasses your annual allowance (after accounting for any carry forward figure).

In addition if you’re utilising scheme pays you should enter the annual allowance tax fee that the trustee will cover for you as well as the plan’s pension scheme tax reference number.

Your plan’s pension scheme tax reference number can be located on your pension savings statement.

Carry forward to reduce or remove the Annual Allowance Charge

If you’re not bound by the money purchase annual allowance (MPAA) you may have the option to carry forward any unused annual allowances from the past three tax years to either decrease your annual allowance charge to a lesser sum or eliminate it entirely.

Pension savings statement

If the total savings to one of your pensions exceed the standard or money purchase annual allowance in a tax year your provider must send you a pension savings statement which will give you a breakdown of the relevant figures.

Higher rate Pension Tax Relief

All individuals contributing to their personal retirement fund are eligible for tax deductions, however if you’re in a higher income tax bracket you may not be receiving the full benefits.

The government provides tax deductions on private pension scheme contributions to incentivise individuals to save for their retirement.

The amount deducted corresponds to the highest tax rate you’re subjected to.

A standard tax relief of 20% on your pension is automatically provided but if you’re a higher rate taxpayer the responsibility to claim the remaining relief falls on you.

The extra tax relief you’re allowed to claim is typically 20% of your contributions, bringing the total to the 40% tax rate you’re presently paying as a higher rate tax payer.

Our complimentary pension tax relief calculator is available for you to estimate the amount you might recover.

Pension Tax Advice

Seeking professional advice from a regulated tax or financial adviser can provide further clarity and guidance on your pension contributions and the effects on your income tax position.

Pension advice tailored to your specific circumstances can help you make informed choices on your retirement savings and keep your income tax bill to a minimum.