If you’re considering dipping into your retirement savings to help make ends meet, remember that doing so could limit the amount you can pay into your pension in future.
High living costs continue to place a huge strain on many people’s finances, prompting some to consider taking money out of their pensions to help cover essential bills.
However, although your retirement savings might provide you with a valuable financial lifeline now, accessing your savings may prevent you from rebuilding them at a later date.
Here, we explain how pension annual allowances work so that you don’t fall foul of the rules. And if you’re planning to take money out of your pension, you can read more about the implications of doing so in our article Should I use my pension to boost my income?
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
Contents
- Pension allowances
- How much is the Annual Allowance in 2024/25?
- What counts towards the pensions annual allowance?
- What happens if I exceed the Annual Allowance?
- Does my Annual Allowance stay the same once I’ve started taking money from my pension?
- What’s happened to the Lifetime Allowance?
- Get expert help
Pension allowances
One of the best things about a pension is the tax relief you get on any contributions you or your employer make, but there are limits to the taxman’s generosity.
When you or your employer pay into a pension, you’ll get tax relief at the basic tax rate of 20%. So, for every £80 that goes into your pension, the taxman will boost this to £100. If you’re a higher or additional rate taxpayer, you can claim back an extra 20% or 25% in tax relief on top of the 20% basic rate relief through your tax return.
The amount you can save into a pension and earn tax relief on is capped each year, known as your Annual Allowance. There was also a Lifetime Allowance, which was the total amount you can save into a pension without being hit by a tax charge. However, this was abolished at the start of the 2024/25 tax year. You can learn more about this in our guide What is the pension Lifetime Allowance and when was it abolished?
How much is the Annual Allowance in 2024/25?
If you pay into a defined contribution pension, sometimes known as a money purchase pension, you can pay in up to 100% of your earnings into your pension each tax year, up to a maximum Annual Allowance of £60,000 in the 2024/25 tax year. It will remain at this level in the 2025/26 year which begins on 6 April 2025. If you have a defined benefit or final salary pension, the Annual Allowance relates to the total amount of benefits you can build up in your scheme each year for tax relief purposes.
You can also ‘carry forward’ any unused Annual Allowance from the last three years as long as you were enrolled in a pension scheme during that time. This can be helpful if you have a big lump sum that you want to invest one year. You can find out more about how carry forward rules work in our guide Pension carry forward explained.
Tapered Annual Allowance for high earners
If you’re a particularly high earner, you may also get a lower Annual Allowance. For every £2 of income you receive over £260,000 in the 2024/25 tax year – you’ll lose £1 of your annual allowance, so if your adjusted income is over £360,000, your annual allowance will be £10,000.
What counts towards the pensions Annual Allowance?
Many of us have more than one private pension, so it’s important to remember that your Annual Allowance applies to all of your private/personal pensions, including all money paid into both defined contribution schemes (by you and your employers) and defined benefit schemes.
If you transfer a pension from one provider to another, this shouldn’t eat up any of your Annual Allowance, as this will be money you have paid in during previous years.
What happens if I exceed the Annual Allowance?
If you pay more than the Annual Allowance into your pension, you’ll have to pay what’s known as an Annual Allowance charge. HMRC has a useful Annual Allowance calculator to help you work out whether you have to pay tax on your pension savings.
The Annual Allowance charge isn’t a set rate – the amount you’ll pay will depend on which income tax bracket you’d fall into if your excess pension savings are added to any other taxable income you get. That means the charge could be 20%, 40% or 45% of any pension savings you made above the Annual Allowance, depending on your circumstances.
If you think you may have paid in more than your Annual Allowance, it’s always worth checking your contributions over the last 3 years to see if you may have some unused Annual Allowance from prior years that you could carry forward before having to pay additional tax.
If you think you may have paid in more than your Annual Allowance, it’s always worth checking your contributions over the last three years to see if you may have some unused Annual Allowance from prior years that you could carry forward before having to pay additional tax. Find out more in our guide Pension carry forward explained.
Does my Annual Allowance stay the same once I’ve started taking money from my pension?
No, once you’ve started taking money out of your defined contribution pension, your Annual Allowance falls from £60,000 to £10,000 in the 2024/25 tax year and becomes known as the Money Purchase Annual Allowance (MPAA). However, if you take a 25% tax-free lump sum out of your pension but not any income, you can still hang onto your full Annual Allowance.
Stephen Lowe, group communications director at retirement specialist Just Group, said: “Anyone who’s taken a flexible payment from their pension, perhaps to carry them or their family through the cost of living crisis, now has more headroom to boost their pension savings and clears them from the tax tangle that the previous low allowance created.”
Find out more about the MPAA in our article What is the Money Purchase Annual Allowance?
It’s worth noting that if you have a small pension you may be able to cash it in without this affecting how much you can save into another pension and receive tax relief on. Learn more in our guide Cashing in small pensions: what you need to know.
What’s happened to the Lifetime Allowance?
The Lifetime Allowance was the maximum you can save in your pensions over your lifetime, without having to pay any extra tax charges when you take money out of them. It was originally due to remain frozen at £1,073,100 until April 2026. However, the Lifetime Allowance was abolished in the 2024/25 tax year.
The maximum pension tax-free cash lump sum that you can take at retirement has been capped at £268,275, or 25% of the former Lifetime Allowance. This means that even though it’s now possible to build a larger pot without incurring a tax charge, your tax-free cash lump sum won’t increase with it.
Under previous rules, any amount over your Lifetime Allowance taken as a lump sum, for example, was taxed at a rate of 55%, whereas if you make cash withdrawals or receive the money as pension payments, you’d be taxed an additional 25% on top of any regular tax payable on your pension income. However, the abolishment of the Lifetime Allowance means that incurring a tax charge won’t be a concern for those savers who may have breached this limit.
Get expert help
If you’re concerned about managing your pension allowances, you might want to get advice from a qualified financial adviser. If you’re 50 or over and have a defined contribution pension, you can get free guidance on the options available to you from the Government’s Pension Wise service.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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