You can pay in 100% of your earnings into your pension each year, up to a maximum of £40,000 – any contributions you make that exceed this limit won’t be eligible for tax relief.
Tax relief is one of the biggest perks of paying into a pension, but the taxman’s generosity has a limit.
If the value of your pension contributions exceeds your Annual Allowance in any particular tax year, you’ll need to pay a tax charge on the amount above the limit, at your marginal rate of income tax. So while you can technically pay in as much as you like into your pension each year, you might want to think twice before you do so.
Here’s what you need to know.
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.
What is the Annual Allowance?
The Annual Allowance is the limit on how much you can pay into a private pension each year and still benefit from tax relief.
If you are a UK taxpayer, you can get tax relief on pension contributions of up to 100% of your earnings each year, up to a cap of £40,000, but if your total contributions exceed the Annual Allowance, you won’t get this tax relief anymore. You can find out more about how tax relief works in our guide How pension tax relief works.
The Annual Allowance includes all contributions into all private pension pots. This means that it’s not just your contributions you need to think about, but also any contributions your employer or anyone else makes on your behalf.
Some people may have a higher or lower Annual Allowance. For example, if you earn over £240,000 a year or if you are flexibly accessing your pension pot, then you might have a lower Annual Allowance, as for every £2 of income you receive over this threshold, you’ll lose £1 of your Annual Allowance, down to a minimum of £4,000. Whereas, if you didn’t use up your full Annual Allowance at any point in the last three years, you might be able to carry over any allowance you didn’t use. You can find out more about this in our guide Pension carry forward explained.
If your annual pension contributions exceed the Annual Allowance then you will need to pay what is known as the pensions Annual Allowance charge. The amount you will pay is not a fixed, and HMRC has an Annual Allowance Calculator so you can work out what you might need to pay if you exceed the limit.
As soon as you start taking money out of your defined contribution pension, your Annual Allowance reduces from £40,000 to £4,000 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 keep your full Annual Allowance. Learn more about the MPAA in our guide What is the Money Purchase Annual Allowance?
What is the Lifetime Allowance?
When paying into your pension, you’ll also need to consider the Lifetime Allowance.
The Lifetime Allowance is the maximum amount that you can save into your pensions over your lifetime, without having to pay any extra tax charges when you take money out of them.
For each of the 2021/22 and the 2022/23 tax years, the Lifetime Allowance is £1,073,100, so if your pension pots, including all growth from investments, are worth more than this amount, you will pay a tax charge when you start taking an income from your pension. The Lifetime Allowance does however ignore any income coming from the State Pension.
If your pension pots are worth less that the Lifetime Allowance, you do not need to worry about paying tax other than income tax where relevant, but if your pension pots are worth more this Allowance, then the amount of tax you need to pay will depend on how you take your pension:
- If you take your pension as a lump sum, you will pay 55% of that lump sum if you take your pension as a lump sum
- If you take your pension in any other way, for example pension payments or cash withdrawals you will pay 25% plus income tax at your marginal rate.
If you are concerned about whether you are going to exceed the allowance, you should contact your pension provider and ask them to check how much of your allowance you have used and what your pension is projected to be when you retire so you can plan accordingly.
There are ways that you might be able to protect your Lifetime Allowance, which you can read about in our article What is the pension Lifetime Allowance?
Where to go for more help
If you need more advice on how these allowances might affect your pension contributions, you might consider seeking professional financial advice. Some people may decide, for example, that even though they might face a tax charge because they’ve reached the Annual or Lifetime Allowances, they want to continue paying into their pension to continue to benefit from their employer’s contributions, or because they would lose valuable life insurance benefits from their pension by opting out. A financial advisor can help compare any tax charges you might have to pay if you exceed your pension allowances with any losses if you were to opt out.
You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.
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.