Saving into a pension is one of the most tax-efficient ways to save for your retirement. Not only do your pensions enable you to grow your retirement savings largely free of tax, but they also provide tax relief on the contributions you make.
There are various pension allowances in place that you need to be aware of and understand how to make the most of them. These limit the amount of money you can contribute to a pension in a year, as well as the total amount of money you can build up in your pension accounts, while still enjoying the full tax benefits.
What is the Lifetime Allowance?
All your pensions, including workplace pensions, count towards the Lifetime Allowance, with the exception of the State Pension and overseas pensions. The standard Lifetime Allowance is currently £1,073,100. However, the Lifetime Allowance charge will be removed from 6 April 2023, before fully abolishing the Lifetime Allowance in a future Finance Bill.
For more detail on the Lifetime Allowance, please visit our dedicated Lifetime Allowance page.
If I’m a non-earner or earn less than £3,600 can I still pay into a pension?
If you have no earnings or earn less than £3,600 a year, you can still pay into a pension scheme and qualify to receive tax relief added to your contributions up to a certain amount. The maximum you can contribute is £2,880 a year. Tax relief is added to your contributions, so if you pay £2,880, a total of £3,600 a year will be paid into your pension scheme, even if you earn less than this or have no income at all.
This applies if you pay into a personal or stakeholder pension yourself, so not through an employer’s scheme, and with some workplace pension schemes – but not all. The way some workplace pension schemes give tax relief means that people earning less than the personal allowance (£12,570 in the 2021/22 tax year) will not receive tax relief.
How does the Money Purchase Annual Allowance work?
The Money Purchase Annual Allowance (MPAA) rules were introduced as an anti-avoidance measure to prevent widespread abuse of the pension freedoms which commenced from 6 April 2015. It is intended to discourage individuals from diverting their salary into their pension with tax relief and then immediately withdrawing 25% tax-free.
The MPAA applies only to money purchase contributions and has remained at £4,000 since 6 April 2017. However, the Money Purchase Annual Allowance will rise to £10,000 from 6 April 2023. If you have taken flexible benefits which include income, such as an ‘Uncrystallised Funds Pension Lump Sum (UFPLS)’ or flexi-access drawdown with income, and you want to continue making contributions to a defined contribution pension scheme, you will have a reduced annual allowance of £4,000 annually towards your defined contribution benefits.
What is the Annual Allowance?
The pension Annual Allowance is the maximum amount of money you can contribute towards a defined contribution pension scheme in a single tax year and receive tax relief on without suffering a tax charge (separate issue to tax relief). All contributions made to your pension by you, your employer or any third-party, as well as any tax relief received, count towards your Annual Allowance.
The Annual Allowance is currently £40,000 and applies to all funding from all sources – any excess is subject to tax (paid by the member or by the pension scheme if eligible). Please note that the government is set to increase the Annual Allowance to £60,000 from 6 April 2023. The limit on personal tax relievable contributions is 100% earnings/£3,600 if more. Employer contributions are tax relievable as long as within the wholly and exclusively requirements.
A lower Annual Allowance may apply, however, if you are a high earner or you have already started accessing your pension flexibly. High earners may potentially be subject to the Tapered Annual Allowance, while those who have already started accessing their pension flexibly potentially face the Money Purchase Annual Allowance (MPAA).
Can I take advantage of Carry forward?
Carry forward is a way of increasing your pension Annual Allowance in the current tax year. It is used when your total contribution amount, including personal, employer’s and third party contributions exceed your annual pension Annual Allowance limit for that year.
You can do this by carrying forward unused allowances from the three previous tax years to make contributions this year. This may enable you to absorb or reduce any pension Annual Allowance excess paid in the current tax year which, in turn, would reduce any potential Annual Allowance charge amount. The 2021/22 tax year allows use of unused allowances from 2018/19, 2019/20 and 2020/21, as long as you held a pension plan in those years.
What is the Tapered Annual Allowance?
The Tapered Annual Allowance calculations will now not affect anyone with a Threshold Income level of £200,000 or below. The taper starts in this tax year at £240,000 (2021/22) and is extended to a minimum of £4,000 Annual Allowance. However, the minimum Tapered Annual Allowance is due to increase from £4,000 to £10,000 from 6 April 2023. This reduces the level of pension funding high earners and their employers can make into pension schemes, without causing a tax charge to fall on the employee (which, in some cases, can be paid out of the scheme funds).
If high earners exceed the threshold and adjusted income amounts, their Annual Allowance may be reduced by £1 for every £2 of adjusted income over £240,000 (increasing to £260,000 from 6 April 2023) until the minimum annual allowance level of £4,000 is reached. The maximum Tapered Annual Allowance reduction is £36,000, if using carry forward, the lower tapered Annual Allowance thresholds apply for 2018/19 and 2019/20.
Last updated: March 2023
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