This article should not be taken as tax advice as the information is not applicable to all types of pension and does not consider factors that are specific to certain individuals. For more tailored guidance please get in touch or contact your pension provider.
Pensions are a form of tax-free retirement savings. Broadly speaking, you will receive full tax relief on the income that you use to fund your pension and then, at the age of 55, you can start to withdraw it. You can withdraw 25% of your pension tax-free, the remaining 75% is subject to your applicable income tax rates. It is important to note that early withdrawals (pre-age 55) are taxed punitively at 55%.
But… there are limitations to the amount you can contribute towards your pension tax-free. This is on an annual and lifetime basis.
The Annual Allowance
Currently (UK tax year 2018/19), the average taxpayer can pay £40,000 into their pension tax-free. It is worth mentioning that this total includes contributions made on behalf of the taxpayer e.g. contributions made by your employer.
NOTE: As of 6th April 2018, employers are required to contribute a minimum of 2% of an employee’s pensionable salary (increasing to 3% on 6th April 2019).
When calculating your total contributions in a particular tax year you must use the gross contribution made to all schemes (it is not a limit per scheme).
NOTE: For individuals who pay into a personal pension scheme, it is likely that you will pay into your scheme with net income. The pension scheme will then claim 20% tax relief directly from the UK government (known as relief at source). Any further allowable tax relief is claimed through your tax code or via a self-assessment tax return. A taxpayer’s “gross contribution” is their net contribution plus the 20% relief at source.
The Tapered Allowance
As of 6th April 2016, the pension contribution allowance is reduced for individuals who earn more than £150,000. This is referred to as the tapered annual allowance.
This rule will “taper” your annual allowance of £40,000 by £1 for every £2 that your adjusted income is above £150,000. However, there is a maximum reduction of £30,000 which is reached once your income is £210,000 or more. Subsequently, this means you will always have an annual allowance of at least £10,000.
NOTE: The £150,000 threshold should also include pension contributions made by you & your employer – “Adjusted Income”. Alternatively, there is a second threshold of £110,000 which does not include pension contributions (but not salary sacrifice) – “Threshold Income”. https://www.gov.uk/guidance/pension-schemes-work-out-your-tapered-annual-allowance
The Lifetime Allowance
There is also a lifetime allowance which caps the amount you can save into your pension pot over your lifetime. This currently stands at £1.03m. Any savings above the limit will not receive tax relief and may also be taxed at the 55% tax rate.
It is possible to apply for “Protection” of your lifetime allowance if your pension pot was above the allowance on 5th April 2016. More details on this can be found on the HMRC website https://www.gov.uk/guidance/pension-schemes-protect-your-lifetime-allowance
What happens if I contribute more than my annual allowance?
Firstly, you should consider whether you have any unused allowances in the previous three tax years. If you have not used the full annual allowance in any given tax year, then you can carry the unused amount forward to be used against excess pension contributions in the following three tax years.
You must use the full allowance for the current year first before using your carried forward unused allowances.
NOTE: When required to utilise the unused allowance carryforward you should apply the excess contribution to the earliest tax year of annual allowance carrying forward first. It is important to remember that the allowance from the earliest year will not carryforward to the following tax year if not fully utilised.
Prior to the 2015/16 tax year, pension contributions in a tax year were accounted for during any 12-month period ending in the tax year. This was known as the pension input period. 2015/16 was a “transitional year” where all pension input periods were aligned with the tax year. There were a few complex adjustments which meant that for the eagle-eyed taxpayer, it was possible to contribute £80,000 to your pension in 2015/16 tax-free. However, the unused allowance carryforward from that year was capped is £40,000.
If you have contributed more than your allowance (and you have no unused allowances carrying forward), then you will be subject to an Excess Contribution Charge. The excess contribution will be included as taxable income on your self-assessment tax return. The objective of this charge is to repay the tax-relief that you have received.
If you would like to discuss any points mentioned above in more detail, please feel free to get in touch.
If you are a US taxpayer, you may benefit from reading our article on UK and US Pensions for US Taxpayers.
Disclaimer – this article is mostly applicable to Defined Contribution Schemes. If you have a defined benefit scheme or you are a member of a foreign pension scheme, some of the information above may not be relevant. Please get in touch for further information.