Every tax year, the government sets the pension annual allowance or the maximum amount of money a person can contribute to their pension savings and still receive tax relief. For the current tax year (6 April 2023 – 6 April 2024) the annual allowance stands at £60,000.
But what if a person would like to pay in more? They are welcome to, however, once their contribution goes above the annual limit, they are obliged to pay tax. How exactly does it work? We reveal this in our article.
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First, let’s have a closer peek at how the private pension contributions system functions in general.
There are two types of private pension schemes available in the UK:
As we’ve already figured out, there is a £60,000 limit on the amount of your annual private pension contributions. This amount comprises your own contributions, your employer’s contributions, and any other 3rd party’s contributions. Let’s say, if you have both personal and workplace pensions, the limit for each of them will be £30,000. It’s worth mentioning that tax relief also counts, as it increases each contribution. This fact should be considered to avoid exceeding the annual allowance threshold.
The annual allowance calculations are very individual as they depend on contributions. To calculate it, you should consider:
Should your annual earnings exceed the £220,000 threshold (also known as ‘threshold income’), and your adjusted gross income (an individual’s taxable income after accounting for deductions and adjustments) is more than £260,000, your annual allowance decreases. This is called the ‘tapered annual allowance’.
So, if your adjusted income is between £260,000 and £360,000, you will lose £1 of annual allowance for every £2 of the income you have over £260,000. The maximum reduction reaches £50,000, therefore, individuals who make over £360,000 have a reduced annual allowance of only £10,000 (starting from April 2023). This is known as the minimum taper.
We’ve created a table to show how the annual allowance is reduced if your income goes beyond the £260,000 threshold:
In case an individual falls into the category of high earners, they have several options to resort to:
In case you haven’t used up your annual allowance in the three previous tax years, you are allowed to carry it forward and add it to the annual allowance for the current pension input period. You also don’t need to report this to HMRC. Let’s break it down.
First, let’s have a look at the key requirements for the ‘carry-forward’ program:
Provided that an individual meets all the standards mentioned above, this is how the carry-forward opportunity can work for them in practice. For instance, in the 2020/21, 2021/22, and 2022/23 tax years, an individual paid yearly £30,000 into their pension pots instead of £40,000, which was the annual allowance limit. Now, they are allowed to carry forward a total of £30,000 (which is 3 times £10,000 from each of the previous three years) to the current tax year and increase their annual allowance up to £90,000 (where £60,000 is the current limit and £30,000 is carried forward).
In the UK, individuals are allowed to have several pension savings schemes. But as we’ve already mentioned, your total pension contributions cannot exceed the £60,000 limit.
Also known as ‘money purchase’ pension schemes, are usually arranged either by you (private pensions) or by your employer (workplace pensions). This money is put into investments. The overall outcome depends on several factors:
25% of your pension pot is tax-free, while the remaining 75% is subject to income tax. The tax rate normally depends on your overall income.
You’ll also have to pay a small fee to your pension provider for managing your pension savings.
Also known as ‘career average’ or ‘final salary’ pensions, defined benefit pension schemes are arranged by the employer. The amount of savings will depend only on your pension scheme’s terms. Those comprise the salary and the length of service. Similar to the defined contribution scheme, you get 25% of the amount tax-free and the rest is subject to tax. Once a person retires, a certain amount of money is paid out annually as their pension allowance.
Last but not least: what happens to those who go above and beyond the annual allowance limit? We unpack it for you here.
Exceeding the £60,000 limit results in such implications:
On the bright side, one doesn’t have to pay a fine directly. The charge is added to the rest of their taxable income for the year in question.
However, there are some exceptions to these terms:
In case you accidentally faced tax implications connected with your annual allowance, there are some ideas on how to manage them: