The Annual Allowance

How much can you pay into your pension?

There is an overall limit on the amount that can be contributed to your pension each year, while still being eligible for tax relief. This is known as the “Annual Allowance” and is currently set at £60,000.

The Annual Allowance is not a “per scheme” limit – it applies across all of your pension arrangements and includes contributions paid by you, your employer, or any 3rd party that may contribute on your behalf. It also includes any increase in your benefits over the year if you are an active member of a “final salary” or “defined benefit” pension scheme.

The maximum that you may contribute personally each tax year is the lower of:

– the Annual Allowance
– 100% of your earned income

If contributions are paid by your employer, these are subject to the Annual Allowance; but the 100% of earnings restriction does not apply, if this is lower.

What if you didn’t pay the maximum in previous years?

If you want to contribute more than £60,000, you are allowed to “carry forward” any unused allowances from the previous 3 tax years.

To do this, you must first pay the maximum for the current year, then you may start to use any unused allowances, starting with the earliest year. 

Please bear in mind:

– you must have been a member of a registered pension scheme for any year’s unused allowance that you want to carry forward
– you do not need to have been an active scheme member – you can still use carry forward even if you were a deferred member
– your total contributions, including any carry forward, cannot exceed your earnings in the current tax year 

How do you arrange to use carry forward with Danbro?

Firstly, it it your responsibility to calculate any unused allowances. Danbro cannot do this for you and if you are not sure, you should take appropriate advice. Danbro cannot be held responsible for any penalties that may be incurred if contributions are paid that are not allowable.

Once you know the total amount that you want to contribute in the current year, Danbro will help you to set this up as regular deductions from your gross earnings. You will need to provide Danbro with evidence of your pension scheme membership for the years in question.

You do not need to notify HMRC that you are using previous unused allowances. However, you should keep proper records in case you are asked to justify these in future. Extra care should be taken if you have accrued benefits within a “defined benefit” scheme, as the amount of the annual allowance this represents is not always straightforward to calculate.

What happens if you do exceed the maximum allowable contributions?

If you have mopped up any unused allowances and you still exceed the maximum allowable contributions in a given year, you won’t receive tax-relief on the excess and you will be faced with an “annual allowance charge”.

This isn’t a penalty for bad behaviour, it is simply the way in which HMRC claw back any tax-relief that you should not have received.

To do this, any excess contributions are added to your income for the year, and become liable to income tax at your highest marginal rate. If the annual allowance charge is more than £2,000, it may be possible for it to be paid from the pension scheme, with a corresponding reduction in your benefits.

The Money Purchase Annual Allowance

If you have taken any pension benefits in the form of flexible income, such as an Uncrystalised Funds Pension Lump Sum (UFPLS), or income from a flexi-access drawdown arrangement;  then your annual allowance is reduced to £10,000 for all future years. This is known as the Money Purchase Annual Allowance (MPAA).

This applies from the day after you take an income payment and you cannot carry forward unused allowances to justify paying higher contributions.

You are allowed to take your 25% tax-free lump sum payment without triggering the MPAA – it is only when income is drawn from a flexible arrangement that the MPAA is applied.

The Tapered Annual Allowance

The Tapered Annual Allowance applies if your “adjusted income” exceeds £260,000 pa AND your “threshold income” exceeds £200,000.

If this applies, then for every £2 of adjusted income above £260,000, the annual allowance is reduced by £1. This reduction stops when your adjusted income reaches £360,000, which leaves you with a minimum annual allowance of £10,000.

If you are a high earner, we recommend that you seek appropriate advice before deciding on the level of pension contributions you wish to make.

The Lifetime Allowance

The Lifetime Allowance applied up to 5th April 2023 and imposed a limit on the overall value of the benefits that could be taken from all of your combined pension schemes, without triggering an extra tax charge.

From 6th April 2023, the Lifetime Allowance charge no longer applies. However, the Lifetime Allowance is still relevant for calculating the maximum tax-free lump sum that may be taken from your pension funds.

You are allowed to draw 25% of your accumulated funds as a tax-free lump sum, but this is now limited to 25% of the value of the Lifetime Allowance, which is currently £1,073,100. The maximum tax-free lump sum is therefore currently £268,275.

You can find out more about the lifetime allowance on the gov.uk website.