The pension annual allowance

While there is no limit on the amount a client can pay into their pension each year, there is a restriction on the amount of tax relief they can receive. Tax relief is only available up to the amount of an individual’s earnings in a given tax year and then may be further restricted by what is known as the pension annual allowance, this amounts to £60,000 (including tax relief) for most people in 2024/25. The allowance applies across all the client’s pension schemes, although it does not apply to the state pension.

Broadly speaking, the following count towards the pension annual allowance:
 

• Defined contribution schemes – all contributions made by the client, their employer or on their behalf by somebody else
• Defined benefit schemes – increases in the capital value of pension and tax-free cash benefits (excluding death in service rights).

The annual allowance may be reduced if a client’s ‘threshold income’ – their annual income before tax, less any personal pension contributions – is over £200,000. If this exceeds £200,000, then a check needs to be made to see if their ‘adjusted income’ is over £260,000.

Adjusted income is calculated by adding together the client’s annual taxable income (including dividends, savings interest and rental income) before tax, plus the value of their pension contributions (including any made by their employer). If this is above £260,000, the client’s annual allowance will reduce by £1 for every £2 that their adjusted income exceeds £260,000. The maximum reduction is £50,000, which reduces the annual allowance to £10,000.

If a client has already taken taxable benefits from a money purchase pension scheme (i.e. more than their tax-free cash), a lower money purchase annual allowance (MPAA) normally applies to them. This is currently set at £10,000, although if taxable earnings are below the MPAA then tax relief is limited to 100% of the client’s earnings (or to £3,600 if this is higher). If the first taxable withdrawal is part way through the tax year, the reduced allowance only applies from that date onwards.

If a client hasn’t put the maximum amount into all of their pensions in the previous three tax years, they may be able to use up their unused annual allowances. This is known as ‘carry forward’. This is possible if they meet the conditions listed below.

They must:

1. Have paid in the maximum amount to their pensions in the current tax year
2. Earn at least the amount they wish to contribute in the tax year they are making the investment
3. Have been a member of a UK-registered pension scheme in each of the tax years from which they wish to carry forward from
4. Use any unused annual allowance from the earliest year first
5. If it applies to them, measure any unused allowance against the tapered allowance for each given year.

HMRC provides an online calculator to check whether a client has any annual allowance they can carry forward.

If a client exceeds their annual allowance, they will normally face a tax charge. The excess contributions will be subject to the client’s marginal rate of income tax. The amount can be determined and paid through the income tax self-assessment process. Alternatively, it may be possible for the charge to be deducted directly from the client’s pension savings – known as ‘Scheme Pays’ – although specific conditions usually need to be met.