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How the pensions annual allowance works

Find out how much you can save into a pension each year - called your annual allowance - and how you could use a loophole to save much, much more.

In this article
What is the pensions annual allowance in 2018-19? What counts towards pensions annual allowance? What is the tapered pensions annual allowance? Can I carry forward my pensions annual allowance?
What happens if you exceed the annual allowance? Final salary pensions and annual allowance charges What is the money purchase annual allowance in 2018-19? When is the money purchase annual allowance triggered?

What is the pensions annual allowance in 2018-19?

The government spends billions of pounds every year on pensions tax relief and, therefore, places a cap on the amount you can save every year, upon which you can earn relief.

This cap is known as the ‘annual allowance’, which is £40,000 in the 2018/19 tax year. 

This has reduced significantly over the years. Our interactive chart shows historic annual allowances over the past 11 years.

 

 

This means with the current annual allowance limit, someone paying income tax at the standard rate of 20% would receive a maximum sum of £8,000 of pension tax relief towards their pot.

If you pay tax at the higher rate of 40% would get up to £16,000 of tax relief, whilst those in the additional rate band of 45% would currently get £18,000 of tax relief.

What counts towards pensions annual allowance?

Your annual allowance is made up of all contributions to your pension made by you, your employer and any third party. 

For example, say you earn £30,000 a year. You contribute 3% to your pension and your employer contributes 5%. 

You also have a private pension, into which you pay a £10,000 lump sum. 

You would pay in £10,900 in total, while your employer would pay in £1,500. Your total contribution is £12,400, leaving £27,600 of your annual allowance unused. 

 

What is the tapered pensions annual allowance?

Once you earn more than £150,000, your annual allowance starts to fall. This is known as the ‘tapered annual allowance’.

The tapered allowance applies if your ‘adjusted income’ is more than £150,000. Adjusted income is your total taxable income – so salary, dividends, rental income, savings interest, plus employer contributions.

If your total adjusted income is between £150,000 and £210,000, you lose £1 of annual allowance (starting at £40,000) for every £2 of adjusted income.

Once your income reaches £210,000, you’ll be left with an annual allowance of £10,000.

The table below shows how your annual allowance reduces as your income increases above £150,000.

Total adjustable income Annual allowance
£150,000 £40,000
£160,000 £35,000
£170,000 £30,000
£180,000 £25,000
£190,000 £20,000
£200,000 £15,000
£210,000 £10,000

Can I carry forward my pensions annual allowance?

If you haven’t used up your annual allowance from previous years, you don’t lose them completely.

A process called ‘carry forward’ allows you to make pension contributions to fill up any unused allowance you might have from the previous three tax years.

There are two conditions you need to satisfy to use carry forward.

First, you must earn at least the amount you wish to contribute in total this tax year (unless your employer is making the contribution).

Second, you must have been a member of a UK-registered pension scheme (this does not include the state pension) in each of the tax years from which you wish to carry forward

Carry forward: an example

Our example shows carry forward allows for a contribution of £80,000 without exceeding the annual allowance in 2018-19 (as long as you’ve earnings of at least that in the latest tax year).

  2015/16 2016/17 2017/18 2018/19
Annual allowance £40,000 £40,000 £40,000 £40,000
Total contribution £30,000 £30,000 £20,000 0
Annual allowance remaining £10,000 £10,000 £20,000 £40,000
Total amount available using carry forward £80,000

What happens if you exceed the annual allowance?

Exceeding the annual allowance will mean that you do not receive pension tax relief on any contributions over the cap and you’ll be faced with an additional tax bill called the ‘annual allowance charge’.

But you don't pay a fine directly. This charge is added to the rest of your taxable income for the year in question to work out your overall tax liability. 

It is down to you to work out if an annual allowance charge may be due. You'll need to fill out a self-assessment tax return to detail how much of your pension contributions exceed the annual allowance (this is done automatically via online tax returns). 

If you have a substantial charge, it could be paid out of your pension scheme funds. You should talk to your scheme administrator if this happens to you. 

Annual allowance charge: an example

Sue has a 'net income' - her annual income less personal allowances - of £140,000.

Her total pension contribution for the year is £20,000 over the £40,000 annual allowance. This puts her total income for these purposes at £160,000.

  • Sue's total income exceeds higher-rate limit (£150,000) by £10,000, so this is subject to 45% tax = £4,500.
  • £10,000 of excess pension savings which fall within the band between basic and higher rate limits (£34,500 to £150,000) and is taxable at 40% = £4,000.
  • Sue’s annual allowance tax charge is therefore £4,500 + £4,000 = £8,500.

Final salary pensions and annual allowance charges

There is a more complex calculation required to determine how much of your annual allowance you’ve used if you are in a final salary scheme

This is because a final salary scheme pays out an income based on your salary while your working and length of service. So each year, the amount put into your pension by your employer will be what's needed to meet the deal you have, not a necessarily a percentage of what you earn. 

It's often referred to as the ‘pension input amount’, and is the difference between your ‘opening value’ and ‘closing value’ of your pension over a set time period (usually the tax year). 

The opening value is worked out as the value of your pension at the beginning of the year, multiplied by 16, plus any lump sum you're entitled to and any increases applied so that your pension keeps up with inflation.

At the end of the period, the closing value is calculated on the same basis with any pay rises you may have earned. 

Final salary annual allowance charge: an example

The following example is from the HMRC: 

Tom is a doctor. He is a member of an NHS pension scheme him a pension of 1/60th pensionable pay for each year of service. At the start of the year, Tom's pensionable pay is £80,000 and he has 31 years pensionable service. 

At the end of the year, Tom's pensionable pay has risen by 5% to £84,000 with 32 years pensionable service.

 

How to work out the 'opening value' of Tom's pension

 

Tom's opening value is calculated as follows:

  • Work out how much pension Tom has for each year of service: 31 years/60 × £80,000 = £41,333
  • Multiply Tom's annual rate of pension by flat factor of 16: £41,333 × 16 = £661,328
  • Add an inflation increase of 3%: £661,328 × 1.03 = £681,168
  • Tom's opening value is £681,168.

 

How to work out the 'closing value' of Tom's pension

Tom's closing value is calculated as follows:

  • Work out how much pension Tom has for each year of service: 32 years/60 × £84,000 = £44,800.
  • Multiply Tom's annual rate of pension by flat factor of 16 - £44,800 × 16 = £716,800.
  • Tom's closing value is £716,800.

 

How much Tom has paid into his pension

 

The difference between the closing value and the opening value is £35,632.

This is less than the annual allowance of £40,000 so Tom does not have to pay the annual allowance charge.

What is the money purchase annual allowance in 2018-19?

If you’ve taken money out of your pension, you can still make contributions to a pension and earn tax relief. But you get a lower annual allowance if you want to make further contributions. In 2018/19, this is £4,000. 

This is called the money purchase annual allowance, or MPAA, and applies people who have taken money from a money purchase, or defined contribution, pension.

The money purchase annual allowance was cut in the 2017-18, down from £10,000 from the previous year. 

The money-purchase annual allowance allows you to receive tax relief on contributions of up to 100% of your earnings or £4,000, whichever is the lower.

When is the money purchase annual allowance triggered?

The lower money purchase annual allowance is only triggered when: you take a lump sum from your pension called an ‘uncrystallised pension lump sum’, or you start taking an income from your pension through income drawdown.

To retain the full £40,000 annual allowance, you can take a 25% tax-free lump sum and buy for an annuity or start a drawdown plan without taking an income.

If you've have triggered the money purchase annual allowance, you can't carry forward any unused allowances from previous years to boost the amount you can pay into your pension

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