Max out your pension contributions without breaching the annual allowance

Monday, 6 June 2016

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Edinburgh and across the UK - independent financial advice on pensions

With employer pension schemes getting less generous all the time, and the self-employed being taxed more on dividends, it makes more sense than ever to save into a pension. However, you need to be careful not to exceed the "annual allowance" set by the government, or you could be hit with a surprise tax bill.

What is the annual allowance?

The government says you can save £40,000 per year into a pension, including the tax relief you get, in any one tax year. For individuals this means you can save £32,000 and the government adds £8,000 in tax relief (higher rate tax payers can claim more tax relief back via their tax return, but that doesn't affect the pension or the annual allowance usage).

What about high earners?

From April 2016 anyone earning over £150,000 gets a reduced annual allowance. The level tapers down to as little as £10,000 per year for anyone earning over £210,000 per year so for these people it becomes difficult to make meaningful pension savings relative to their income.

Can you exceed that if you haven't saved in previous years?

Yes, you can "carry forward" any unused annual allowance from the last 3 years, and since the annual allowance was £50,000 until April 2014, this means that in this tax year (16/17) someone who has made no pension contributions at all in the past could contribute £170,000 including the tax relief. However, if you have exceeded the annual allowance in previous years the calculations get fiendishly complicated so ask for more details if you think you might be affected. To make things worse, tax year 15/16 was a very odd year, with budget changes leading to some people being able to contribute £80,000 in a single year, so it can be hard to work out what impact that had on your annual allowance record.

How is the amount you have saved into a pension calculated?

For "money purchase" (defined contribution) pension schemes it is just the amount of money paid in by you or your employer, plus any tax relief added to this.

For final salary pension schemes it is much more complicated and has nothing to do with how much you or your employer pay into the scheme - in essence you have to calculate the increase in your accrued annual pension income entitlement, adjust that increase for inflation, then multiply the post-inflation increase by 16! Get in touch for more information regarding working this out.

What happens if you exceed the annual allowance, including any carried forward allowance?

The excess amount you contribute, over the annual allowance, is treated as being earned income for you in the tax year concerned. So you have to pay tax at your marginal rate on that excess (e.g. 40% for a higher rate taxpayer).

Who tells me if I have exceeded the pension annual allowance?

If you put more than the annual allowance into a single pension scheme then that scheme has to warn you of this. But if you spread your pension savings over several schemes it is up to you to monitor your situation.

What about if I have already started to take income from my pension

If you have just taken the tax free lump sum, your annual allowance is not affected, but if you have started to take income "drawdown" then your annual allowance may be reduced to £10,000.

If you are worried about your annual allowance, what should you do?

First thing is to accurately calculate how much carry-forward allowance you have from previous years. We can help with that, and answer any other questions you may have. Just get in touch.

Useful links

Government page on annual allowance

Our main pension advice page

Chartered Financial Planners. FCA Regulated (FCA no. 603653)