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Pensions: contributions and annual allowances

Pensions represent one of the most tax efficient ways to save in the UK. However, changes in legislation over the years have resulted in increased complexity, as well as restrictions on the maximum tax relievable amount that can be contributed.

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Pension_contributions_and_allowances

Ola Adeosun, Senior Wealth Planner

Pensions represent one of the most tax efficient ways to save in the UK. However, changes in legislation over the years have resulted in increased complexity, as well as restrictions on the maximum tax relievable amount that can be contributed.

Personal, employer and third-party contributions all count towards an overall pension’s allowance in the tax year. For defined contribution arrangements, the total contributions inclusive of tax relief received at the source would be the amount contributed into the pension for the tax year. For defined benefit schemes, the rules are different.

When deciding on an optimum contribution level of pension savings, the tax relief rules need to be considered alongside annual allowance limits.

Tax relief on pensions

For contributions into a money purchase arrangement, such as a personal pension, tax relief is limited to the higher of £3,600 gross per tax year or 100% of relevant UK earnings. Basic rate tax relief is received at source on personal contributions. Higher and additional rate taxpayers are then able to claim additional tax relief via self-assessment.  

Contributions made via an employer are not restricted by earned income, however they do need to be wholly and exclusively for business purposes. Employer contributions benefit from corporation tax relief as it is deemed a business expense.

Annual allowance

Since April 2016, the standard annual allowance has been £40,000 per tax year. There are two circumstances where an individual’s annual allowance could be reduced and therefore be less than the standard allowance available:

  • Money purchase annual allowance (MPAA) – individuals who have withdrawn pension income under a flexible arrangement from their pensions, in the form of flexi-access drawdown or an uncrystallised fund pension lump sum, may be limited to a maximum tax relievable allowance of £4,000 in the tax year.
  • Tapered annual allowance (TAA) – in the 2021/22 tax year, individuals with adjusted income in excess of £240,000 could also see a reduction in their annual allowance. For those with adjusted income at or above £312,000, the TAA would be £4,000 gross.

Carrying forward unused allowances

Provided an individual was a member of a UK registered pension scheme in the relevant tax years to be carried forward, there is scope to carry forward unused allowances from previous tax years. Once the current year allowance has been maximised, carry forward of unused allowances is automatic and utilises unused allowance from the earliest of the three tax years before more recent years.

Tax relief however is only granted in the year in which contributions are made, even where unused allowances from previous tax years are carried forward.

Defined benefit pensions

To establish the impact of defined benefit pension schemes on the annual allowance, the pension input amount is required. This is the capitalised value of increase in benefit accrued at the end of the tax year in comparison to the start of the tax year. Quite often, the accurate figure would need to be provided directly by the pension scheme administrator.

Pensions: at a glance

  • Personal, employer and third-party contributions can all count towards overall pensions’ allowance in the tax year.
  • There is scope to make a larger pension contribution than the pension allowance permits by making use of carry forward allowances.
  • Where personal contributions exceed the tax relievable amount or total contributions from all sources exceed the available allowance inclusive of unused carry forward allowances, then annual allowance tax charges may apply.
  • A restricted annual allowance may apply to high earning individuals or to those who have flexibly accessed their defined contribution pension arrangements.

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