Pension savings can be tax efficient when they are contributed to registered pension schemes and can attract tax relief up to certain amounts.

What is the limit on tax relief?

Tax relief can be awarded on private pension contributions to the greater of 100% of earnings and £3,600 but is subject to the annual allowance limit.

When an employer deducts pension contributions from your gross pay, tax relief may automatically be awarded. If you pay into a personal pension, or your employer pays contributions into the scheme after tax is deducted, the pension scheme will claim basic rate relief.

For example, if you pay £2,880 into a pension scheme, the provider will claim a basic rate relief of £720, meaning that the gross contribution into your pension pot will be £3,600.

Higher and additional rate taxpayers can reclaim the difference between the basic rate tax and your marginal rate through a self-assessment tax return through HMRC.

What is the annual allowance?

There is a pension annual allowance that caps the amount of pension savings that are eligible for tax relief. You can make contributions above this allowance, but you will not get tax relief on these amounts.

The allowance is set at £40,000 per annum for 2019/20 and 2020/21. If you have high earnings, this can be reduced.

The annual allowance adjustment applies when both your:

  • Threshold income is more than £110,000 (income excluding pension contributions)
  • Adjusted net income is more than £150,000 (income including pension contributions)

When this is applied, your annual allowance will be reduced by £1 for every £2 that your adjusted net income exceeds £150,000, until the annual allowance reaches £10,000, which is the minimum amount.

The annual allowance can be carried forward for up to three tax years if it is not used. The current year allowance must be used before previous years allowance are brought forward for use.

Example

Lara has an income of £100,000 in 2019/20. She has also received an inheritance, making her want to make a pension contribution of £60,000. In the last 3 years, she has only used £10,000 of her annual allowance meaning that she has £30,000 to be carried forward for the next 3 tax years.

In order to make the contribution of £60,000 in 2019/20 Lara must take the following steps:

  • Use 2019/20’s annual allowance of £40,000
  • Use £20,000 of the £30,000 that has been carried forward from 2016/17
  • The remaining £10,000 from 2016/17 will be lost as it cannot be carried forward

What is the reduced money purchase annual allowance?

The money purchase annual allowance (MPAA) is set at £4,000 and applies to people that have a flexibility accessed pension when they reach age 55. This prevents contribution recycling that can secure additional tax relief.

What is the lifetime pension allowance?

The lifetime allowance is the maximum amount you can put into your pension pot. For 2019/20, it is set at £1,055,000, if you exceed this, you will be subject to a tax charge.

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