Pension annual allowance
The annual allowance is the maximum amount of pension savings an individual can accumulate each year without incurring a tax charge. This briefing explains how the annual allowance works, when it does not apply, and when it is reduced.
- The annual allowance is currently £60,000, it was previously £40,000 between the tax years 2016/17 to 2022/23.
- An individual’s total pension savings are called the pension input amount, which is assessed over a pension input period and aligned with the tax year.
- Individuals can carry forward any unused annual allowances from the three previous tax years and add these to the annual allowance for the current tax year. This enables contributions to exceed the annual allowance for the current tax year.
- If the annual allowance (including carry forward) is exceeded there will be a tax charge.
- Where individual contributions are being made it is also important to make sure that they will receive tax relief and do not exceed the individual’s net relevant earnings or £3,600 per annum if higher. This requirement does not apply to employer contributions.
- The annual allowance can be reduced; high earners may be subject to the tapered annual allowance and, those who have flexibly accessed any of their money purchase pensions will be subject to the money purchase annual allowance.
- There are some limited circumstances when the annual allowance does not apply – for example on year of death, when drawing benefits on serious ill-health grounds or for most deferred benefits in defined benefits pension schemes where an individual is not an active member.
- The annual allowance
- Calculating pension input amounts
- Carry forward of unused annual allowance
- The tapered annual allowance
- The money purchase annual allowance (MPAA)
- What triggers the MPAA?
- Annual allowance tax charge
- Paying the annual allowance tax charge
The annual allowance
The current rate of annual allowance is £60,000 having previously been £40,000 for the tax years 2016/17 to 2022/23. This is the maximum amount of pension savings an individual can accumulate each year and not be subject to an annual allowance tax charge, thus removing the benefit of tax relief.
The assessment against the annual allowance includes all pension savings, including individual contributions, employer contributions and active benefit accrual in defined benefit (DB) schemes.
Exceeding the annual allowance (including any carried forward) results in the individual being subject to an annual allowance tax charge. The charge essentially offsets the tax relief granted to those contributions. The member may be able to ask the scheme administrator to deduct some of pension benefits to cover this charge.
The annual allowance is different from the limit on individual contributions eligible for tax relief. This is set at the higher of the individual’s net relevant earnings or £3,600 per annum gross, if higher. However, the impact of the annual allowance tax charge essentially removes the benefit of tax relief given if the allowance is exceeded.
The annual allowance does not apply if:
- the individual dies during the tax year,
- the individual becomes eligible for severe ill-health retirement during the tax year,
- the individual is a deferred member of a DB scheme throughout the tax year and their benefits are increased in accordance with provisions set out in the scheme rules in force on 14 October 2010 or do not increase at a higher rate than CPI (if there was no provision for increases in deferment in the scheme rules).
Calculating pension input amounts
The annual allowance is tested over a pension input period (PIP) which, since 2016/17, has been aligned with tax years. The benefits tested against the annual allowance are known as pension inputs and include:
- all contributions allocated to provide pension benefits on a defined contribution (DC) basis including any reallocation of funds held within a scheme,
- all increases in capital value of a DB pension and tax-free cash sum rights (excluding any death in service rights),
- increases in the capital value of cash balance schemes.
For hybrid schemes the increase in value is calculated on the basis that the pension will be provided by each type of benefit that may be payable under the arrangement and then uses the greater or greatest of these amounts as the final figure.
For DB schemes the input amount is calculated by subtracting the opening value of benefits from the closing value. For active members this is calculated as follows:
- The accrued member’s pension benefits at the start of the year is multiplied by 16 to provide a capital value.
- Add any accrued tax-free cash which is provided separately (not by commutation).
- The value from the above is increased by any annual increase in CPI up to September of the previous tax year.
- The accrued member’s pension benefits at the end of the year is multiplied by 16.
- Add any accrued tax-free cash which is provided separately (not by commutation).
The accrued member’s benefits are calculated based on the member's salary, years of service and the accrual rate of the scheme e.g 1/60ths per year of service.
There is no pension input for a deferred member with preserved benefits provided the benefits don’t increase by more than the greater of: CPI, or, in line with the provisions of the scheme rules as at 14 October 2010.
Carry forward of unused annual allowance
Individuals can carry forward any unused annual allowances from the previous three tax years and add these to the allowance for the current tax year. This means that for 2023/24 potentially up to £180,000 (£60,000 for 2023/24 and £40,000 from the three previous years) could be payable in one tax year without breaching the annual allowance. Each year after 2023/24, £60,000 annual allowance could be carried forward instead of £40,000.
To be eligible for carry forward the individual must have been a member of a registered UK pension scheme in the tax year(s) they wish to carry forward from. There is no requirement to have made any contributions in those years and deferred or pensioner membership provides eligibility.
The annual allowance for the current year must be used first and then carry forward relief is used in chronological order with the earliest year first.
Sam is self-employed and has paid the following contributions and wants to know the maximum additional contribution that can be made personally in the current tax year:
Sam has £40,000 of annual allowance still available for the 2023/24 tax year. £16,000 can be added from 2020/21 and £20,000 from 2021/22 to give a total maximum contribution of £76,000, in addition to the £20,000 already paid. If Sam doesn’t pay more than a further £40,000 in the current tax year (i.e. £60,000 in total) all of the £16,000 carry forward from 2020/21 will be lost.
Note that as Sam is paying personal contributions, he must have UK net relevant earnings of at least the total amount of the contribution (£96,000) to be eligible for tax relief on the full contribution. If Sam was employed and the contribution was 100% employer funded the net relevant earnings criteria only apply to personal contributions paid – not the employer contributions.
Where an individual exceeds the annual allowance in one of the previous two tax years then a further look back is required to determine if any excess can be offset against earlier years.
There is no requirement to report to HMRC when carry forward has been used, but there is a requirement to report, in a self-assessment tax return, when pension contributions have been made that exceed the annual allowance including any carry forward used. It is therefore sensible to ensure that, when carry forward is used, a record is kept by both the adviser and the client.
The tapered annual allowance
This has applied from the tax year 2016/17 and was introduced to restrict tax relief for high earners. The relevant thresholds for when the taper applies have changed over the years as shown below.
- 2023/24 onwards - the tapered annual allowance will apply if an individual’s threshold income exceeds £200,000 and their adjusted income is more than £260,000. Where the taper applies, an individual’s annual allowance will be reduced by £1 for each £2 their adjusted income exceeds the adjusted income. The taper cannot reduce the annual allowance below £10,000.
- 2020/21 to 2022/23 - the tapered annual allowance will apply if an individual’s threshold income exceeds £200,000 and their adjusted income is more than £240,000. The taper cannot reduce the annual allowance below £4,000.
- 2016/17 to 2019/20 - the tapered annual allowance will apply if an individual’s threshold income exceeds £110,000 and their adjusted income is more than £150,000. The taper cannot reduce the annual allowance below £10,000.
Details of how to calculate threshold and adjusted income, together with an example, can be found in HMRC’s Pensions Tax Manual PTM057100.
The money purchase annual allowance(MPAA)
This was introduced from 6 April 2015 to work alongside the introduction of pensions flexibility. Without the MPAA, an individual could pay higher amounts into their pension with tax relief and then immediately withdraw it with 25% payable tax-free.
When triggered, the MPAA reduces the annual allowance from £60,000 to £10,000, but only for contributions to money purchase (defined contribution) schemes. For the tax years 2017/18 to 2022/23 the MPAA was £4,000.
Where the MPAA is exceeded, the member will be liable to an annual allowance tax charge.
Defined benefit (DB) accrual is not limited by the MPAA, so the annual allowance for benefit accrual under a DB scheme would remain at £60,000 minus any contributions to a money purchase scheme (up to the MPAA); this is referred to as an alternative annual allowance.
It is important to draw the distinction as carry forward of annual allowance can never be used to increase the MPAA. Once the MPAA is triggered carry forward can only be applied to the alternative annual allowance. Furthermore, if the member is subject to the tapered annual allowance, the alternative annual allowance will be calculated against the tapered allowance, rather than the normal annual allowance.
HMRC’s Pensions Tax Manual PTM056500 includes a number of examples of the MPAA in practice.
The MPAA only applies to contributions into your pension after the date the MPAA has been triggered. So, where the MPAA is triggered part way through a tax year, contributions prior to the MPAA may exceed the £10,000 without triggering an annual allowance charge. In this scenario contributions would still be limited by the annual allowance.
What triggers the MPAA?
Designating funds to flexi-access drawdown doesn’t trigger the MPAA, however drawing any income from flexi-access drawdown will.
The MPAA is triggered if someone draws their benefits flexibly in the following situations:
- receives an uncrystallised funds pension lump sum,
- draws income from a flexi-access drawdown fund,
- converts a capped drawdown fund to a flexi-access drawdown fund and subsequently taxes drawdown income from that fund,
- takes more than the maximum allowance income from a capped drawdown fund,
- had a pre-5 April 2016 flexible drawdown plan,
- receives a standalone lump sum where they have primary protection and a protected lump sum right in excess of £375,000,
- receives a payment from an annuity that can decrease except in certain circumstances,
- receives a payment from a scheme pension other than through an annuity in a scheme with fewer than 12 members (e.g. a small self-administered pension scheme),
- receives a payment of one of the types noted above from an overseas pension scheme that has benefitted from tax relief.
Taking any of the following retirement options won’t trigger the MPAA:
- pension commencement lump sum – commonly known as tax free cash,
- trivial commutation lump sum - this option is now only available from defined benefits,
- small lump sum (small pots) – lump sums taken under this specific rule with a value up to £10,000,
- scheme pensions or annuities (unless they decrease),
- capped drawdown – drawing income from existing capped drawdown wont trigger the MPAA as long as the income remains within the income cap,
- survivors’ pensions.
Annual allowance tax charge
The purpose of the annual allowance charge is to effectively remove the tax relief given to any pension contributions that exceed the annual allowance or the MPAA.
Where an individual has exceeded their annual allowance or the MPAA, and the excess cannot be covered by any available carry forward from previous years, then there will be an annual allowance charge.
To determine the charge, the excess over the available annual allowance is added on top of the individual's taxable income for the year. This determines the tax band(s) the charge falls into, and therefore the tax rate that applies.
The individual, not the scheme administrator, is responsible for working out if their total pension input exceeds their available annual allowance. Individuals may require details from all schemes to work out their total pension input. Where the member exceeds their annual allowance, it must be reported to HMRC through self-assessment. HMRC will confirm the charge due.
Paying the annual allowance tax charge
There are two ways the annual allowance tax charge can be settled.
- Using member pays - the individual pays the tax charge due directly to HMRC in the same way as any other tax charge. If the charge is less than £2,000, this is the only way it can be paid unless the scheme agrees to pay on the voluntary basis.
- Using scheme pays - this means the pension scheme pays all or part of the charge by deducting it from the individuals pension benefits. The benefits under the scheme are then reduced, either the fund value is reduced or defined benefits are appropriately reduced. Where benefits have already been put into payment, an annuity or scheme pension may be reduced as appropriate to account for the charge.
The scheme administrator then accounts for the payment to HMRC. Any residual charge would need to be settled by the member.
There are two versions of the scheme pays rules, compulsory and voluntary.
1. For compulsory scheme pays to apply:
- The charge must be at least £2,000 and the total annual pension savings in the scheme for the tax year that the charge relates to must exceed the annual allowance (not the MPAA).
- The member must inform the scheme administrator they want the scheme to pay the charge by 31 July following the end of the tax year in which the charge applies.
An administration fee cannot be applied under compulsory scheme pays.
Once the member declaration has been received the scheme administrator and individual are jointly liable for the charge.
Where the total charge is more than £2,000 across several schemes, but the annual allowance is not exceeded in any one scheme, then the compulsory pays conditions are not met.
2. Voluntary pays
Where the compulsory scheme pays rules do not apply, or if the member missed the deadline, it is possible for the scheme administrator to agree to apply scheme pays on a voluntary basis.
Schemes may charge a fee for the use of voluntary scheme pays. Under voluntary scheme pays the scheme administrator does not become jointly liable to the charge.
If voluntary scheme pays is agreed, then the member benefits will be reduced, and the scheme must account for the tax to HMRC.