Pension contributions - all you need to know

This analysis focuses on pension contributions, who can pay them and if there are any restrictions.
Key facts
  • Contributions made by an individual have to be supported by relevant UK earnings, employer contributions do not.
  • Income from a pension is not relevant UK earnings.
  • Investment income, property rental income and dividends are not relevant UK earnings.
  • Contributions made by an individual, employer or a third party all count towards the annual allowance.
  • The annual allowance is currently £40,000.

Personal contributions

Individuals can contribute to any number of pension plans.

Personal contributions made by an individual are unlimited. However there is a limit on the amount of gross contributions that an individual can pay each year and benefit fully from tax relief.

Tax relief is restricted to the higher of £3,600 or 100% of relevant UK earnings - subject to the annual allowance

If the Money Purchase Annual Allowance (MPAA) has been triggered, tax relief on money purchase contributions is restricted to £4,000.

Tax relief is only given in the tax year the contribution is paid.

Investment income and dividends don't count as relevant UK earnings.

Income from pension products doesn't count as relevant UK earnings.

Individual, employer and third party contributions all count towards the annual allowance, MPAA and the tapered annual allowance.

If the tapered annual allowance has been triggered for an individual their annual allowance will be reduced, potentially as low as £10,000.

The annual allowance that applies is based on pension input periods (PIP). Since 8 July 2015 PIPs have been in line with tax years.

It may be possible to pay more than the annual allowance in a tax year without an annual allowance charge becoming due by carrying forward unused annual allowance from previous years.  It's not possible to carry forward unused annual allowance against the MPAA.  It is however possible to carry forward unused relief against the full annual allowance if it still applies to a defined benefit plan.  For more information see An explanation of the Money Purchase Annual Allowance.

There are three main methods for giving tax relief; relief at source, net pay arrangement and relief on making a claim.

Our article Member contributions - tax relief and annual allowance provides more in depth analysis.

Special rules apply for those who are not resident in the UK. Further details can be found in Contributions to Registered Schemes for Overseas Individuals.

Employer contributions

Employer contributions are not restricted by the employee's relevant UK earnings, however they must satisfy the 'wholly and exclusively' requirement to receive tax relief.

Employer contributions are paid gross and corporation tax relief is granted via the company accounts.

Tax relief is normally only given in the accounting period the contribution is made but if the contribution is over a certain amount it may be spread over more than one year.

Employer contributions count towards the annual allowance, MPAA and the tapered annual allowance.

Carry forward of unused annual allowance can also be used to cover employer contributions that are over the annual allowance.

Employer contributions over the annual allowance may also be subject to the annual allowance or MPAA charge, payable by the individual. Carry forward can also be used here to avoid the annual allowance charge but not the MPAA charge.

There are a number of other issues such as contributions for controlling directors, connected employee's, ex and non-employees.

Third party contributions

The payment of contributions is not limited to the individual or employer; other people can also make contributions on the individual's behalf.

These contributions are treated as if they are paid by the individual with the limits that apply to individual contributions. So tax relief is restricted to the higher of £3,600 or 100% of relevant UK earnings - subject to the annual allowance, MPAA or tapered annual allowance.

If the contributions are for (grand)children this means that tax relief will be restricted to £3,600 gross per year unless they have relevant UK earnings.

Third party contributions count towards the annual allowance, MPAA or tapered annual allowance.

How are contributions valued against the annual allowance?

The annual allowance applies to the total of all pension contributions paid into registered pension schemes for an individual. How the contributions are valued for annual allowance purposes is explained in our annual allowance article.

Note

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.

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Last updated: 05 Apr 2017

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The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.