Annual allowance

What is the annual allowance?

The annual allowance is the maximum amount of pension savings an individual can make each year without an annual allowance charge applying. This includes pension contributions made by the individual, their employer, a company or a third-party.

Individuals are subject to a tax charge on the amount of any contribution paid (personally, by their employer or a third-party) in excess of the annual allowance each year. The tax charge will be at the individual's marginal rate of tax. This also applies to the value of any benefit increase under a defined benefit or cash balance scheme over the annual allowance. If an annual allowance charge is due this will usually be dealt with through the individual's tax return.

It’s important not to confuse the annual allowance with the limit on tax relief on gross personal and third party contributions which is the higher of £3,600 or 100% of relevant UK earnings gross; that is the earnings that attract tax relief.

The annual allowance has changed several times since it was introduced in 2006 and is £60,000 currently. Historic levels of the annual allowance can be found on our rates and factors page.

What is a pension input amount?

The pension input amount for a defined contribution plan is the amount of contributions made during the pension input period.

For defined benefit schemes, the pension input amount is the value of benefits accrued over the pension input period.

Transfers from other plans don't count towards the pension input amount.

There will be no liability to the annual allowance charge as a result of:

• severe ill-health,
• being a member of the UK armed forces who becomes entitled to benefits from the arrangement and those benefits are not taxable due to s641(1) Income Tax (Earnings and Pensions) Act 2003, or
• the individual dying.

This means no pension input amount will arise for pension input periods ending in the tax year in which any of these events happen.

HMRC Pensions Tax Manual - PTM053000: Pension input amounts

HMRC Pensions Tax Manual - PTM051200: When the annual allowance charge does not apply

Let’s take a closer look at how benefits are tested against the lifetime allowance.

Money purchase benefits

The total contributions paid in any pension input period. This includes all individual, employer and third-party contributions.

HMRC Pensions Tax Manual - PTM053200: pension input amounts: money purchase arrangements

Defined benefits schemes

How do you work out how much the benefits have increased by in the pension input period?  The increase is the difference between the value of the individual’s benefits immediately before the start of the pension input period (the opening value) and the value of the individual’s benefits at the end of the pension input period (the closing value).

To calculate the opening value, take the annual pension amount at the beginning of the pension input period (this is the pension that the individual would get if they retired now at normal pension age) and multiply this amount by 16. If the scheme also gives the individual a lump sum in addition to the pension (so not by commutation of pension), add this on.  The total should then be increased by the increase in CPI over the 12-month period to the September before the start of the tax year in which the annual allowance is being calculated.  

To calculate the closing value, take the annual pension amount at the end of the pension input period and multiply this amount by 16. Unlike the opening value, this doesn’t have to be increased by CPI. Again, if the scheme also gives the individual a lump sum in addition to the pension (not by commutation of pension), add this on.

Take the opening value away from the closing value you have calculated above; this is the pension input amount.

The rights to be valued will include any benefits taken during the period, any rights transferred out to another registered pension scheme, and any pension debits. The value of any rights given on transfers into the scheme and any pension credits can be excluded.

As an example:

Fred has 34 years of benefits accrued in a defined benefit scheme. The scheme provides a pension of 1/60 of pensionable salary for each year of pensionable service.

His pensionable salary is £36,000. In year 35 he gets a promotion and his new salary is £46,000. His pension input period ends on 5 April 2025.

In this example, Fred's pension input amount is over the annual allowance. He needs to tell HM Revenue & Customs (HMRC) he has exceeded the annual allowance through his tax return. The excess will suffer an annual allowance charge that will effectively remove all tax relief on the excess. If he has any unused annual allowance from previous years this can be carried forward to remove or reduce the annual allowance charge.

HMRC Pensions Tax Manual - PTM053320 pension input amounts: defined benefits arrangements: worked examples

Cash balance plans

The increase in the value of the individual's rights over the pension input period.

How do you work out how much the benefits have increased by in the pension input period? Like defined benefits schemes above, first you need the opening value. To calculate the opening value, you use a 2-step process' You take the amount of the promised pension fund that the individual had immediately before the start of the pension input period. You then increase this amount by the 12 month increase in the CPI to the September before the start of the tax year for which the calculation is being done.

This is then compared with the closing value, which is the amount of the individual’s promised pension fund at the end of the pension input period.

The rights to be valued will include partial benefits taken during the period, any rights transferred out to another registered pension scheme, and any pension debits. The value of any rights given on transfers into the scheme and any pension credits can be excluded.

HMRC Pensions Tax Manual - PTM053400: pension input amounts: cash balance arrangements

Why do pension input periods matter?

They matter because the pension input amount is measured against the annual allowance in force at the end of the pension input period.

If the money purchase annual allowance or tapered annual allowance applies, the pension input amount is tested against the lower allowance.

If the pension input amount from all the individual's plans, ending in that tax year, is greater than the annual allowance available, an annual allowance charge is due. If the end of the pension input period is 5 April 2025, it will be tested against the 2024/25 limit of £60,000. The tax charge is at the individual's marginal rate of tax and will be dealt with through their tax return.

It's possible to carry forward unused annual allowance from previous pension input periods to increase the amount of annual allowance or tapered annual allowance available. You cannot use carry forward if the money purchase annual allowance applies.

How long does a pension input last for?

The pension input period lasts from the day the first regular or single contribution is paid to the plan and runs to the following 5 April. They then run in line with the tax year.

Annual allowance charge

The aim of the annual allowance charge is to remove the tax relief given to any pension contributions over the annual allowance.

The steps for calculating the annual allowance charge and how to pay the annual allowance charge can be found in HMRC Pensions Tax Manual - PTM056000 - Annual allowance: tax charge (opens in a new window).

Any contributions over the annual allowance must remain in the plan and an annual allowance charge paid. It’s not possible to receive a full, or partial refund of a contribution, to avoid the charge. Our refunds of contributions article talks more about when a refund of contribution can and cannot be made.

For worked examples of the annual allowance charge, see HMRC Pensions Tax manual - PTM056130 - Annual allowance: tax charge: rate of tax charge: worked examples (opens in a new window).

Carry forward of unused annual allowance

It may be possible to reduce or completely avoid the annual allowance charge using carry forward. Carry forward allows unused annual allowance from pension input periods ending in the previous three tax years to be carried forward and added to the annual allowance for the current pension input period.

More details can be found in our carry forward article.

Money purchase annual allowance

Since 6 April 2015, there has been an additional annual allowance called the money purchase annual allowance. This is normally triggered by taking income from a flexi-access drawdown plan or taking an uncrystallised funds pension lump sum. However, other actions can trigger it.

If the money purchase annual allowance has been triggered, only £10,000 can be paid to all defined contribution plans in any pension input period before the annual allowance tax charge is applied. The money purchase annual allowance does not apply to contributions to cash balance plans or defined benefit schemes. 

If it is triggered part-way through a pension input period, only contributions made to defined contribution plans, after the trigger, are tested against the money purchase annual allowance. However, the total contributions/accrual in that tax year are also tested against the £60,000 annual allowance.

Tapered annual allowance

Individuals who have adjusted income for a tax year of greater than £260,000 will have their annual allowance for that tax year restricted. It will be reduced, so that for every £2 of income they have over £260,000, their annual allowance is reduced by £1. Any resulting reduced annual allowance is rounded down to the nearest whole pound.

The maximum reduction is £50,000, so anyone with income of £360,000 or more will have an annual allowance of £10,000. Individuals with high income caught by the restriction may therefore have to reduce the contributions paid by them and/or their employers or suffer an annual allowance charge.

The reduction in annual allowance doesn’t apply to individuals who have threshold income of no more than £200,000.

Individuals with high income caught by the restriction may therefore have to reduce the contributions paid by them and/or their employers or suffer an annual allowance charge.

Our article, Tapering of annual allowance for high incomes - adjusted and threshold incomes, provides more detail, including the historical rates and definitions of adjusted and threshold income.

Is paying the annual allowance tax charge such a bad thing?

Mick Jones of The Clash famously sang “Should I stay, or should I go?” This can also apply to those thinking of leaving their pensions scheme to avoid a tax charge. Will the individual derive greater benefit from opting out and thereby avoid future charges or greater benefit from staying in the scheme and paying the charges? The value of employer contributions should not be overlooked.

Jennifer, lives in England and is a company director with a salary of £360,000. She’s a 45% taxpayer, subject to a tapered allowance of £10,000 and has no carry forward available. Her employer pays 8% as standard and contributions are matched 1 for 1 up to a further 6%. Jennifer expects to retire in 10 years’ time.

¹Assumes 4% growth after charges.

As you can see from the table under option 1, after paying the annual allowance charge, Jennifer will generate additional funds of £20,340 at no cost to herself.

But, under option 2, if Jennifer continues to make personal contributions, she will generate additional funds of £44,100. After considering tax relief, this will only cost her £11,880.

On top of this, under option 2, as the pension input amount is greater than £60,000 and tax charge exceeds £2,000, she is eligible to make a scheme pays election.