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Annual allowance

Published  06 April 2024
   6 min read

An annual allowance for pension savings applies each year, which is based on a pension input period. This limits the amount of tax privileges available on pension savings each year.

Key facts

  • Annual allowance is based on pension input periods.
  • Pension input periods are aligned with tax years.
  • Annual allowance is currently £60,000.
  • Any contributions over the annual allowance available attract a tax charge.
  • A reduced annual allowance could apply if the money purchase annual allowance or tapered annual allowance has been triggered.

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 3rd party.

Within this allowance, tax relief on an individual’s gross contributions is restricted to the higher of £3,600 or 100% of relevant UK earnings; that is the earnings that attract tax relief (opens in a new window).

Individuals are subject to a tax charge on the amount of any contribution paid (personally, by their employer or a 3rd 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.

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.

The following details how these benefits are valued when testing against the annual allowance: 

Money purchase benefits

The total contributions paid in any pension input period.

This includes all individual, employer and third-party contributions.

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.

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 (opens in a new window)
HMRC Pensions Tax Manual - PTM058070: Transitional rules for tax year 2015/16 (opens in a new window)

Find more information on pension input periods and pension input amounts.

 

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's Pensions Tax Manual (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 refund 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

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 the contributions made 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.

HMRC has issued a guidance note: Money purchase annual allowance: split pension input periods which provides more detail (opens in a new window).

Tapered annual allowance

Since 6 April 2023 - Individuals who have taxable 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.

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.

Historic rates

Between 6 April 2020 and 5 April 2023 - Individuals who had taxable income greater than £240,000 had their annual allowance restricted. The maximum reduction was £36,000, so anyone with income of £312,000 or more had an annual allowance of £4,000. 

Between 6 April 2016 and 5 April 2020 - Individuals who had taxable income greater than £150,000 had their annual allowance restricted. The maximum reduction was £30,000, so anyone with income of £210,000 or more had an annual allowance of £10,000. 

Our article, tapering of annual allowance for high incomes, provides more detail.

Disclaimer

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.