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Member contributions tax relief and annual allowance
An individual can pay as much as they like into a pension but unfortunately, there's a limit on the amount of tax relief that can be given.
Key facts
- Tax relief is based on tax years.
- Annual allowance is based on pension input periods. Pension input periods are aligned with tax years.
- Tax relief is limited to contributions up to the higher of £3,600 a tax year or 100% of relevant UK earnings.
- Annual allowance is £60,000 unless the money purchase annual allowance or tapered annual allowance apply.
- Individual contributions are unrestricted although a tax charge applies on contributions above the annual allowance, money purchase annual allowance or tapered annual allowance.
- Income from a pension is not relevant UK earnings.
- Investment income, property rental income and dividends don't count as relevant UK earnings.
- Three main methods in giving tax relief: relief at source, net pay arrangement, and relief on making a claim.
- Any contributions over the annual allowance, money purchase annual allowance or tapered annual allowance available may attract a tax charge.
How much tax relief is given?
Tax relief is calculated in tax years. In any tax year, tax relief on individual contributions, or contributions paid on the individual's behalf by anybody other than their employer is only given on gross contributions of up to £3,600 or 100% of relevant UK earnings, whichever is the higher.
Looking at two examples, an individual with no relevant UK earnings can get tax relief on a contribution of up to £3,600 while an individual with relevant UK earnings of £25,000 can receive tax relief on contributions up to £25,000.
What are relevant UK earnings?
In short this is:
- employment income
- self-employed income
- income from patent rights
- certain redundancy payments
- earnings from overseas crown employment
- royalties
- income from commercial furnished holiday lettings business
This means salary counts as relevant UK earnings. Investment income, buy to let income and dividends don't. This can have implications for controlling directors in deciding whether to make a pension contribution as an individual or an employer contribution.
Redundancy payments
Only part of a redundancy payment counts as relevant UK earnings. A redundancy payment can be made up of the actual redundancy payment and other payments such as salary, payment in lieu of notice or holiday pay. Any part of a lump sum redundancy payment that comes from salary, payment in lieu of notice or holiday pay does count as relevant UK earnings.
However, only the part of the actual redundancy payment over the tax-exempt threshold of £30,000 is classed as employment income and therefore count as relevant UK earnings.
Let's look at an example where an individual receives a lump sum payment on redundancy that's made up as follows:
- one month's salary - £2,500
- one month's salary in lieu of notice - £2,500
- holiday pay - £750
- redundancy payment - £31,250
- total - £37,000
The first three items all count as relevant UK earnings. In addition to that, £1,250 of the redundancy payment is also classed as relevant UK earnings.
How is tax relief given?
Let's look at the three main methods: relief at source, net pay arrangement and relief on making a claim.
Relief at Source
Type of pension scheme:
- Personal pension (including stakeholder).
How does the tax relief work?
- Pension contribution is made from individual's salary after deduction of income tax.
- When a pension contribution is received by the provider, basic rate tax relief is normally added to the contribution.
- The scheme administrator then reclaims the tax relief from HMRC.
What about higher and additional rate tax relief?
- Claimed through individual's self-assessment form or by writing to HMRC.
- Can go back 4 tax years to claim back any tax relief greater than basic rate.
Net pay arrangement
Type of pension scheme:
- Occupational pension scheme.
How does the tax relief work?
- The employer deducts contributions from the individual's salary before income tax is deducted.
- Must be used for all contributing members.
What about higher and additional rate tax relief?
- Given immediately.
For those individuals that earn below their personal allowance (standard personal allowance is £12,570 for 2024/25) and pay personal contributions to a scheme where tax relief is by the net pay method, historically, these individuals have not been able to get tax relief on their personal contributions. This has been rectified from 6 April 2024, as HMRC will now pay an amount equal to the basic rate of tax, based on the individual’s residency, to that individual. This will occur as soon as reasonably practicable after the tax year in which the contribution is paid.
Pensions relief relating to net pay arrangements
Relief on making a claim
Type of pension scheme:
- Retirement annuity contracts and some occupational pension schemes.
How does the tax relief work?
- Claimed through individual's self-assessment form.
- Used when not possible to use relief at source and net pay arrangement.
What about higher and additional rate tax relief?
- Claimed through individual's self-assessment form.
Further details of how higher rate tax relief is given can be found in Member contributions and higher rate tax relief.
HMRC Pensions Tax Manual - PTM044100: Contributions: tax relief for members
What is the annual allowance?
The annual allowance is the total amount of contributions that can be paid into all pensions for an individual before a tax charge applies. This allowance applies to all personal contributions, company/employer contributions and contributions for the individual paid by a third party, for example a grandparent.
It is the contributions paid during a period of time, called a pension input period, that are tested against the annual allowance. Pension input periods are aligned with tax years. More details of pension input periods can be found in Pension input periods and pension input amounts.
For pension input periods ending in the current tax year tax year the annual allowance is £60,000. There's a tax charge on any contributions paid over the annual allowance in each year. This is called the annual allowance charge and is calculated at the individual's marginal tax rate. Any potential tax charge is dealt with through the individual's self-assessment or by writing to HMRC.
To see if an annual allowance charge applies, the total amount of contributions paid or the increase in the value of the individual’s rights during the pension input period (where a defined benefit or cash balance scheme) in the pension input period needs to be calculated.
It may be possible to use carry forward to reduce or remove the annual allowance charge.
It's important to remember that the annual allowance and tax relief work separately from one another. This means it's possible for some contributions to receive tax relief but for an annual allowance tax charge to also apply. Let's take a look at how this works in the current tax year:
- Individual's relevant UK earnings - £80,000.
- They work and are taxed in England.
- Annual allowance - £60,000.
- Individual receives tax relief on gross contributions up to £80,000.
- Annual allowance charge on (£80,000 - £60,000) = £20,000.
- All of the excess contribution lies in the amount of taxable income taxed at 40%. So, the amount of the charge will be:
- £20,000 x 40% = £8,000
Although the tax bands and rates of income tax in Scotland are different from the rest of the UK the calculation is the same but applied to the different bands/rates.
Contributions that don’t receive tax relief still count towards the annual allowance apart from if the individual is age 75 or over, so care needs to be taken. For example, if an individual's is under age 75 and has UK relevant earnings of £70,000 and they make a gross personal contribution of £80,000 to their plan, they'll only receive tax relief on £70,000. They will face a tax charge of 40% on the amount above the annual allowance, which is £20,000 (assuming they have no carry forward to use).
If the money purchase annual allowance or tapered annual allowance applies the tax charge will be even higher.
In this situation, it would have been best to request a refund of excess contributions lump sum for the extra £10,000 contribution over their relevant UK earnings. It’s worth noting that some providers can’t accept personal contributions over an individual’s relevant UK earnings.
Some frequently asked questions
Q. Does this mean everyone can get tax relief on contributions up to £60,000?
A. No, to get tax relief the total gross personal contributions must be within the higher of 100% of relevant UK earnings in the tax year and £3,600 a year. What the annual allowance, money purchase annual allowance or tapered annual allowance does is place a limit on the amount of tax relief an individual can receive.
For defined contribution schemes, the pension input amount is simply the total of all gross contributions. If the pension input amount exceeds the annual allowance, money purchase annual allowance or tapered annual allowance, an annual allowance charge is payable on the excess via the member's self-assessment.
So, if Sally has UK earnings of £80,000 and tax relief is given by the relief at source method, she can pay a net contribution of up to £64,000. The provider will gross this up to £80,000 and claim the £16,000 basic rate tax relief from HMRC. Sally will then claim higher rate tax relief through her self-assessment but will also have to declare that her pension input amount is £20,000 over the annual allowance.
A tax charge equal to her marginal rate of tax will be levied, effectively removing all tax relief from the excess contributions. If the money purchase annual allowance or tapered annual allowance applied to her the tax charge would be levied on the difference between £80,000 and the lower annual allowance that applies.
Q. Can an individual make contributions more than their relevant earnings even though they don't receive tax relief?
A. Yes, but most pension providers (including Royal London) will not accept contributions that exceed an individual’s relevant earnings.
Q. How does this work with company or employer contributions?
A. If the contributions meet the 'wholly and exclusively' conditions the company/employer can claim corporate tax relief in respect of them. These contributions count towards the annual allowance, money purchase annual allowance or tapered annual allowance and if that results in contributions of over £60,000 being paid in respect of an individual an annual allowance charge will be payable by the individual unless they have unused annual allowance they can carry forward.
Q. Does the annual allowance operate over the tax year?
A. Yes, since 8 July 2015 the pension input periods have been aligned to the tax year for all plans.
Q. If an individual hasn't paid the maximum tax relievable contribution in previous tax years can they use carry forward to pay contributions higher than 100% of earnings in this tax year?
A. No, it's unused annual allowance that's being carried forward, not unused tax relief. If Sally in the example above had unused annual allowance of at least £20,000 to carry forward, she could avoid the annual allowance charge.
However, if she had paid less than 100% of her earnings in previous years, that unused tax relief couldn't be carried forward to justify tax relief on personal contributions of more than £80,000.
You cannot carry forward unused annual allowance to pay a contribution to a money purchase plan if the money purchase annual allowance applies.
Q. How much can a controlling director pay into a registered pension in a tax year?
A. Since 6 April 2006 contributions paid by and in respect of controlling directors are subject to the same limits and restrictions as anyone else.
Q. Can an individual pay into a pension if they’re over age 75?
A. Contributions can be made post age 75 (if the provider accepts them). Personal contributions are not relievable pension contributions and cannot qualify for tax relief. This means the 100% of relevant UK earnings limit is irrelevant and that personal contributions don’t count towards the annual allowance.
Q. When a customer turns 75, are tax relievable contributions based on relevant earnings for the full tax-year or only up until customer turns 75?
A. Pension contributions can be based on the relevant earnings for the full tax-year (not just on the earnings up to age 75).
Q. Can a compensation payment be paid into a pension?
A. Yes. But the compensation payment made into a pension plan is classed as a personal contribution. This means that it is subject to the usual tax relief limitations.
HMRC Pensions Tax Manual -PTM044100 - Contributions: tax relief for members: conditions (opens in a new window)
Q. Can a seafarer pay into a pension?
A. Yes. The Seafarer’s deduction means the individual’s earnings are subject to UK income tax but a deduction from the tax due can be made of up to 100%, depending on the length of time in the tax year that they’re away from the UK.
As the earnings are subject to UK income tax, they count as relevant UK earnings even although they don’t pay UK tax (or reduced UK tax). That allows the provider to claim basic rate tax relief from HMRC. No higher rate tax relief can be claimed by the individual as no higher rate tax is paid.
More general information about tax and seafarers can be found at: Seafarers Earnings Deduction: tax relief if you work on a ship (opens in a new window).
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.