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Pension contributions - all you need to know
This article looks at pension contributions, who can pay them, tax relief and if there are any restrictions.
Key facts
- Contributions made by an individual or the self-employed must be supported by relevant UK earnings; company or 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, self-employed, company, employer or a third party all count towards the annual allowance.
- The annual allowance is currently £60,000.
- From 6 April 2023 the annual allowance increased from £40,000 to £60,000 and the money purchase annual allowance and tapered annual allowance increased from £4,000 to £10,000.
How much can someone pay into a pension?
Individuals, including the self-employed, 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 they can pay each year and benefit fully from tax relief.
Tax relief on personal contributions is restricted to the higher of £3,600 or 100% of relevant UK earnings (opens in a new window).
Tax relief is only given in the tax year the contribution is paid.
Investment income, buy to let income and dividends don't count as relevant UK earnings (opens in a new window).
Income from pension products don't count as relevant UK earnings (opens in a new window).
There are three main methods for giving tax relief: relief at source, net pay arrangement and relief on making a claim.
Our articles Member contributions - tax relief and annual allowance (opens in a new window) and Member contributions and higher rate tax relief (opens in a new window) provide 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 (opens in a new window).
What is the annual allowance?
Total pension contributions are subject to the annual allowance. This is different to the limit on tax relief for personal contributions.
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, self-employed contributions, company/employer contributions and contributions for the individual paid by a third party, for example a grandparent. The annual allowance is currently £60,000.
What is the money purchase annual allowance?
Anyone taking income from a flexi-access drawdown plan or using an uncrystallised funds pension lump sum will trigger the money purchase annual allowance.
If the money purchase annual allowance has been triggered, an annual allowance charge will apply if pension contributions exceed £10,000 in a year.
What is the tapered annual allowance?
People with taxable income over £260,000 will have their annual allowance for that tax year restricted. This means that for every £2 of income they have over £260,000, their annual allowance is reduced by £1. Their reduced annual allowance is rounded down to the nearest whole pound.
If the tapered annual allowance has been triggered for an individual their annual allowance will be reduced, potentially as low as £10,000.
Personal, company, employer and third-party contributions all count towards the annual allowance, money purchase annual allowance and the tapered annual allowance.
The annual allowance that applies is based on the tax year (6 April to 5 April) the pension input period(s) ends. Since 8 July 2015 pension input periods have been in line with tax years.
What is carry forward?
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 money purchase annual allowance.
It is however possible to carry forward unused annual allowance 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.
How much can an employer or company pay into a pension?
Employer or company contributions are not restricted by the employee's relevant UK earnings, however they must satisfy the 'wholly and exclusively' (opens in a new window) requirement to receive tax relief.
Employers/companies pay contributions gross and corporation tax relief is granted by deducting the pension contribution as a business expense. We tell you more in our Employer contributions & tax relief article (opens in a new window).
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 (opens in a new window) over more than one year.
Employer and company contributions count towards the annual allowance, money purchase annual allowance and the tapered annual allowance.
Carry forward of unused annual allowance can also be used to cover employer/company contributions over the annual allowance.
Employer or company contributions over the annual allowance may also be subject to the annual allowance charge or money purchase/tapered annual allowance charge. The charge is payable by the individual; not the employer/company. The individual can also use carry forward here to avoid the annual allowance charge but not the money purchase annual allowance
There are a number of other considerations, 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/company; 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 personal contributions. So, tax relief is restricted to the higher of £3,600 or 100% of relevant UK earnings. It's the individual themselves who gets the tax relief; not the third party making the contribution.
If the contributions are for (grand)children 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, money purchase annual allowance 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.
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.