Like most people, it is likely your pension is one of the most valuable assets you hold. Your pension may be crucial for providing yourself with a high quality of life when you stop working.

One of the important regulations you need to be aware of when it comes to your pension is the Annual Allowance.

Standing at £40,000 as of the 2022/23 tax year, the Annual Allowance is the maximum that can be contributed to your pension each tax year from all sources combined (employer included) without incurring an additional tax charge.

The Annual Allowance has been £40,000 since 2014 and, according to Money Marketing, the number of people exceeding the allowance has increased by 675% in the five years to the 2019/20 tax year.

If you are regularly contributing into your pension in order to save for your future, now is the time to understand how the Annual Allowance works, and how to reduce the risk of exceeding it.

Read on to find out all you need to know about the Annual Allowance, and how working with a financial planner can help.

The pension Annual Allowance allows you to have total pension funding from all sources of up to £40,000 without incurring an additional tax charge

When you make personal contributions to your pension, you can claim tax relief on this sum as long as your own total gross contributions in a tax year do not exceed your earnings (or £3,600 if more). The level of relief you can claim depends on the amount of your income. For example:

  • If you are a basic-rate taxpayer, you can claim 20% tax relief on pension contributions.
  • If you are a higher-rate taxpayer, you can claim 40% tax relief; 20% is automatically applied, and a further 20% can be claimed through self-assessment or via an adjustment to your tax code.
  • If you are an additional-rate taxpayer, you can claim 45% relief. 20% is automatically applied, and a further 25% can be claimed through self-assessment only.

The above assumes contributions are made to a scheme operating “relief at source”.

With “net pay” occupational schemes, full tax relief is given at outset with no need for any tax reclaim. And where salary sacrifice is used, full tax relief is also given at the outset.

In addition to the above limits on personal tax relief, the Annual Allowance limits tax-efficient funding from all sources, including contributions from your employer.

If you exceed the Annual Allowance then a tax charge, the “Annual Allowance charge”, is payable on the excess. In some cases, the tax charge can be paid out of your pension scheme using “scheme pays”.

Where you pay the Annual Allowance charge yourself, this can have the effect of cancelling out some or all the tax relief you received on your own contributions, but there is no direct link between personal tax relief and the Annual Allowance charge.

That is because personal tax relief is still claimed as normal, and any Annual Allowance charge is settled separately. It may be paid out of the scheme, leaving your tax relief unaffected.

Even if the excess funding relates to employer contributions, the Annual Allowance charge still falls on the member.

Paying an Annual Allowance charge does not affect employer eligibility to claim Corporation Tax relief on their contributions.

It is possible to carry forward and make contributions using any unused Annual Allowance from up to the three previous tax years.

So, if you have not maximised your pension contributions in recent years, you may be able to make up for lost time and claim additional tax relief in the process.

If you exceed the Annual Allowance, you pay tax on the excess

Exceeding the Annual Allowance, as more than 42,000 people did in the 2019/20 tax year, is not illegal.

However, any contributions in excess of the Annual Allowance will be subject to Income Tax which, as explained above, may have the overall effect of cancelling out some or all of your tax relief, even though tax relief is claimed as normal.

In fact, the additional amount will be added to your taxable income for that tax year and will be subject to Income Tax at your marginal rate. However, subject to conditions, some or all of the Annual Allowance charge can be paid out of your pension fund, in which case you still have the benefit of your personal tax relief.

In simple terms, exceeding the Annual Allowance can be detrimental to your wealth, as it could cause you to pay a higher tax bill than you need to.

3 ways to avoid exceeding the Annual Allowance

1. Plan your pension contributions ahead of time

If you have an idea of your prospective earnings for the remainder of this tax year, planning your pension contributions could be extremely helpful.

By fixing your monthly or quarterly pension contributions, you are less likely to exceed the Annual Allowance, and may escape an unnecessary tax charge in the process.

This can be especially useful if you are a business owner or are otherwise self-employed, as it can encourage you to contribute to your pension as regularly as employed workers.

2. Use alternative savings options for funds in excess of the Annual Allowance

Although pension contributions are constructive when saving towards your future, there are alternative options that might help if you want to remain within the Annual Allowance.

For example, rerouting additional funds into a Stocks and Shares ISA could be beneficial. While positive returns are never guaranteed in any investment, long-term non-pension investments can prove lucrative over time.

3. Work with your financial planner to ensure your pension contributions are on track

There are other considerations to keep in mind when it comes to pension saving, too.

The Annual Allowance is reduced for some people. High earners may be subject to the Tapered Annual Allowance, and those who have flexibly accessed a pension may be subject to the Money Purchase Annual Allowance (MPAA). In these cases, the Annual Allowance can be as little as £4,000.

There is also a separate limit on total accrued pension funds called the Lifetime Allowance (LTA) which, if exceeded, may result in a tax charge on the excess when you come to draw it.

So, whether or not you have exceeded the Annual Allowance before, working with a professional could be highly beneficial.

At DBL, we can help you ensure your pension contributions stay within the Annual Allowance, and assess the long-term viability of your retirement savings.

On the other hand, if you are struggling to make sufficient pension contributions this year due to the cost of living crisis, we can review your circumstances and help you prioritise your later-life income.

Get in touch

For guidance on pension contributions, later-life saving, or any other financial matter, get in touch today. Email or call 01625 529 499.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

Workplace pensions are regulated by The Pension Regulator.